Form 8938 and the Requirement to Report Foreign Deferred Compensation and Foreign Pension Plans

By Thomas St.G. Bissell  

Celebration, FL

International tax professionals were stunned in late 2011 when the IRS announced that foreign deferred compensation and foreign pension plans would have to be reported on the new Form 8938 (Statement of Specified Foreign Financial Assets), along with the foreign investment assets that the 2010 Foreign Account Tax Compliance Act (FATCA) legislation was aimed at. The announcement came in the form of draft instructions to Form 8938, released for the first time in September 2011,1 and later confirmed in the final instructions released in November 20112 and in the temporary regulations issued in December 2011.3 The news touched off a flurry of activity among tax professionals to determine what kinds of foreign plans would have to be reported, and how to value an individual's rights in those plans for purposes of Form 8938 reporting.

Although it will obviously be critical for many taxpayers to determine the precise boundaries of the new rule and also how to value their participation rights, this commentary will discuss more basic issues - specifically, the propriety of requiring these plans to be reported at all under the language of the statute itself, and under the applicable legislative history. A subsequent commentary will discuss the details of these new rules as they have been enunciated by the IRS to date, and as they will be further clarified in the coming months.

As noted in this author's previous commentary on the subject,4 §6038D was enacted as part of Congress's response to a highly publicized series of events in which several foreign financial institutions assisted U.S. owners of securities to reduce or avoid U.S. federal income tax on income from those securities by holding them in offshore custodial accounts. Congress chose to deal with this problem from two directions - first, by imposing a potential new 30% U.S. withholding tax on income from U.S. securities (including gross proceeds from the sale of those securities) held by a "foreign financial institution" for the benefit of either U.S. or foreign customers,5 and second, by imposing under §6038D an annual information reporting requirement (backed up by severe penalties) on certain U.S. individuals who own either U.S. or foreign securities through a foreign brokerage account or similar foreign custodial account.6

The new §6038D reporting rules took effect for most U.S. individuals starting with the 2011 taxable year. A U.S. individual (generally, a U.S. citizen or a §7701(b) "resident alien") must file Form 8938 as an attachment to his 2011 federal income tax return (Form 1040) if he owns an interest in one or more "specified foreign financial assets" (SFFAs) the total value of which exceeds a threshold amount on the last day of the year or a threshold amount at any time during the year. An unmarried U.S. individual living in the United States must file Form 8938 if the value of his SFFAs is more than $50,000 on the last day of the year or more than $75,000 at any time during the year, but higher thresholds apply for other categories of individuals (based on marital status, and whether the individual lives in the United States or abroad). Severe penalties can be imposed for failure to file the form (or for failure to file an accurate form), in addition to an extension of the statute of limitations for the IRS to audit the return and impose income taxes.7

Numerous categories of U.S. individuals who would not otherwise be required to file Form 8938 - probably numbering in the tens of thousands - will likely be affected by the new requirements to report foreign deferred compensation and foreign pension rights. U.S. individuals working abroad for foreign employers (whether foreign subsidiaries of U.S. companies, or foreign-controlled foreign companies) may be required to report deferred compensation (both vested and unvested) that has been promised by their foreign employers or set aside in a separate account, and to the extent that they have accrued pension rights under foreign law or participate in foreign-based stock option or similar plans, they may also be required to report those items.8 U.S. individuals working in the United States - primarily resident aliens who have been transferred from abroad to work in the United States - may also be required to report their participation in foreign deferred compensation plans (usually with respect to services rendered before they moved to the United States) and in foreign-based stock option or similar plans, as well as accrued rights under foreign pension plans that are maintained by the foreign employers that sent them to the United States. Because of the broad scope of the new Form 8938 reporting requirements for all of these categories of individuals, therefore, it is appropriate to examine the statutory basis for these requirements.

