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By Thomas S. Bissell, CPA
Treasury and the IRS issued final regulations in December 2014 defining the term "specified foreign financial asset" (SFFA) for purposes of the annual report on Form 8938 that many U.S. citizens and resident aliens have been required to file since 2012.1 The new rules provide some limited relief for restricted stock plans where foreign stock (or other property) that is subject to a substantial risk of forfeiture under §83 is transferred to an employee at the beginning of the vesting period2, but unfortunately the income tax laws of many foreign countries make it unlikely that this exception will be widely available in practice. At the same time, the final regulations provide no exceptions for any cash-only foreign deferred compensation plans (whether the employee's rights are vested or unvested), nor do they provide any exceptions for traditional stock option plans (again, whether the employee's rights are vested or unvested).3
To aid in analyzing how the final regulations apply to various types of plans, the following summary is provided of the most typical kinds of deferred compensation plans and equity-based compensation plans that exist in an international context.
Cash-only deferred compensation plans not related to the employer's stock performance. These kinds of deferred compensation plans typically fall into one of three categories: (1) employee compensation that is voluntarily postponed by the employee until a later year; (2) an incentive bonus that will be paid only if the employee continues working for the employer up to the end of a vesting period; and (3) unfunded "supplemental employee retirement plans" that are accrued on the employer's books as a "top-up" plan to the employer's regular pension plan for all employees. All three types of plans are typically subject to the employer's creditors, and all are to be distinguished from the employer's regular tax-qualified pension plan(s). All three plans are common in the United States, but because many foreign countries impose income tax (as well as both employer and employee social security tax) immediately on the employee under the first type of plan,4 only the second and third types of plans are common in most foreign countries (provided, of course, that income tax deferral on the employee is allowed under the foreign country's tax laws).
Section 83-type restricted stock plans. Under this type of plan, employer stock (colloquially referred to as "restricted stock") is transferred to the employee, provided that the employee continues to work for the employer until the end of a prescribed vesting period. If the employee is subject to U.S. income tax, he is not taxed until the end of the vesting period unless he makes an "up front" election under §83(b). A variation of this plan is that the stock is not transferred to the employee until the end of the vesting period.5 Because so many foreign countries impose income tax on the employee if the stock is transferred to him "up front" but defer tax if the stock is not transferred until the end of the vesting period, it is unusual for stock in a non-U.S. employer to be transferred to an employee at the beginning of the vesting period if the employee is working for the employer outside the United States.
Traditional stock option plans. Under this type of plan, an employee is entitled to purchase employer stock from the employer at a pre-determined price, usually starting at the end of a "waiting period" (vesting period) and lasting until a subsequent fixed date. If the employee is a U.S. taxpayer, the "spread" on the stock on the "exercise date" (i.e., the excess of the stock's market value over the price paid by the employee on the exercise date) is usually taxed to him, but if the employee is taxable under foreign law, the applicable tax rules vary widely.
Cash-only equity based compensation (EBC) plans. Some employers maintain plans that are similar to restricted stock plans and stock option plans, but where only cash is transferred to the employee instead of employer stock. For example, at the end of the vesting period, the employee may be given cash equal to the value of a certain number of the employer's shares. Under a "phantom stock" plan, the employee may be paid cash equal to the amount of the "spread" that he would realize if he had purchased actual employer stock at a bargain price. Because there can be adverse U.S. accounting consequences to these types of cash-only plans, however, it is more common for U.S. companies to ensure that their EBC plans involve the transfer of actual stock.
A cash-only deferred compensation plan – whether or not it is equity-based – is typically maintained by the employer that directly employs the employee. Thus, if the employee is working outside the United States for a U.S. company's foreign subsidiary, the plan will typically be maintained by the subsidiary and not by the U.S. parent company. In contrast, a non-cash EBC plan (i.e., a restricted stock plan or a stock option plan) will typically be maintained by the parent company whose stock is involved. If the employee works for a subsidiary of the parent company, however, the parent company will usually "charge over" its cost to the subsidiary company for corporate income tax deduction purposes – i.e., the value of the stock under a restricted stock plan, or the value of the "spread" in the case of a stock option plan.
