IRS issues final regulations on domestic entity foreign asset reporting
TAX ALERT |
On Feb. 23, 2016, the Treasury and IRS issued final regulations that will affect the reporting requirements of many domestic entities with specified foreign assets. The regulations modify and finalize the 2011 proposed regulations issued under section 6038D(f) that set forth the conditions under which a domestic entity is considered a ‘specified domestic entity’ and, therefore, required to report its specified foreign financial assets. With the issuance of these regulations, specified domestic entities must file Form 8938, Statement of Specified Foreign Financial Assets, a form previously only required for specified individuals. The regulations also generally clarify and streamline the applicable tests for determining whether a reporting requirement exists and modify the definition of passive income to coordinate with the final regulations issued under FATCA.
The regulations are generally effective for taxpayers with taxable years beginning after Dec. 31, 2015. Failure to timely file Form 8938 may result in a $10,000 penalty.
Elimination of principal purpose test
Under the regulations, a domestic entity that is ‘formed or availed of’ for the purpose of holding specific foreign financial assets must file Form 8938. The final regulations remove the principal purpose test for determining whether a domestic entity satisfies the formed or availed of test. Under the proposed regulations, an entity met this test if either (1) at least 50 percent of the entity’s gross income or assets are passive; or (2) at least 10 percent of the entity’s gross income or assets are passive and the entity was formed with a principal purpose of avoiding section 6038D. The IRS determined that the 50 percent test is sufficient to identify entities that may have been designed to circumvent the reporting requirements of section 6038D. Therefore, the principal purpose test was eliminated. Furthermore, the IRS decided that a single objective requirement is preferential to the subjective principal purpose test. Treasury and the IRS noted that they will continue to monitor for inappropriate activity and may expand the definition of a specified domestic entity in future guidance.
Definition of passive income
Since the issuance of the proposed regulations, comprehensive regulations under section 1472 (FATCA) were enacted that provided a similar, although not identical, definition of passive income. Because FATCA and section 6038D were both enacted as part of the HIRE Act, and both serve to identify entities that have a high risk of being used for tax evasion, the final regulations largely adopt the modifications to the term passive income that were included in the FATCA regulations. Additionally, the proposed regulations had failed to specify how an entity was to determine whether 50 percent of its assets were passive for purposes of the specified domestic entity test. The final regulations, therefore, adopt the weighted average test used for active non-financial foreign entities in the regulations under section 1472. Corporations and partnerships may use either fair market value or book value to determine asset values.
Simplified aggregation rules
Under the proposed regulations a group of entities that are closely held by the same specified individual were treated as a single entity and all assets and items of income of that group were aggregated and treated as owned by each member of the group. The Treasury and IRS determined that it was not necessary to treat the group as a single entity and to attribute the assets and income of the group to each entity. The final regulations simplify the aggregation rules by retaining the attribution of assets and income but not treating the group as a single entity.