When Must a Treaty Tie-Breaker Alien File an IRS International Reporting Form?

By Thomas S. Bissell, CPA

Celebration, FL

Many U.S. international tax practitioners were taken aback when
the instructions to new IRS Form 8938 (Foreign Financial Assets
Reporting Form) stated that the form must be filed by a so-called
treaty tie-breaker client, i.e., an alien who is a resident alien
under the Code but considered a resident of a foreign country under
the "tie-breaker" rules of a U.S. income tax treaty.1 The Treasury
regulations provide that a treaty tie-breaker alien is classified
as a nonresident alien (NRA) for all purposes of the Code in
computing his U.S. income tax liability.  Thus, it seemed
anomalous for the IRS to request information about foreign assets
from someone whose foreign income would generally not be subject to
U.S. tax, and about U.S. assets from someone whose U.S. income
would generally be subject to withholding under the rules of

What is so unusual about this requirement is that there are a
number of other IRS international reporting forms that may also be
required to be filed by treaty tie-breaker aliens, yet none of the
instructions to those forms mentions them. The issue is crucial
because most of those forms, like the Form 8938, can result in
extremely severe civil penalties for non-filing. Because of the IRS
silence on this issue in recent decades, it must be assumed that
many tax return preparers do not advise their treaty tie-breaker
alien clients to file those forms, thus potentially exposing their
clients to those penalties.

Treaty tie-breaker aliens typically fall within one of two
categories.3 The first
category consists of so-called green card holders (permanent
residents under the U.S. immigration laws), who are resident aliens
under §7701(b)(1)(A)(i) no matter where they reside, and who are
classified under treaty tie-breaker rules as income tax residents
of a treaty country, usually because they live there.4 The second
category consists of non-immigrant aliens working temporarily in
the United States, who are resident aliens under the "substantial
presence" test of §7701(b)(1)(A)(ii), and who are classified under
treaty tie-breaker rules as income tax residents of a treaty
country, usually because they retain a home there and their
immediate family members remain there. In both situations,5 the Treasury
regulations provide that the alien is classified as an NRA for all
purposes of the Code in computing his own U.S. income tax
liability.6 However, the
regulations also provide that the tie-breaker alien will still be
classified as a resident alien in determining the U.S. income tax
liability of other persons - for example, in
determining whether a foreign corporation should be classified as a
controlled foreign corporation (CFC) under §957.

The §7701(b) regulations provide further that a treaty
tie-breaker alien must file Form 1040NR and attach Form 8833 in
order to disclose her treaty tie-breaker status to the IRS. 
Unfortunately, the regulations are silent on whether any of the
international reporting forms that apply to U.S. citizens and
resident aliens must also be filed, although there is a confusing
discussion of CFCs that could be interpreted to mean that Form 5471
must be filed if the alien individually controls a majority of the
stock in a foreign corporation.7

When the U.S. Treasury in 1987 first proposed the rule that
treaty tie-breaker aliens should be classified as NRAs in
calculating their U.S. income tax liability, this author argued
that this rule was an incorrect interpretation of both §7701(b) and
of the relevant tax treaties, and that the correct way for a
tie-breaker alien to file was as a resident alien on Form 1040, but
with an exclusion for income that was exempt from U.S. tax under
the treaty.8 The principal
argument in favor of this "hybrid" rule was that the "all NRA" rule
resulted in an improper windfall to the taxpayer in many
situations, and in an improper increase in U.S. taxes in many
others. The Treasury no doubt considered adopting a "hybrid" method
that would more properly have reflected the language of §7701(b)
and of the treaties, but eventually concluded that the "all NRA"
method would be much easier for the IRS to administer.9 Accordingly, the
"all NRA" method has been in effect for more than a quarter

Of course, if the "hybrid" method had been adopted, there would
have been no doubt that a treaty tie-breaker alien was required to
file the relevant IRS international reporting forms, whenever
applicable to the taxpayer's situation. However, the Treasury's
"all NRA" rule, together with the silence on this issue in both the
§7701(b) regulations and in the instructions to the relevant forms,
have left this issue effectively in limbo since the §7701(b)
regulations became final in 1992. The instructions to the new Form
8938 dealing with treaty tie-breaker aliens, however, suggest that
treaty tie-breaker aliens (and their tax return preparers) should
probably attach to their Form 1040NR all international reporting
forms that they would have filed if they had filed Form 1040
without electing NRA status under the treaty.

