Avoid a Trap for the Unwary by Reporting Your Foreign Assets and Income

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When you receive your completed 2014 federal and state income tax returns for the October 15th extension deadline, you may have the urge to simply sign the e-file forms and send them back to your preparer for filing.  After all, reviewing your tax return isn’t exactly fun, and the attached schedules and forms may not be that easy to follow.  However, it is a good idea to review your entire tax return to make certain that all of the reported information is complete and accurate.  While you have trusted a professional to prepare complete and accurate returns with the tax information you have provided, it is ultimately your responsibility to make certain that the returns are correct, and that all required forms and information have been submitted with your Form 1040.  For example, the failure to report your foreign assets and income can be a costly trap for the unwary.

As you review your federal return, take a look at the bottom of the page for your Schedule B (reporting interest and dividend income). Part III of Schedule B asks a series of questions related to “Foreign Accounts and Trusts.”  Did you have a financial interest in or signatory authority over a financial account, such as a bank account, securities account, or brokerage account located in a foreign country during the prior tax year?  Unless you do own a foreign bank account and specifically advised your tax preparer the same, he or she may overlook these important questions. 

If you did have an interest in foreign financial assets having an aggregate value over $10,000 during a prior tax year, you were likely required to file the FinCen Report 114a, Report of Foreign Bank and Financial Accounts, more commonly referred to as an “FBAR.”  The FBAR is an informational return that provides the name and address of the foreign financial institution, the names and personal information of the account owners, account numbers, and maximum fair market value for each account.  For tax years before 2016, taxpayers must file the FBAR using the Bank Secrecy Act (BSA) e-filing website before the June 30th due date the following year.  Recent legislation has changed the due date for filing future FBARs so that it coincides with the due dates for income tax returns.  For tax years 2016 and thereafter, FBARs will be due the following April 15th, but taxpayers will also be able to request an automatic six-month extension to file their FBAR. 

Some taxpayers mistakenly believe (or have been ill advised) that foreign source income is not reportable or subject to tax in the U.S., especially if that income has already been reported and taxed in a foreign jurisdiction.  However, U.S. taxpayers must report and pay income tax on worldwide income, regardless of whether the same income was reported and taxed in another jurisdiction.  If foreign source income was taxed in another country, the U.S. tax laws may provide a credit for the foreign tax paid.  This credit is subject to certain limitations, but generally avoids the double taxation of foreign income to the extent that the foreign tax paid does not exceed the U.S. income tax on the same income.  Even if you do not own a foreign account, your U.S. brokerage account may hold a stock or a mutual fund that paid foreign taxes on dividend income, thereby entitling you to the foreign tax credit. You should find the foreign tax credit on line 48 of your 2014 Form 1040, and its calculation may be shown on an attached Form 1116, entitled the “Foreign Tax Credit.” 

Depending on your filing status, residency, and your gross income for the tax year, you may also be required to file the Form 8938, “Statement of Foreign Financial Assets.”  This form requests information concerning the type of foreign financial assets you own, the highest value of each such asset during the tax year, and the total income earned from the asset.  It is therefore imperative to keep all statements for your foreign accounts during the tax year, so that you can determine the highest value of each account during the tax year.  The foreign dividend and interest income reported on your Form 8938 should reconcile with the items reported on Schedule B of your Form 1040.

If you are a beneficiary who received distributions during the tax year from a foreign trust, you may also be required to file the Form 3520, “Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts.”  A trust is a “foreign trust” if it does not meet one of the following two criteria:  (1) a court within the United States is able to exercise primary supervision over the administration of the trust; or (2) one or more U.S. persons have the authority to control all substantial decisions of the trust.  For example, if your non-U.S. citizen parent is the sole Trustees of a trust in which you have received a distribution, you may very well be the beneficiary of a foreign trust and subject to additional filing requirements.  Further, if you are the recipient of assets exceeding $100,000 from a foreign individual or a foreign estate, you must disclose this information on the Form 3520.

Failure to file any of these forms can subject you as a taxpayer to harsh tax penalties. Even if the income from these assets were previously reported, taxpayers are required to file the additional informational tax returns, such as the FBAR, Form 8938, or Form 3520.  You may have heard about taxpayers who previously held accounts in known tax havens, such as Lichtenstein and Switzerland, now being required to pay millions in tax penalties and being subject to criminal investigation.  Over the past several years, various countries have entered into agreements with the United States, disclosing lists of U.S. clients holding accounts in brokerage firms within their borders, some foreign firms going so far as to advise their U.S. account owners that they may no longer hold their assets there.  Since 2009, the I.R.S. has collected over seven billion dollars through its Offshore Voluntary Disclosure Program (OVDP). 

