U.S. taxpayers that own foreign financial assets (e.g., foreign stocks, securities or options to acquire such property) need to pay special attention to a NEW federal tax filing requirement. Foreign employers that issue equity or equity derivatives to U.S. taxpayers as compensation may also need to understand the new reporting requirements.
FATCA REPORTING: The Foreign Account Tax Compliance Act (“FATCA”), enacted as part of the Hiring Incentives to Restore Employment Act of 2010, requires individual U.S. taxpayers holding specified foreign financial assets in excess of certain aggregate thresholds to attach a Form 8938 to their federal income tax returns. Form 8938, Statement of Specified Foreign Financial Assets, is required for tax years starting after March 18, 2010 which for most people will require a filing for the first time with their 2011 tax returns filed in 2012.
Stock Options and Other Equity Derivatives are Subject to FATCA Reporting
Specified foreign financial assets include (1) any financial account maintained by a foreign financial institution and (2) stock, securities, a financial instrument or contract that is issued by a foreign person, and an interest in a foreign entity if any such interest or instrument is held for investment.1 The Temporary Treasury Regulations clarify that “held for investment” means the asset is not used in, or held for use in, the conduct of a trade or business.2 The Temporary Treasury Regulations further clarify that foreign partnership interests, swaps, and options or other derivative instruments (with respect to corporate or partnership equity) are specified foreign financial assets.3 Based on the Temporary Treasury Regulations, stock options and other equity derivatives are treated as specified foreign financial assets subject to FATCA reporting.
Who Needs to Report?
FATCA applies to specified persons.4 A specified person means an individual who is a: (1) U.S. citizen; (2) U.S. resident alien for any portion of the taxable year; (3) U.S. nonresident alien for whom an election under Internal Revenue Code Section 6013(g) or (h) is in effect; or (4) U.S. nonresident alien who is a bona fide resident of Puerto Rico or certain other U.S. possessions.5
Specified persons subject to FATCA need to determine whether the aggregate value of specified foreign financial assets held by such person (including, but not limited to, the foreign stock options and equity derivatives) exceeds the FATCA thresholds. The aggregate FATCA thresholds vary based on a U.S. taxpayer’s filing status but U.S. taxpayers that have more than $50,000 in specified foreign financial assets should be alerted to the potential filing requirement and should consult with their personal tax advisors.
A specified person that exceeds the FATCA thresholds must prepare and file a Form 8938 with his or her federal income tax return. If the U.S. individual taxpayer files his or her federal income tax form on extension then the Form 8938 may also be filed on extension. Failure to file Form 8938 can result in substantial penalties.
Filing Form 8938 does not relieve a U.S. taxpayer from the obligation to file a “Report of Foreign Bank and Financial Accounts” – commonly known as “FBAR” – if an FBAR is required for the applicable year. Generally, an FBAR must be filed with the U.S. Treasury Department by all U.S. persons having a financial interest in, or signature or other authority over, a bank, securities or other financial account in a foreign country if the aggregate value exceeds $10,000 at any time during the calendar year. FBARs are not included with the annual federal income tax return; rather, the FBAR is filed on Form TD F 90-22.1 and must be received by the U.S. Treasury Department by June 30th of the following year. It is important to note that foreign stock and foreign stock options alone are not sufficient to generate an FBAR filing obligation (i.e., such assets are not considered financial accounts for the FBAR rules). Rather, an FBAR filing obligation may arise if the equity holder owns more than 50% of the stock or partnership interests of the entity. In such case, the owner of more than 50% of the equity would be attributed all foreign accounts maintained by such entity.
Foreign Employer Considerations
When a U.S. employee receives and holds foreign stock or options that were granted by a foreign employer as compensation, it is the U.S. employee’s responsibility to satisfy the FATCA reporting rules discussed above. However, this does not imply that a foreign employer will not be impacted by FATCA’s new reporting requirements. FATCA requires that the foreign stock and equity derivatives held by an employee be valued for purposes of determining whether the FATCA thresholds are breached and again for purposes of reporting the maximum value of such assets. Guidance issued to date has been silent on how to value compensatory equity.
For companies whose stock is publicly traded, the value is likely to be the maximum value of the foreign stock during the prior calendar year, based on readily available information of the stock’s maximum value during such tax year. However, there is no guidance on how to value stock options or non-vested equity awards. Due to this lack of authority, it is likely that U.S. employees will turn to the foreign employer for instruction about how and when to report the equity compensation issued to the U.S. employee. Due to the impending federal income tax filing deadline (April 17, 2012), employers may wish to advise U.S. employees of the FATCA reporting requirements and discuss the benefits of such U.S. employees filing an extension for U.S. federal income tax reporting purposes in order to obtain an additional six months to examine and consider the FATCA reporting rules.
- Temp. Treas. Reg. Section 1.6038D-3T(b). An asset is not a specified foreign financial asset if the rules of Section 475(a) apply to the asset or an election under Section 475(e) or (f) is made with respect to the asset. These are generally the mark-to-market election rules.
- Temp. Treas. Reg. Section 1.6038D-3T(b)(3).
- Temp. Treas. Reg. Section 1.6038D-3T(d).
- Temp. Treas. Reg. Section 1.6038D-2T.
- Temp. Treas. Reg. Section 1.6038D-1T(a)(2).
- The current Form 8938 instructions provide that, until future regulations are issued, Form 8938 only needs to be filed by U.S. individuals. It is anticipated that certain domestic entities will also be required to file Form 8938 in future tax years.