The following are the principal international forms about which
a treaty tie-breaker alien should be concerned, and the potential
civil penalties that could be imposed for non-filing:

FinCEN Form 114 - This form (formerly Form TD F
90-22.1) requires that certain foreign financial assets be reported
by a U.S. citizen or "resident" if the value of those assets
exceeds a prescribed dollar amount at any time during the year. The
penalty for non-filing can be as much as 50% of the value of the
assets that should have been reported for each year. The
instructions to the form say that an alien is a "resident" for FBAR
purposes if classified as a resident alien under §7701(b).10 The
Preamble to the 2011 FBAR regulations does provide that "a legal
permanent resident who elects under a tax treaty to be treated as a
non-resident for tax purposes must still file the FBAR,"11 but that
language has not been incorporated into the regulations themselves
or into the instructions on the FinCEN website, and in addition it
does not mention treaty tie-breaker aliens who are non-immigrants
(the "second category" described above).

Form 5471 - This form may have to be filed by a
resident alien to report information about a foreign corporation
(including a CFC) in which the alien may own stock (or may have
disposed of stock), or of which she may be an officer or
director.12 The potential
penalty can go as high as $50,000.

Form 8865 - This form may have to be filed by a
resident alien who is or was a partner in a foreign
partnership.13 The
potential penalty can go as high as $50,000.

Forms 3520 and 3520-A - These forms are required
to be filed in a number of situations involving foreign trusts
(including transfers or distributions between a U.S. person and a
foreign trust, or where the foreign trust is a grantor trust under
§§671 - 679), or where the resident alien receives gifts from
abroad.14 Depending on
the facts, on a worst-case basis the penalty can be as high as 100%
of the amount required to be reported.

Form 926 - This form must be filed in certain
situations where a resident alien transfers property to a foreign
corporation in certain nonrecognition transactions.15 However, there
appear to be no specific civil penalties for non-filing.

Form 8621 - For many years this form has been
required to be filed by a resident alien to report income from a
passive foreign investment company (PFIC), and/or to make certain
elections with respect to the individual's investment in a PFIC.
However, starting with the 2013 taxable year, a resident alien
whose stock in a PFIC is worth more than $25,000 must annually
report information about his PFIC stock, even if he realizes no
income from the PFIC and makes no PFIC elections.16 Nevertheless,
the Code apparently does not impose a specific civil penalty for
non-filing of Form 8621, nor does there appear to be a specific
civil penalty now that the filing requirement has been

Form 8938 Itself - Although the instructions to
Form 8938 make clear that a treaty tie-breaker alien may be
required to file this form, it must be filed only if the total
dollar amount of the alien's "specified foreign financial assets"
exceeds a threshold amount. If the form must be filed, however, the
potential penalty for non-filing can be $10,000, increasing to as
much as $50,000 in certain circumstances.17

Because at least four of the above IRS forms apart from Form
8938, i.e., Forms 5471, 8865, 3520, and 3520-A, can result in
significant civil penalties for non-filing, the IRS is urged to
clarify whether or not a treaty tie-breaker alien must file these
forms in the appropriate circumstances. The IRS is also urged to
clarify the instructions to the FinCEN Form 114 (which also can
result in severe civil penalties). To the extent that the filing of
any or all of these forms by treaty tie-breaker aliens is required,
those individuals (and their tax return preparers) should be
offered the same clarity that has now been included in the Form
8938 instructions, without having to rely on the extremely
ambiguous language of the §7701(b) regulations and of the FBAR

This commentary also will appear in the May 2014 issue of
 Tax Management International Journal.  For
more information, in the Tax Management Portfolios, see Bissell,
907 T.M.
, U.S. Income Taxation of Nonresident Alien
Individuals, Williamson, 943 T.M., U.S. Income Tax
Treaties - Provisions Relating Only to Individuals, Blum,
Canale, Hester, and O'Connor, 947 T.M.
, Reporting Requirements
Under the code for International Transactions, and in Tax
Practice Series, see ¶7160, U.S. Income Tax Treaties, ¶7170, U.S.
International Withholding and Reporting Requirments..