What both the prior and the final regulations apparently provide is that if a cash-only deferred compensation plan or cash-only EBC plan is involved, the employee's rights in the plan are an SFFA if the company maintaining the plan is foreign, but not if it is a U.S. company. In the case of a stock-only plan, the plan is an SFFA if the underlying stock is in a foreign company, but not if it is in a U.S. company. This is true even where the company is a foreign parent and where the company charges its cost (i.e., the value of the stock or of the "spread") over to a U.S. subsidiary, because the employee works entirely within the United States as an employee only of the U.S. subsidiary.
Applying this matrix, a variety of fact patterns can arise. In the case of a cash-only non-EBC or EBC plan, the reporting individual may be: (1) a U.S. citizen or green card holder working in a foreign country directly for a foreign company that may have no U.S. subsidiaries, or which may be a foreign subsidiary of a U.S. parent; or (2) the individual may be someone who was previously working abroad for the foreign company that maintains the plan and who was classified as a nonresident alien for U.S. tax purposes, but who subsequently moved to the United States and became a resident alien while continuing to have rights in the foreign plan. In the case of a non-cash EBC plan, the reporting individual may fall within one of these two categories, or he may be within a third category: a U.S. citizen or resident alien who has always worked entirely within the United States for the U.S. subsidiary of the foreign parent that maintains the plan.6
Under both the prior regulations and the final regulations, an interest in any of the plans just described is an SFFA. As noted above, however, the final regulations provide that where restricted stock in a foreign company is transferred up-front to the employee, the stock is not an SFFA until the restriction has lapsed (i.e., until the end of the vesting period).7 This relaxation of the prior rule can benefit employees who work entirely within the United States (usually for a U.S. subsidiary of the foreign company), but it is unlikely to apply to many U.S. citizens or resident aliens working abroad (or to nonresident aliens who move to the United States and become resident aliens during the vesting period), because the foreign income tax laws of so many foreign countries usually make it necessary for the employer to postpone transfer of the stock until the end of the vesting period.
It should be noted that the new rule in the final regulations could possibly be interpreted so as to provide a reporting exemption not only for restricted stock that is transferred up-front, but also for stock that might be transferred to the employee if he continues to work for the employer until the end of the vesting period. Because the final regulations are so ambiguous on this point, however, a more conservative approach (particularly in view of the harsh penalties for not fully complying with the Form 8938 requirements) is to assume that the new exception only applies to stock that is in fact transferred up-front.
What is so astonishing about the final regulations is that there are no exceptions for cash-only deferred compensation plans (whether EBC or non-EBC plans), even where the employee's rights are unvested. For example, if a foreign company has promised to pay deferred compensation in cash to an employee who is a U.S. person (or who becomes a U.S. person during the vesting period), the employee's rights in the plan are a reportable SFFA at all times even though the employee may not continue working until the end of the vesting period and thus forfeits his right to receive any of the cash.
It should be noted that the final regulations continue to provide (as did the prior regulations) that if the employee's rights in the plan are difficult to value, then he may give his rights in the plan a value equal to his distributions from the plan for the year, or a zero value if he received no distributions for the year.8 However, the regulations also provide that if the IRS determines that the employee's rights could have been valued, the IRS may assign an arbitrarily high value to those rights. Because it should not be difficult to calculate a "ballpark" value for an employee's rights in most of the plans discussed above, it would be prudent for most employees to give their rights in any such plans a conservatively high value for Form 8938 reporting purposes.
Although it seems likely that an employee's rights in a foreign non-cash EBC plan fall within the definition of the term "SFFA" in the statute itself (§6038D(b)(2)), this author continues to question whether an interest in a cash-only EBC or non-EBC plan of a foreign employer is properly classified as an SFFA under the statute.9 Neither the final regulations nor the prior regulations explain why these interests are classified as an SFFA, but only discuss how to value an employee's rights in a deferred compensation plan. Although the IRS may well be on shaky ground in this area, it seems unlikely that this rule will ever be challenged in court.
