IRS Finalizes Rules on Reporting Foreign Financial Assets

For over 50 years, Bloomberg BNA’s renowned flagship daily news service, Daily Tax Report® has helped leading practitioners and policymakers stay on the cutting edge of taxation and...

Feb. 22 — The IRS issued final rules simplifying the process for determining which domestic corporations or partnerships must report specified foreign financial assets on Form 8938.

The rules (T.D. 9752, RIN 1545-BM54), issued under tax code Section 6038D, eliminate a proposed “principal purpose” test.

Joseph Calianno, partner and international technical tax practice leader for BDO USA LLP, told Bloomberg BNA that by removing language referring to “a principal purpose” the final regulations make it easier for taxpayers to determine if they are required to file.

“I think that's a good development,” Calianno said. “From a practical standpoint, whenever you have one of these types of tests, it is very fact-intensive. It does create a lot of subjectivity, so by taking this test out it makes it more objective.”

Section 6038D was enacted under the 2010 Hiring Incentives to Restore Employment Act, which included requirements for taxpayers to report foreign assets. Under proposed and temporary rules issued in 2011, taxpayers were required to submit Form 8938 (Statement of Specified Foreign Financial Assets) starting with tax year 2011, in addition to filing the FBAR (Report of Foreign Bank and Financial Accounts).

In December 2014, the Internal Revenue Service finalized the regulations under 6038D, but didn't adopt proposed Treasury Regulations Section 6038D-6, which dealt with the criteria for specified domestic entities. Without a final rule under Treas. Reg. Section 6038D-6, the requirement to file Form 8938 applied only to individuals (241 DTR GG-1, 12/15/11).

Multi-Prong Test

The proposed regulations (REG-130302-10) called for a multi-prong test for determining whether a corporation or partnership is a “specified domestic entity”—defined as one that is “formed or availed of” for the purposes of holding, directly or indirectly, specified foreign financial assets.

One of the prongs, as proposed, provided that the entity would be required to file if:

• at least 50 percent of its gross income or assets was passive, or
• at least 10 percent of its income or assets was passive and the entity was formed or availed of by a specified individual with a principal purpose of avoiding Section 6038D.

The final regulations eliminate the second element of that prong—the principal purpose test, Calianno said—thus providing more certainty for taxpayers.

Candace Ewell, a principal with PricewaterhouseCoopers LLP, agreed that the elimination of the principal purpose test eliminates a subjective element and makes the process easier for taxpayers.

“It is always difficult when we have these reporting obligations that read in these subjective items,” she said. “When it's an objective test, it is very clear who is on the hook or who is off. In this case, an entity that is at least 80 percent owned by an individual and that has greater than 50 percent passive assets and greater than 50 percent passive income is the kind of domestic entity that needs to report.”

In the final regulations, the IRS states that the 50 percent passive-assets or income-threshold test is sufficient for determining which entities must file. However, the IRS said, it will continue to monitor whether entities are using the rules to avoid reporting. If so, the agency may expand the definition of a specified domestic entity.

The final regulations, which are effective Feb. 23 when they are published in the Federal Register, also specify ways to determine whether 50 percent of the assets are passive: “Corporations or partnerships may use either fair market value or book value” to determine the asset value, and they may be required to substantiate their determinations.

The final rules apply to taxable years beginning after Dec. 31, 2015.

To contact the reporter on this story: Dolores W. Gregory in Washington at dgregory@bna.com
To contact the editor responsible for this story: Molly Moses at mmoses@bna.com