Certain domestic entities and trusts may be required to file Form 8938
As the September 15 deadline draws ever closer and taxpayers and return preparers alike begin to ramp up filing efforts again, it’s important to remain cognizant of changes in reporting requirements that may have occurred for the tax year. One such notable change relates to Form 8938, Statement of Specified Foreign Financial Assets.
New for tax years beginning in 2016, certain entities called “specified domestic entities”—corporations, partnerships, and trusts “formed or availed of” for the purpose of directly or indirectly holding certian foreign financial assets—may now be required to file Form 8938. Along with a change from past reporting requirements, this update to Form 8938 brings along with it additional complexity, particularly in the area of determining whether a corporation, partnership, or trust is a “specified domestic entity” (SDE).
For the purposes of Form 8938, a corporation or partnership will be considered an SDE if it meets the following requirements. First, the entity must be closely held by a specified individual—a U.S. citizen, U.S. resident alien, or nonresident alien electing to be subject to U.S. tax—and second, the entity must be used to generate passive income.
When assessing the first requirement, a corporation or partnership will be considered closely held if a specified individual, directly, indirectly or constructively, owns 80 percent or more of the combine voting power or value of the corporation, or 80 percent or more of the capital and profits interest of the partnership. It is important to note that the generally applicable constructive stock ownership rules are taken into account when making this determination.
For the purposes of the passive activity test, a corporation or partnership will be considered to be used to generate passive income if at least 50 percent of the gross income is passive, or at least 50 percent of the corporation’s or partnership’s assets are held for the production of passive income. It is key to note that both the passive income and passive asset sides of the passive activity test are subject to the entity aggregation rule.
Turning to trusts, a U.S. trust will be considered an SDE if it has one or more specified individuals or specified domestic entities as a current beneficiary. Generally any person who, during the year, was entitled to or may receive a distribution of principal or income from the trust will be considered a current beneficiary. However, any holder of a general power of appointment that was exercisable during the year—irrespective of whether that power was exercised during the year—is also considered a current beneficiary.
It is important to note that these rules generally do not apply to U.S. trusts that are regulated banks or financial institutions with supervisory authority or fiduciary obligations over trust investments, and that, unlike corporations and partnerships, the passive income and asset rules do not apply to trusts.
Given the complexity associated with this new reporting requirement, taxpayers, especially those with closely held investment entities or domestic non-grantor trusts, should make sure to carefully assess whether these reporting changes could result in a new Form 8938 filing requirement moving forward.