Section 6038D(b) in effect divides SFFAs into two categories: (1) all assets held in a foreign "financial account" within the meaning of §6038D(b)(1); and (2) assets that are not held in either a U.S. or foreign financial account but which have some kind of foreign nexus as defined in §6038D(b)(2).  The three categories enumerated in §6038D(b)(2) are: (A) "any stock or security issued by" a non-U.S. person; (B) "any financial instrument or contract held for investment that has an issuer or counterparty" that is a non-U.S. person; and (C) "any interest in a foreign entity" within the meaning of §1473.  Thus, if a U.S. individual's rights in a foreign deferred compensation plan or foreign pension plan must be reported on Form 8938, they must fall within one or more of these three categories.9

The IRS's temporary regulations apparently do not treat deferred compensation or pension rights as a "stock or security" or as a "financial instrument or contract held for investment" within the meaning of §6038D(b)(2)(A) or (B). Instead, they apparently treat these rights as an "interest in a foreign entity" within the meaning of §6038D(b)(2)(C), because they are discussed in a paragraph with the heading "Interests in estates, pension plans, and deferred compensation plans."10 What is curious is that this particular paragraph in the regulations deals only with valuation issues, and the terms "deferred compensation" and "foreign pension plans" are not mentioned in a "laundry list" of SFFAs that is set forth elsewhere in the regulations.11 Even if deferred compensation and pension rights are considered to be "interests in a foreign entity" within the meaning of §6038D(b)(2)(C), however, the regulations elsewhere provide that an "interest in a foreign entity" is only classified as an SFFA if it is "held for investment;"12 this additional requirement is not included in the statute, but since it is a requirement of the regulations, as a threshold matter it might be questioned whether deferred compensation, or even an individual's pension rights, are being "held for investment."13

If it is correct that the IRS does classify both deferred compensation and pension rights as "interests in a foreign entity" (ignoring for the moment the additional rule in the regulations that the item must be "held for investment"), the question arises whether this classification is proper. Section 6038D(b)(2)(C) incorporates the definition of the term "foreign entity" that is in §1473(5), which provides that "the term `foreign entity' means any entity which is not a United States person." Although the term "United States person" is defined in detail in §7701(a)(30),14 §7701(a) does not define the term "entity." None of the FATCA regulations is helpful on this score, because the §6038D regulations simply refer to the §1473(5) regulations, which merely repeat the language of §1473(5) itself.15 Thus, while a foreign deferred compensation plan and a foreign pension plan would probably never be classified as "United States persons," it must still be determined whether they are "entities." Because the term "entity" is not defined generally for federal tax purposes in §7701(a), the regulations under both §§6038D(b)(2)(C) and 1473(5) have apparently left the interpretation of this term to "common sense."

If one takes a common sense approach, a very tentative interpretation of the term "entity" might be any "thing" that has a juridical (i.e., legal) status of its own under either U.S. or foreign law. In this regard, the term "person" as defined in §7701(a)(1) may offer some guidance. Thus, §7701(a)(1) provides that "the term `person' shall be construed to mean and include an individual, a trust, estate, partnership, association, company or corporation," although a common sense approach would clearly not treat an "individual" as an "entity," and the term "entity" would probably include certain other juridical persons not enumerated in §7701(a)(1), such as foreign governments. Applying this general rule, a foreign pension plan would probably be classified as an "entity" if it is maintained in the form of a trust (as is the case in most common law jurisdictions) or in the form of a foundation or corporation that is separate from the employer that created it (as is the case in many civil law jurisdictions). However, a foreign pension plan that is maintained as a "book accrual" plan on the books of the employer itself (as is the case in certain foreign countries)16 would usually not be classified as an entity separate from the employer, although it might possibly be argued in that case that the employee has an "interest" in the employer itself within the meaning of §6038D(b)(2)(C).  As noted above, however, the IRS regulations apparently treat all kinds of foreign pension plans (presumably including book accrual plans) as "entities" in themselves, and not as integral parts of the employers that maintain them - although none of this is made clear in the regulations.

In the case of deferred compensation plans - whether "classic" salary deferral plans, unfunded "top-up" pension plans, or any kind of equity-based compensation plan (classic stock option plans, plans with stock appreciation rights, or restricted-stock-unit plans)17 - it would be extremely unusual for the plan itself to be classified as a legal "entity" separate from the employer under either U.S. or foreign law. However, it is possible that the IRS could publish a clarification of its regulations at some time in the near future and explain that where an individual participates in a foreign deferred compensation plan, the "foreign entity" in which he has an "interest" is actually his foreign employer, and not the plan itself. If the IRS did so, however, there would seem to be two objections to this interpretation. First, the regulations provide that an asset which is held for use in a "trade or business" is exempt from reporting,18 and a forceful argument can be made that a contract right to be paid deferred compensation is part of the individual's trade or business as an employee of the employer.19 Second, if an employee's contract rights to receive deferred compensation from his employer constitute "an interest in a foreign entity," the regulations should include all other types of contract rights that an employee has against his employer - for example, claims for reimbursement of business expenses under a non-accountable plan; claims for reimbursement of medical expenses under a self-insured employer medical plan; claims for past-due salary that has not yet been paid because of the employer's financial difficulties; or claims for a bonus that has been declared but not yet paid (possibly for the same reason).20 There is no apparent justification for singling out deferred compensation rights.

