Puerto Rico, American Samoa, Guam, The United States Virgin Islands, The Northern Mariana Islands—these are all United States territories or possessions. Individuals born in these territories are deemed by law to be either United States citizens or United States nationals. Yet these locations are separated from the contiguous United States by vast bodies of water. Many U.S. citizens from the contiguous United States have never been to any of the territories. Travel from the contiguous United States to any one of these territories involves a multiple-hour trip by either air or sea. In many ways, these locations seem foreign and exotic to most Americans.
The FBAR, Form 8938, Form 3520, Form 5471, Form 8621—these are all information reporting forms used to report various types of foreign assets to different bureaus within the U.S. Department of the Treasury, such as the Internal Revenue Service (the IRS) or the Financial Crimes Enforcement Network (FinCen). When most people think of “foreign” assets, they think of assets located in foreign countries, such as Switzerland, Israel, China, the United Kingdom, or Russia.
What about an asset—such as a bank account—located in a U.S. territory or possession? Is it a foreign or a domestic asset? The answer, unfortunately, is not so simple.
Foreign asset reporting is an important tool in the IRS’s tax compliance arsenal. The federal tax law requires U.S. persons to report and pay taxes on their worldwide income, including income generated by foreign bank accounts or other foreign assets. The Government Accountability Office (GAO) has noted that the failure of U.S. persons to report and pay taxes on income generated by foreign assets results in the loss of billions of dollars in tax revenues annually. The IRS views foreign asset information reporting forms as necessary checks on U.S. taxpayers’ proper reporting and payment of taxes on income generated by such assets.
U.S. persons are required to report their foreign assets on a variety of forms. First and foremost, the Form 1040 tax return itself requires some disclosure of foreign assets: Schedule B, Part III asks whether the taxpayer has an interest in a foreign account or foreign trust. Foreign assets must also be reported on Form 8938, which is attached to and made part of the Form 1040 tax return. It requires reporting on a variety of foreign assets, including interests in foreign bank accounts, foreign trusts, foreign corporations, and various others. Other common foreign asset reporting forms include the FBAR, aka the Foreign Bank Account Report form, aka FinCen Form 114, used to report interests in foreign bank accounts; Form 3520, used to report interests in foreign trusts; Form 5471, used to report interests in foreign corporations; and Form 8621, used to report interests in passive foreign investment corporations, i.e., foreign mutual funds.
An asset located in a U.S. territory or possession may or may not be considered “foreign” depending on the type of information reporting form. In addition, an individual’s residence in a U.S. territory or possession may impact whether or not they must report an asset located in that territory. This difference in treatment becomes most apparent when comparing the treatment of U.S. territories and possessions on the FBAR Form versus their treatment on Form 8938.
Foreign financial accounts must be reported on the FBAR Form filed annually with FinCen. U.S. persons must file FBARs if the aggregate value of their foreign financial accounts exceeds $10,000 at any point during the tax year. The penalty for willful failure to file the FBAR is the greater of 50 percent of the account balance or $129,210. Even a non-willful failure to file a FBAR may result in a $12,921 penalty.
Foreign financial accounts must also be reported on Form 8938. The obligation to file Form 8938 depends on three factors: (i) the filing status of the taxpayer; (ii) the residence of the taxpayer; and (iii) the aggregate value of the taxpayer’s specified foreign financial assets. For example, an unmarried taxpayer residing in the United States must file Form 8938 if her specified foreign assets exceed $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year. At the other end of the spectrum, married taxpayers residing outside the United States and filing a joint Form 1040 income tax return must file Form 8938 if their specified foreign assets exceed $400,000 on the last day of the tax year or more than $600,000 at any time during the tax year. In between there are various other threshold amounts for married taxpayers residing in the United States and either filing separately or jointly, unmarried taxpayers residing outside the United States, and married taxpayers residing outside the United States but filing separately. Failure to file a Form 8938 may result in a $10,000 penalty, with an additional penalty of $10,000 for each 30-day period during which the Form 8938 is not filed, up to a maximum of $50,000. If the failure to disclose a specified foreign financial asset on Form 8938 also results in an underpayment of tax, then there is a 40 percent accuracy-related penalty on the underpayment.