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Although the Preamble to the final regulations discusses why most changes proposed by the public were rejected, the final regulations do make one important change that was recommended by this author10, among many commentators. The final regulations provide that an individual who is classified as a resident alien under §7701(b) but as a nonresident alien by reason of the "tie-breaker" provisions in an income tax treaty and Reg. 301.7701(b)-7 is exempt from filing Form 8938 because of his nonresident alien status.11 Now that the IRS has made this clarification, it is to be hoped that it will consider providing similar clarification for a number of other international reporting forms, including Forms 5471, 8865, 3520, 3520-A, 926, and 8621, as well as the "FBAR" FinCEN Form 114.
This commentary also will appear in the February 2015 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, U.S. International Withholding and Reporting Requirements.
1See T.D. 9706, 79 Fed. Reg. 73,817 (Dec. 12, 2014), pursuant to §6038D, enacted by §511(a) of the Hiring Incentives to Restore Employment (HIRE) Act, Pub. L. No. 111-147. The previous temporary and proposed regulations were published in T.D. 9567 and REG-130302-10. For those individuals whose SFFAs exceed certain U.S. dollar thresholds, the requirement to file Form 8938 became effective for the first time with the 2011 taxable year. See the discussion in Bissell, More Concrete Guidance Needed for the New Foreign Financial Assets Reporting Form (Form 8938), 41 Tax Mgmt. Int'l J. 135 (March 9, 2012).
2 It is assumed in this commentary that the term "restricted stock" refers to stock that is transferred at some point in time to an employee in return for services, but that the employee cannot become the unrestricted owner of the stock or will not be paid the cash equivalent unless he provides "substantial services" to the employer within the meaning of §83(c)(1) – typically, continued employment as a full-time employee — throughout a "vesting period" that starts when the employee is promised his rights, and ends when the employee has finished rendering the required services. If the employee renders the required services up to the end of the vesting period, he becomes the unrestricted owner of the stock (whether it is transferred to him at the beginning or at the end of the vesting period), or of a cash equivalent. It should be noted, however, that many U.S. tax advisors consider "restricted stock" to include only stock that is transferred to an employee at the beginning of the vesting period; where stock is transferred to an employee only at the end of the vesting period, those advisors refer to the plan as a "restricted stock unit" (RSU) plan.
3 For a critique of the requirement in the temporary and proposed regulations that deferred compensation plans be reported on Form 8938, see Bissell, Form 8938 and the Requirement to Report Foreign Deferred Compensation Plans and Foreign Pension Plans, 41 Tax Mgmt. Int'l J. 193 (April 13, 2012), and Bissell, Further Comments on Form 8938: How to Report Deferred Compensation, 41 Tax Mgmt. Int'l J. 511 (Sept. 14, 2012).
4 Since 2004 the first type of plan has been subject to the requirements of §409A under U.S. law, but such plans are still widely used in the United States.
5See n. 2, above.
6 Where the employee is a U.S. citizen or resident alien who has always worked entirely within the United States and who participates in a cash-only EBC or non-EBC plan, the plan would typically be maintained entirely by his U.S. employer. Thus, his rights in the plan would not be an SFFA.
7 See Reg. §1.6038D-2(b)(2). If a §83(b) election is made by the employee to report the value of the stock "up front," then this exception does not apply and the foreign stock is an SFFA.
8 Reg. §1.6038D-5(f)(3).
9See Bissell, in 41 Tax Mgmt. Int'l J. at 193, cited in n. 3, above.
10See Bissell, When Must a Treaty Tie-Breaker Alien File an International Reporting Form?, 43 Tax Mgmt. Int'l J. 283 (May 9, 2014).
11See Reg. §1.6038D-2(e). The regulations contain special rules for individuals who are treated as treaty tie-breaker nonresident aliens for only part of the year.
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