If it is correct that the IRS regulations are on extremely shaky ground with respect to foreign deferred compensation plans (though possibly not with respect to most foreign pension plans), the legislative history of §6038D does not help the IRS's position.  The Joint Committee Report on §6038D essentially parrots the statutory language, and there is no indication whatsoever that contract rights of an employee of any kind (whether for deferred compensation, for pensions, or for other items) should be classified as SFFAs.  In this regard, it is useful to compare the new "anti-expatriation" rules of §877A, which were enacted in 2008 and which contain detailed provisions on "deferred compensation."21 Neither §6038D nor its legislative history contains any mention of any type of deferred compensation.  From the standpoint of tax policy, moreover, it must be questioned whether Form 8938 reporting should be required for those items of foreign deferred compensation that will eventually be reported to the IRS on Form W-2.22

Nevertheless, because mounting a legal challenge against the IRS regulations could be extremely expensive and time-consuming for any individual, it is questionable whether an effective court challenge will ever take place - especially because the comparative cost of simply complying with the regulations is so much less.23 Even if such a challenge did occur, Congress might well amend §6038D (at the request of the IRS) to clarify that deferred compensation rights are required to be reported.

* * * * *

The author's previous commentary on Form 893824 took the IRS to task for not giving more complete guidance on the Form 8938 requirements to individuals who hold securities in either a U.S. or a foreign brokerage account.  On February 29, 2012, the IRS issued a set of "Frequently Asked Questions" (FAQs) that effectively adopts the recommendations that were included in that commentary.

See,,id=255061,00.html.  In addition to the instructions to Form 8938, these FAQs should be consulted by any individual who may potentially be required to complete Form 8938. Hopefully, the IRS will make an effort to publicize these FAQs as widely as possible.

This commentary also will appear in the April 2012 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Blum, Canale, Hester, and O'Connor, 947 T.M., Reporting Requirements Under the Code for International Transactions,  and in Tax Practice Series, see ¶7170, International Withholding and Reporting Requirements.

 1 Draft instructions for Form 8938, dated September 28, 2011, at page 5 ("Valuing interests in estates, pension plans, and deferred compensation plans"). 

 2 Instructions for Form 8938, dated Nov. 2011, at page 5 ("Interests in foreign pension plans and foreign deferred compensation plans"), and at page 6 ("Valuing interests in foreign estates, foreign pension plans, and foreign deferred compensation plans"). 

 3 Regs. §1.6038D-5T(f)(3), T.D. 9567, 76 Fed. Reg. 78553 (12/19/11). 

 4 Bissell, "More Concrete Guidance Needed for the New Foreign Financial Assets Reporting Form (Form 8938)," 41 Tax Mgmt. Int'l J. 135 (3/9/12). 

 5 §§1471-1474, enacted by §501(a) of the HIRE Act (P.L. 111-147). For a detailed discussion of these rules, see Tello, 915 T.M. (Bloomberg BNA Tax & Accounting), Payments Directed Outside the United States - Withholding and Reporting Provisions Under Chapters 3 and 4, XXIX. 

 6 These new rules were intended to reduce the possibility that U.S. individuals could reduce or avoid paying the correct amount of federal income tax on their securities in the future. With respect to U.S. individuals who had neglected to report the correct amount of income from their U.S. and/or foreign securities in the past, the IRS initiated an "offshore voluntary disclosure initiative" (OVDI) to encourage U.S. taxpayers with unreported income to voluntarily apply to the IRS so as to potentially reduce the penalties that otherwise applied to their situation. The IRS's third OVDI program was announced on Jan. 9, 2012. See IR-2012-5. 

 7 §§6229(c), 6501(c)(8), and 6501(e)(1), as amended by §513 of the HIRE Act. 

 8 U.S. individuals who work abroad for foreign subsidiaries of U.S. companies typically do not participate in foreign pension plans, and if they participate in stock option plans or restricted stock plans, those plans are typically maintained directly by the U.S. parent company and not by the foreign subsidiary. However, U.S. individuals working abroad for foreign-controlled foreign companies often participate in both foreign pension plans and in foreign stock option plans. 