  1 The Preamble to the regulations under §6038D (the
statutory provision governing Form 8938) states, "For section 6038D
purposes, a specified individual is a U.S. citizen, a resident
alien of the United States (as determined under section 7701(b) and
§§301.7701(b)-1 through 301.7701(b)-9 of this chapter), or a
nonresident alien who has elected under section 6013(g) or (h) to
be taxed as a U.S. resident. A resident alien who elects to be
taxed as a resident of a foreign country pursuant to a U.S. income
tax treaty's residency tie-breaker rules is a specified individual
for purposes of section 6038D and the regulations.
" (Emphasis
added.) T.D. 9567, issued on Feb. 21, 2012. The regulations
themselves do not contain this language, however. The instructions
to Form 8938 state, "If you qualify as a resident alien under
either [the green card test or the substantial presence test], you
are a specified individual [and thus potentially required to file
Form 8938] even if you elect to be taxed as a resident of a foreign
country under the provisions of a U.S. income tax treaty."

  2 "Specified foreign financial assets" (SFFAs) that
are to be reported on Form 8938 include foreign financial assets
(primarily foreign stocks and bonds) that are owned directly or
through a foreign brokerage account, as well as U.S. securities
that are held through a foreign brokerage account.  However,
income from foreign assets would almost always be exempt from U.S.
income tax when realized by a NRA, and income from U.S. securities
would be subject to the §1441 withholding procedures, which are
being substantially strengthened by the new FATCA rules. See
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).

  3 See Bissell, 907 T.M. (Bloomberg BNA Tax &
Accounting), U.S. Income Taxation of Nonresident Alien
 at V.C.

  4 Most U.S. attorneys who specialize in immigration
law advise a green card holder who files his U.S. tax return as a
treaty tie-breaker NRA that he could be at risk of losing his green
card. Regs. §301.7701-7(b) specifically warns of this risk.
Nevertheless, it is believed that numerous green card holders
living abroad do file Form 1040NR as treaty tie-breaker NRAs,
especially if doing so significantly reduces their U.S. income tax

  5 See Article 4(3) of the U.S. Treasury's 2006
Model Income Tax Treaty, which has formed the basis for the
definition of the term "residence" in most income tax treaties.

  6 Regs. §301.7701-7(a)(1).

  7 Regs. §301.7701-7(c)(2).

  8 See Bissell, "The Treasury's Proposed Regulations
on Nonresident Alien Status," 17 Tax Mgmt. Int'l
 287-288 (7/8/88).

  9 An important additional consideration was no
doubt that because treaty tie-breaker status is entirely elective
on the part of the taxpayer, a taxpayer who prefers to file Form
1040 as a resident alien without claiming any treaty benefits is
free to do so.

  10 See
at page 49. It should be noted that the definition of the term
"resident" in the statute requiring Form 114 to be filed by a
resident appears to be much broader than the definition in
§7701(b). See the discussion of this issue - which has been
rendered moot by the current FBAR regulations - in Bissell, "The
2004 Act: Impact on Foreign Private Clients," 34 Tax Mgmt.
Int'l J.
 177 (3/11/05), at 185-187.

  11 Seehttp://www.gpo.gov/fdsys/pkg/FR-2011-02-24/pdf/2011-4048.pdf
at pages 10238 and 10245 (31 CFR §1010.350(b)(2), which defines
"resident of the United States" as "an individual who is a resident
alien under 26 U.S.C. §7701(b) and the regulations thereunder
" (Emphasis added.)

  12 For a detailed discussion of Form 5471, see
Blum, Young, Canale, Hester and O'Connor, 947 T.M. (Bloomberg BNA
Tax & Accounting), Reporting Requirements Under the Code
for International Transactions,
 at III.

  13 See 947 T.M., at VI.

  14 See Zaritsky, 911 T.M. (Bloomberg BNA Tax &
Accounting), U.S. Taxation of Foreign Estates, Trusts and
, at VII.

  15 See 947 T.M., at IV.

  16 See Blanchard, "New PFIC Reporting
Rules Under §1298(f)", 43 Tax Mgmt. Int'l J. 166

  17 See 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).  It should be noted
that Part IV of Form 8938 provides that if assets are separately
reported by the taxpayer on Form 3520, 8621, 3520-A, 8865, 5471, or
8891 (relating to Canadian "RRSP" self-directed pension plans),
those assets are not required to be reported on Form 8938, although
in determining whether the taxpayer's SFFAs exceed the relevant
dollar threshold, the value of assets reported on those forms would
definitely have to be counted. Because most taxpayers who file both
Form 8938 and any of those other forms would be U.S. citizens and
resident aliens other than treaty tie-breaker aliens, no conclusion
can be drawn from this special rule concerning whether the IRS
believes that a treaty tie-breaker alien might be required to file
any or all of those other forms in the appropriate