The Foreign Account Tax Compliance Act (FATCA) requires certain U.S. taxpayers holding foreign financial assets, including an interest under a foreign pension or deferred compensation plan and foreign equity awards, to report those interests beginning with this tax filing season (the 2011 Form 1040). FATCA, enacted in 2010 as part of the Hiring Incentives to Restore Employment Act, is aimed at U.S. persons holding investments in offshore accounts and imposes steep penalties for failure to comply. Although it is the employee’s responsibility to meet any reporting requirements, employers with a multinational and mobile workforce should understand the possible filing obligations and may wish to consider alerting individuals of this new filing requirement. Note that FATCA reporting requirements are separate from FBAR reporting of foreign financial accounts described in a prior newsletter.
Individuals with a Reporting Obligation under FATCA
U.S. taxpayers holding certain foreign financial assets with an aggregate value exceeding $50,000 are generally required to report certain information about those assets on new Form 8938 (Statement of Specified Foreign Financial Assets) that must be attached to the taxpayer’s annual Form 1040 tax return. Reporting applies for assets held in taxable years beginning after March 18, 2010 (generally starting with the 2011 tax return). Higher asset thresholds apply to U.S. taxpayers who file a joint tax return or who reside abroad. U.S. citizens, resident aliens and nonresident aliens holding an interest in certain foreign assets may be required to file Form 8938. An individual who is not required to file a U.S. income tax return for a year is not required to file a Form 8938 for that year.
Employee Benefits Required to be Reported as Foreign Financial Assets on Form 8938
Guidance and instructions issued by the Internal Revenue Service (IRS) list several types of “specified foreign financial assets” that should be reported on Form 8938, including interests in a foreign pension or deferred compensation plan generally exceeding an aggregate value of $50,000. Limited relief from the reporting requirement may apply, including where an account has been reported on a Form 8891 (U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans) and for an interest in foreign governmental retirement schemes, such as social insurance. Additionally, no reporting under FATCA is required for a financial account that is maintained by a U.S. payer, including a retirement account at a U.S. branch of a foreign financial institution or a foreign branch of a U.S. financial institution. However, in most cases, a U.S. taxpayer's interest in a foreign pension plan must be reported on Form 8938, even if the individual is no longer actively accruing benefits under the plan. Pension industry groups are lobbying for additional relief from this requirement, but with filings due next month, employers need to address this issue now.
For example, consider an executive of a multinational company who performed services in the United Kingdom and participated in the company’s UK pension plan for several years. In 2010 the individual transfers to the United States and became a U.S. taxpayer. This individual will most likely need to report the UK pension plan interest on Form 8938, even if the individual has no way to value the pension plan interest to determine whether it exceeds the applicable filing thresholds.
Also included in the list of specified foreign financial assets are compensatory stock options and equity awards. This means U.S. taxpayers who have equity awards of foreign stock must report these interests on Form 8938.
Determining whether a particular type of interest must be reported requires a case-by-case analysis. Issues to consider include whether to report non-vested interests in an employee benefit program, the determination of whether the investments, assets or stock are held in a U.S. or foreign account and whether the amounts meet reporting thresholds. In determining the value of a foreign pension or deferred compensation plan for purposes of compiling Form 8938, the IRS instructs that the value of such interest is the fair market value in the plan on the last day of the year. If the fair market value is not readily accessible to the individual, the value can be reported as the value of cash and/or other property distributed during the year. The same value is to be used in determining whether a reporting threshold has been triggered. If an individual does not have access to the fair market value and did not receive a distribution from the plan during the year, the value of the interest in the plan is zero for reporting purposes. If an individual meets the reporting requirements, a Form 8938 must be filed, even if the value of the foreign financial asset cannot be determined.
Penalties for Non-Compliance
Taxpayers who fail to meet their obligation to file Form 8938 are subject to significant penalties, including $10,000 for failure to file, with a maximum penalty of up to $50,000 for continued failure to file and a 40 percent penalty on the understatement of any tax attributed to non-disclosed assets.
Employers should examine whether any U.S. employees of the company or other U.S. taxpayers participate in any of the company’s foreign pension plans or deferred compensation plans, or have received foreign equity awards. Because it may be difficult for the company to determine which employees have a filing obligation under FATCA, it may be advisable to provide a general notice to all participants in the company’s foreign plans to alert them of the possible filing requirements and applicable penalties, and to encourage them to contact their personal tax adviser to determine whether they have a filing obligation. McDermott Will & Emery has developed a model notice to participants in the event you wish to take this approach. For more information, contact your regular McDermott laywer or an author.