Realizing that many honest taxpayers may have unwittingly failed to disclose information concerning their foreign source assets and income over the past several tax years, the I.R.S has developed a “streamlined” disclosure program for individuals to report their foreign assets and income with less onerous penalties.  One common situation involves a U.S. resident whose non-U.S. parent has established a foreign bank account and added the child’s name as joint owner for convenience purposes.  The child’s signatory authority over that foreign bank account causes an FBAR filing requirement, regardless of whether the child has accessed any of the funds within said account.  Unfortunately many situations still arise involving taxpayers relying upon the ill advice of a tax professional who was not aware of the various filing requirements.  Whatever the case, if you believe that you may have missed a required reporting of your foreign assets and/or income, please contact us immediately to explore the various steps that may be taken to become compliant.   

The Estate Planning Blues

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Who would you have manage your financial affairs if you were unable to do so yourself?

It’s a story that’s becoming more and more common as the elderly population continues to grow. A parent’s physical and mental health begins to fail, and the children begin to wonder whether that parent’s financial affairs are being properly managed.

In early May, Blues legend B.B. King posted on his website that he had entered into hospice care at his Las Vegas residence. He thanked all of his fans for their well wishes and prayers.

Less than a week later, three of Mr. King’s eleven surviving children went before a Hearing Master at the Clark County Family Court in Las Vegas arguing that Mr. King’s longtime manager, Laverne Toney, was mismanaging their father’s finances and claiming that they were unable to account for more than $1 million of their father’s assets.  In response, Mr. King’s children filed an action with the Court seeking the formal appointment of a fiduciary to gain control over Mr. King’s financial affairs.

After the hearing, the Hearing Master concluded that no evidence was shown indicating that Mr. King’s affairs were not being properly administered, and that he “[did]n’t have anything here that says (King) lacks capacity. He has some serious health issues. But he has counsel. If he feels he is being taken advantage of, he has remedies.” Based upon the comments from the Hearing Master from Cook County, Nevada, the need for the formal appointment of a Court appointed fiduciary to manage Mr. King’s financial affairs was not necessary. 

Similar cases have arisen numerous times within the Massachusetts Probate Courts, in which a child attempts to gain control over a parent’s finances. The Uniform Probate Code sets forth the standards for determining when it is appropriate for the Court to appoint a conservator to step in and take over one’s financial affairs. The statute’s goal is to make certain that one’s ability to manage his or her own finances is not relinquished until absolutely necessary. Specifically, the Court will appoint a conservator if and when the individual has a “clinically diagnosed impairment that renders him unable to receive or evaluate information or make or communicate decisions that would make him unable to manage his property and business affairs.”

Massachusetts law also allows an individual to appoint an “attorney-in-fact” to act on one’s behalf by executing a document most commonly referred to as a “Durable Power of Attorney.” Depending upon the type of durable power of attorney you sign, your named agent or agents may “step into your shoes” and act on your behalf immediately. Such authority may also be delayed until, if and when, you are deemed to lack capacity (called a “springing power of attorney”).  Whatever type of durable power of attorney you choose to implement as part of your estate plan, it is important to execute before losing capacity. Doing so may save you both time and legal expense.

If you became incapacitated, whom would you appoint to manage your financial affairs? This may be a difficult question for you, but is definitely worth contemplating and answering. You may have complicated and particular business dealings that you feel would be better managed by a trusted professional who has worked closely with you over the years. Alternatively, you may have a family member or friend whom you feel is well suited for the task. Depending upon the situation, you may choose to appoint multiple agents who may act independently, or who must act unanimously. Whomever you choose, it is important to have discussions with your prospective agent or agents, as well as your loved ones, to make certain that no one questions the authority and trust you have given to those you have named to manage your financial affairs.

After the May 7th hearing, Mr. King’s daughter Karen Williams declared, “We lost the battle, but we haven’t lost the war.” On May 15, Mr. King died at 89 years old, but it’s apparent that the legal battle concerning the management of his financial affairs may wage on. What’s most unfortunate is that the emotional and financial costs incurred in this matter may have been avoided through better estate planning and/or communication.