With respect to a financial account located in a U.S. territory or possession, the asset will be reported differently on the two forms. For FBAR purposes, such an account is treated as a U.S. account and therefore does not need to be reported on the FBAR. That same account, however, is considered a foreign account for purposes of Form 8938 and must be reported on that form.
This difference in treatment can be traced to the different statutes that govern the FBAR and Form 8938. The obligation to file an FBAR is derived from Title 31 of the U.S. Code, specifically 31 U.S.C. § 5314, which requires U.S. persons to maintain records and file reports with respect to that person’s financial accounts held at a foreign financial institution. Title 31 deals with monetary instruments, including topics such as money laundering. The definition section of Title 31 defines the term “United States” as including U.S. possessions and territories.
(6) “United States” means the States of the United States, the District of Columbia, and, when the Secretary prescribes by regulation, the Commonwealth of Puerto Rico, the Virgin Islands, Guam, the Northern Mariana Islands, American Samoa, the Trust Territory of the Pacific Islands, a territory or possession of the United States, or a military or diplomatic establishment.
The practical effect of this definition is that U.S. territories and possessions are not deemed foreign for Title 31 purposes. As a result, a financial account in a U.S. territory or possession is deemed a United States-based account, and therefore does not need to be reported on the FBAR. This is confirmed by the FBAR regulations.
By contrast, the obligation to file Form 8938 is derived from Title 26 of the U.S. Code, specifically § 6038D. Title 26, of course, is the Internal Revenue Code that deals with topics related to the U.S. federal tax system. Title 26’s definition section defines the term “United States” as excluding U.S. possessions and territories.
(9) United States.--The term ‘United States’ when used in a geographical sense includes only the States and the District of Columbia.
The practical effect of this definition is that U.S. territories and possessions are deemed foreign for Title 26 purposes. Thus, a financial account in a U.S. territory or possession is deemed a foreign account and must be reported on Form 8938, a fact confirmed by the regulations governing Form 8938.
Because of these different statutory definitions, it appears that a legislative change may be needed to harmonize the FBAR and Form 8938 in their treatments of accounts based in U.S. territories. That said, the FBAR was first introduced in the 1970s, and Form 8938 was introduced in mid-2010. There does not appear to be any legislative fix on the horizon for the differing manner in which these forms treat such accounts. Taxpayers and their professional advisers must therefore be mindful of the fact that accounts that do not need to be reported on the FBAR may nonetheless need to be reported on Form 8938.
Just as the FBAR and Form 8938 differ in their treatment of financial accounts located in U.S. territories or possession, so too do they differ in their treatment of residents of such territories and possessions.
With respect to the FBAR, the rule is straightforward. Residents of all U.S. territories and possessions must file an FBAR if their foreign financial accounts meet the applicable monetary threshold. This is because an individual must file an FBAR if they are a “United States person,” and for FBAR purposes a United States person includes a bona fide resident of a U.S. territory or possession.
With respect to Form 8938, the issue of whether a resident of a U.S. territory or possession must file the form is more complicated. An individual must file Form 8938 if they are deemed a “specified individual” whose specified foreign assets meet certain monetary thresholds. The term “specified individual” includes residents of certain U.S. territories and possessions, namely Puerto Rico and American Samoa, but not residents of other U.S. territories, such as Guam, the United States Virgin Islands, or the Northern Mariana Islands.
The difference in Form 8938’s treatment of residents of Puerto Rico and American Samoa compared to residents of Guam, the United States Virgin Islands, and the Northern Mariana Islands derives from the fact that certain U.S. territories and possessions are “mirror code” taxing jurisdictions, while others are “non-mirror code” jurisdictions.
Three of the five United States territories—Guam, the Northern Mariana Islands, and the United States Virgin Islands—have a mirror code system of taxation, meaning that their income tax laws essentially are identical to the Internal Revenue Code, except for the substitution of the name of the relevant territory for the term “United States.” As a result, residents of Guam, the Northern Mariana Islands, and the United States Virgin Islands have no income tax obligation (or related filing obligation) with the United States provided that they properly report income and fully pay their income tax liability to the taxing authority of their respective U.S. territory. Accordingly, because they are in mirror code jurisdictions, residents of Guam, the Northern Mariana Islands, and the United States Virgin Islands generally do not need to file a Form 1040 individual income tax return or a Form 8938 (as that form is attached to and made part of a Form 1040 tax return). They may, however, have to file a similar form with the taxing authority of their jurisdictions.