 9 It is assumed that, except in extremely unusual situations, these rights would not be held by a U.S. individual through a foreign "financial account" within the meaning of §6038D(b)(1). 

 10 Regs. §1.6038D-5T(f)(3).  Curiously, the regulations do not include any guidance on what constitutes a "deferred compensation plan" or a "foreign pension plan." However, the IRS presumably intends to incorporate the definitions in §§409A and 877A, under which there is extremely detailed IRS guidance. 

 11 Regs. §1.6038D-3T(d). It is possible that the portion of the regulations on what constitutes an "interest in an SFFA" for purposes of §6038D(a) is intended to "bootstrap" foreign deferred compensation plans and foreign pension plans into SFFA status. See Regs. §1.6038D-2T(b), which provides that an individual has an "interest" in an SFFA (as required by §6038D(a)) if the SFFA has some kind of income tax consequences to the individual currently, or is likely to have some kind of income tax consequences for him in the future.  Nevertheless, Regs. §1.6038D-2T(b) still requires that the asset in which the individual has an interest be an SFFA.


Note that in applying both §6038D(a) and §6038D(b)(2)(C) (as must be done in order for foreign deferred compensation plans and foreign pension plans to be reportable), the terminology of the Code can become quite confusing, because it must be shown that the individual has an "interest" in an "interest in a foreign entity" - in other words, that he has an income interest in a particular kind of property interest.  

 12 Regs. §1.6038D-3T(b)(1)(iii). 

 13 Regs. §1.6038D-3T(b)(3) provides that an asset is deemed to be "held for investment" if it is "not used in, or held for use in, the conduct of a trade or business." Thus, if it is assumed that deferred compensation rights or pension rights are not trade-or-business assets of an employee, this definition would classify them as being "held for investment", regardless of whether they might be considered to be held for investment in a colloquial sense. 

 14 Section 7701(a)(30) in effect classifies the following persons as "United States persons": a U.S. citizen, a resident individual, a domestic partnership, a domestic corporation, a domestic estate, and a domestic trust. 

 15 Regs. §1.6038D-1T(a)(10) quite correctly states that "the term foreign entity has the meaning set forth in section 1473(5) and the regulations." However, the §1473 regulations - which were published on Feb. 8, 2012 (subsequent to the 12/14/11 publication of the §6038D temporary regulations) - merely repeat the statutory language of §1473(5) without further clarification. Thus, Prop. Regs. §1.1473-1(e) provides, "The term foreign entity means any entity that is not a U.S. person and includes a territory entity." The mention of a "territory entity" is not relevant for the discussion in this commentary. 

 16 See the rules on "qualified [foreign] reserve plans" in §404A(c), and the regulations thereunder. 

 17 If an individual received restricted stock in a foreign company that was subject to a risk of forfeiture, the stock itself would have to be reported on Form 8938, subject to the applicable dollar threshold. 

 18 Regs. §1.6038D-3T(b)(4). 

 19 The IRS might contend that it has carved out a de facto exception to the exemption for trade-or-business assets by the mere fact that the regulations require foreign deferred compensation plans to be reported, but one could respond that any such exception should have been explicitly provided for in the -3T(b)(4) regulations. 

 20 At the same time, it would seem appropriate to exclude those contract rights from reporting as "trade or business" rights arising out of the employee's trade or business of being an employee. 

 21 See §877A(d), dealing with the "treatment of deferred compensation items," and Notice 2009-85, 2009-45 I.R.B. 598. See also Bissell, "An `Exit Tax' Enters the U.S. Tax Lexicon - §877A and Guidance Under Notice 2009-85," 51 Tax Mgmt. Memo.123 (4/12/10). 

 22 Form W-2 reporting is usually required to be done by the employer in the various fact patterns described at the beginning of this commentary, and it is understood that even foreign-controlled foreign corporations comply with this requirement much more commonly than was true in the past. Because the Form 8938 instructions and temporary regulations provide for a number of reporting exceptions for SFFAs that are reported on other IRS reporting forms, it would seem appropriate to also include an exemption for foreign deferred compensation that will eventually be reported on Form W-2. 

 23 Any challenge to the regulations would be likely to occur in the case of an individual who failed to report deferred compensation and who then challenged the resulting penalty in court. No consideration has been made in writing this commentary to the possibility that some kind of class action might challenge the regulations. 

 24 Bissell, "More Concrete Guidance Needed for the New Foreign Financial Assets Reporting Form (Form 8938)," 41 Tax Mgmt. Int'l J. 135 (3/9/12).