Form 8938

Form 8938 is a comprehensive U.S. tax reporting requirement that was created under the Foreign Account Tax Compliance Act (FATCA FATCA The Foreign Account Tax Compliance Act (FATCA) is U.S. legislation requiring foreign financial institutions, including offshore hedge funds, to report information about financial accounts held by U.S. taxpayers or foreign entities in which U.S. taxpayers hold substantial ownership, with non-compliance resulting in significant withholding penalties. ). The requirement was added by Section 511 of the HIRE ActFederal legislation that includes the Foreign Account Tax Compliance Act (FATCA) provisions requiring reporting on foreign accounts and investments. ("HIRE Act"). Under Section 6038D of the Internal Revenue Code, any U.S. person who owns a "specified foreign financial asset" must file IRS Form 8938 along with their annual tax return if certain conditions are met.

The form helps the IRS track foreign investments by U.S. taxpayers. This reporting requirement aims to reduce tax evasion through undisclosed foreign accounts and investments.

Section 6038D(b) of the Internal Revenue Code defines "specified foreign financial assets" quite broadly. The definition includes financial accounts held at foreign financial institutionsFinancial entities located outside the United States that accept deposits, hold financial assets for others, or engage in investing and trading activities., as well as certain other foreign assets not held in such accounts.

The definition covers two main categories. First, it includes financial accounts maintained with foreign financial institutions. A "financial account" means a depository or custodial account, or any ownership interest in a financial institution, as defined in Section 1471(d)(2) of the Internal Revenue Code.

Second, it covers assets not held in financial institution accounts. This category includes foreign securities, financial instruments or contracts held for investment with foreign issuers or counterparties, and ownership interests in foreign entities.

For Form 8938 purposes, a "financial institution" is defined as an entity that accepts deposits as part of its regular banking or similar business, holds financial assets for others as a substantial part of its business, or primarily engages in investing or trading securities, commodities, and other investments.

A "foreign financial institution" is defined by reference to Section 1471(d)(4) of the Internal Revenue Code as "any financial institution which is a foreign entity."

These broad definitions ensure that most offshore fund Offshore fund An offshore fund is a hedge fund established outside the United States, typically in low-tax jurisdictions like the Cayman Islands or British Virgin Islands. These funds primarily serve non-U.S. investors and U.S. tax-exempt organizations by offering tax advantages and greater regulatory flexibility than domestic fund structures. structures fall within Form 8938 reporting requirements, regardless of their specific legal form or how they operate. The comprehensive nature of these definitions reflects the regulatory intent to capture the full range of foreign investment vehicles and structures commonly used by U.S. taxpayers.

An investment in a non-U.S. hedge fund generally qualifies as a "specified foreign financial asset" when held by an individual or certain entities. Additionally, nonqualified entitiesEntities that do not meet specific tax or regulatory qualification requirements, often subject to different treatment under tax or securities laws. deferred compensation plans involving offshore funds may also be considered "specified foreign financial assets."

This aspect is particularly relevant for investment managers who have deferred compensationCompensation arrangements where payment is postponed until a future date, often subject to specific tax treatment and reporting requirements. from such funds. The broad definition ensures that most offshore hedge fund investments by U.S. persons will require Form 8938 reporting, regardless of the specific legal structure or investment vehicle used. This creates practical compliance obligations for both hedge fund investors and investment managers with offshore arrangements.

Individual taxpayers must file Form 8938 if their foreign accounts have a combined value of more than $50,000 on the last day of the tax year, or more than $75,000 at any point during the year. However, these thresholds vary depending on your filing status and where you live.

The thresholds are higher for married couples filing jointly and for people living abroad. These higher limits recognize that different types of taxpayers face different compliance burdens and practical challenges when dealing with foreign investments.

Certain closely held entitiesBusiness entities with concentrated ownership among a small number of individuals or entities, often subject to specific reporting requirements. must also file Form 8938. This requirement applies when at least 50% of the entity's assets are passive investmentsInvestment activities that do not involve active business operations or management, typically generating income from dividends, interest, or capital appreciation. (like hedge fund investments), or when at least 50% of their income comes from such passive assets.

These entities must file if their total investment in specified foreign financial assets exceeds the same dollar thresholds that apply to individuals. The IRS may also require additional U.S. entities to file if they determine these entities were created primarily to invest in foreign financial assets.

If you meet the filing requirements, you must complete IRS Form 8938 with the information required by Section 6038D(c) of the Internal Revenue Code. Generally, you must provide information that helps identify the nature of each financial asset, though the specific information required varies depending on the type of asset.

In all cases, you must report the asset's highest value during the tax year. The form requires detailed information about each reportable asset, including identifying information about the asset and any foreign entity involved, the maximum value during the year, and any income or gains you recognized from the asset.

The information requirements vary because foreign financial assets come in many different forms, and the IRS has designed the form to accommodate this diversity while maintaining practical compliance standards.

Failing to comply with these reporting requirements can result in significant penalties. The initial penalty is $10,000. After the IRS notifies you of the requirement, additional failures can result in extra penalties of $10,000 for each 30-day period you remain noncompliant, up to a maximum total of $50,000.

For penalty purposes under Section 6038D of the Internal Revenue Code, the IRS assumes that your foreign assets exceed the $50,000 threshold if you don't provide enough information to determine their actual value.

This presumption rule means taxpayers must maintain adequate records and provide sufficient information to demonstrate compliance. Rather than requiring the IRS to prove violations, this approach shifts the compliance burden to the taxpayer. This reflects practical enforcement considerations and emphasizes the importance of thorough recordkeeping for taxpayers with foreign investments.

Form 8938 is one part of a comprehensive international tax reporting system that includes FBAR filing FBAR filing FBAR (Report of Foreign Bank and Financial Accounts) filing refers to the requirement for U.S. persons, including certain hedge fund managers and investors, to report financial interests in or signature authority over foreign financial accounts exceeding $10,000 in aggregate value during a calendar year. , Form 8621 Form 8621 Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund) is an IRS form that U.S. investors must file annually when they invest in hedge funds organized as foreign corporations. The form helps the IRS track these investments and any income they generate, which are subject to special tax rules called PFIC regulations. for PFIC investments, and Form 926 Form 926 Form 926 (Return by a U.S. Transferor of Property to a Foreign Corporation) is an IRS form that U.S. persons must file when they transfer cash or other property to a foreign corporation. This includes investors who put money into offshore hedge funds. The form is required only when certain dollar amounts or ownership thresholds are met. for transfers to foreign corporations. While these forms sometimes overlap in their coverage, each serves different purposes and has different filing thresholds and requirements.

This overlapping system reflects the U.S. government's comprehensive approach to monitoring offshore investments and ensuring tax compliance. However, it creates significant compliance complexity for taxpayers with international investment activities. Understanding the distinct requirements and how these various forms work together is essential for proper compliance.