On the other hand, Puerto Rico and American Samoa are non-mirror code jurisdictions, meaning that their residents generally are subject to U.S. income taxation and have a related income tax return filing requirement with the United States if they have non-territory-source income. They generally exclude territory-source income from their U.S. federal gross income. This means that residents of Puerto Rico and American Samoa generally must file tax returns with their respective tax authority, as well as Form 1040 tax returns (and Form 8938 as an attachment to that return if the monetary thresholds are met) with the IRS.
Form 8938 further provides that residents of U.S. territories or possessions do not need to report on that form any financial accounts maintained in the territory or possession in which they reside. They must still report any accounts located in territories in which they do not reside.
These differences in the treatment of U.S. territories and possessions have practical consequences. Assume, for example, that an individual has financial accounts located in Switzerland, Puerto Rico, and Guam, the monetary value of which exceeds the reporting threshold for both the FBAR and Form 8938. How would those accounts be reported on these forms? The answer will differ depending on where the hypothetical individual resides. An individual residing in Texas will report differently than an individual residing in Puerto Rico who, in turn, will report differently than an individual residing in Guam.
If the hypothetical Swiss, Puerto Rico, and Guam accounts are held by an individual residing in Texas, that individual would report only the Swiss account on the FBAR, since the Puerto Rico and Guam accounts are deemed U.S. accounts for FBAR purposes because they are located in U.S. territories. For Form 8938 purposes, however, the Texas resident must report all three accounts, since accounts in Puerto Rico and Guam are deemed foreign accounts for Form 8938 purposes. If the Texas resident simply duplicated the FBAR filing on Form 8938—i.e., excluded the Puerto Rico and Guam accounts—then she will have filed an incorrect Form 8938 and may have exposed herself to applicable Form 8938 penalties and/or inadvertently kept open the statute of limitations on her entire Form 1040 tax return.
If the hypothetical accounts are held by an individual residing in Puerto Rico, then that individual would likewise report only the Swiss account on the FBAR and once again exclude the Puerto Rico and Guam accounts from that filing. The Puerto Rico resident’s Form 8938 filing, however, would differ from the Texas resident’s filing. The Puerto Rico resident would need to file a Form 8938 reporting both the Swiss and Guam accounts but would not need to report the account held in Puerto Rico, since it is held in the U.S. territory where she resides.
If these hypothetical accounts were held by an individual residing in Guam, the information form filings would be even more different. The Guam resident would still file an FBAR reporting the accounts in the same fashion as the Texas and Puerto Rico residents—the Swiss account would be reported, while the Puerto Rico and Guam accounts would be excluded. The Guam resident, however, would not need to file any Form 8938, since Guam is a mirror code taxing jurisdiction. Nor would the Guam resident file a Form 1040 tax return to which Form 8938 would attach. Instead, the Guam resident would have to file a tax return (and any related forms) with the taxing authority of Guam.
Taxpayers must also be mindful that other foreign asset information reporting forms–such as Form 5471, Form 3520, and Form 8621–may have their own peculiar rules for the treatment of U.S. territories and possessions. For example, residents of Puerto Rico and American Samoa must file Form 8621 (used to report interests in foreign mutual funds, i.e., PFICs) if they meet the applicable reporting thresholds, while residents of Guam, the Northern Mariana Islands, and the United States Virgin Islands have no obligation to file that form. For purposes of Form 3520 (used to report interests in foreign estates, trusts, and gifts), trusts formed in any U. S. territory or possession are typically deemed to be foreign trusts. While corporations incorporated in a U.S. territory or possession are typically deemed foreign corporations for purposes of Form 5471 (used to report interests in foreign corporations), there may be other considerations that impact a Form 5471 filing, such as the specialized rule for controlled foreign corporations applicable to U.S. territories or possessions, or the rule applicable to corporations created or organized in both a U.S. territory and a State within the United States.
Taxpayers should consult their tax professionals for advice on how to properly report all of their assets located in U.S. territories or possessions.
