“Stay Compliant: Annual Foreign Information Returns Filing Obligations for U.S. Persons with Foreign Assets or Interests”

US Canada Cross Border Taxes

Certain U.S. persons must adhere to the IRS’ requirement of filing various annual information returns regarding foreign financial assets or interests. Failure to do so may result in severe penalties for taxpayers who fail to adhere.

U.S. Persons:

U.S. persons are generally defined as U.S. citizens and permanent residents (green card holders), non-resident aliens who have elected to be treated as U.S. residents, domestic partnerships, domestic corporations, and estates and trusts that are not foreign estates or trusts.

FinCEN Form 114, “Report of Foreign Bank and Financial Accounts (FBAR)”

FinCen Form 114 (“FBAR”) is a report that must be filed with the U.S. Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”). It is not covered by the Internal Revenue Code (IRC). The Bank Secrecy Act of 1970, commonly known as the “BSA,” governs its filing. Form FBAR must be electronically submitted on the FinCEN’s BSA E-Filing System website.

Financial Interest: Includes

  • Any accounts in which the U.S. persons either possess legal title, or are the owner of record, regardless if it is kept for their own benefit or that of others such as non-U.S citizens.
  • Accounts where the legal titleholder is acting as an agent, a nominee or in some other capacity on behalf of the U.S. person or is one of the entities controlled by the U.S. person.

Financial Accounts:

Financial accounts cover bank accounts (such as savings, checking, and term deposits), non-registered investment/securities accounts (mutual funds, brokerage accounts, derivatives, or other financial instrument accounts), registered investment accounts such as Tax-Free Savings Accounts (TFSAs), Registered Educational Savings Plans (RESPs), Registered Disability Savings Plans (RDPSs), Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs) held in Canadian or foreign financial institutions, and life insurance policies with cash value.

Filing Threshold:

The FBAR form is submitted to the IRS by each United States person who holds a financial interest in (directly or indirectly), signing authority over, or has any authority over foreign (non-U.S.) financial accounts with a total value of more than $10,000 at any time throughout the calendar year.

  • It’s important to note that the US $10,000 threshold is defined as a whole, not per individual accounts.
  • The FBAR does not contain information about taxable income.

This form identifies the Individuals who can control the flow of money in non-U.S. bank accounts and is integrated with a variety of law enforcement techniques to identify money laundering, organized crime, terrorism financing, other financial crimes and any other criminal activity.

Individuals who are corporate officers, trustees, or have control over a financial account may be required to submit their personal and business accounts on their FBAR filings.

Penalties:

The IRS can impose one of two civil penalties on an individual who fails to submit the FBAR:

  • A non-willfulness penalty of up to US $10,000, may be imposed on any U.S. person who violates or causes any violation of the FBAR filings and recordkeeping requirements; or
  • A willfulness penalty of $100,000 or 50% of the balance in the account at the time of the violation, whichever is greater may be imposed on any U.S. person who willfully fails to file the FBAR.

Criminal penalties may also be imposed.

Schedule B “(Form 1040A or 1040), Interest and Ordinary Dividends”, Part III Foreign Accounts and Trusts includes questions regarding the requirement to file an FBAR.

 

Form 926, “Return by a U.S. Transferor of Property to a Foreign Corporation”

To report transfers of certain property to foreign corporations, a U.S. citizen or resident, a U.S. domestic corporation, or a U.S. domestic estate or trust must complete and file Form 926.

A form 926 may be required to report a transfer if, for example, a U.S. citizen resident in Canada has gone through a corporate reorganization and transferred property (i.e., shares) to a new Canadian entity as part of that transaction.

Penalties:

If the taxpayer fails to file the form, a penalty equal 10% of the fair market value (FMV, not an elected transfer price for Canadian tax purposes) of the property at the time of the transfer will be levied. Unless the failure to file is due to intentional neglect, the fine is restricted to $100,000.

 

Form 3520, “Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts”

This form is completed by a U.S. citizen who has had a transaction with (i.e., a contribution to or distribution from) a non-U.S. trust, or acquires a gift or bequest/ inheritance from a non-U.S. person. If you do not file Form 3520 on time, the penalty of either $10,000 or 35% of the gross value of the property transferred to a foreign trust or distributions received from a foreign trust is imposed in the first instance of failing to submit this form.

A TFSA and RDSP may be considered foreign trusts for U.S. tax purposes (a question of fact). RRSPs, on the other hand, are expressly excluded.

The IRS Rev. Proc. 2020-17 has granted an exemption to some types of accounts, including Canadian RESPs, that were previously classified as trusts for purposes of form 3520 filing.

Penalties:

For tax planning reasons, legally formed Canadian resident family trusts have been quite popular in Canada. Such trusts would be caught under these rules if distributions are made to a U.S. resident beneficiary. Consider an example, if a Canadian resident family trust pays out a distribution of $50,000 to a beneficiary who had moved from Canada and now resided in the U.S. but missed to file the Form 3520, a penalty of $17,500 may be levied.

 

Form 3520-A, “Annual Information Return of Foreign Trust With a U.S. Owner”

When a U.S. citizen is determined to be the owner of a foreign trust under the rules of the U.S. grantor trust, this form is completed. This would be applicable when a person who is a citizen, green card holder, or resident alien of the United States transfers property to a Canadian trust in such a way that he or she is considered to still own or have control over the trust assets. A Canadian alter-ego trust is one possible case, as the settler continues to control the property and it may revert back to him at any moment.

Penalties:

The greater of US $10,000 or 5% of the gross value of any foreign trust assets deemed to be owned by the grantor under the grantor trust rules is assessed as a penalty in the event of first instance of non-filing.

The IRS Rev. Proc. 2020-17 has granted an exemption to some types of accounts, including Canadian RESPs, that were previously classified as trusts for purposes of form 3520-A filing. The filing and completion of Form 3520/3520-A is time-consuming, so you'll need expert assistance. It's critical to consult your cross-border accountant or lawyer before making any decisions.

 

Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations”

This form must be completed and filed by certain U.S. persons who are officers, directors or 10% or more shareholders in Canadian or foreign corporations. The filing requirements for Form 5471 depend on the category of the filer and the type of foreign corporation. Generally, following U.S. persons are required to file Form 5471:

  • Category 1 Filer (1a – Other than 1b or 1c, 1b-Unrelated U.S. shareholder & 1c-Related Constructive Shareholder): A U.S. person (i.e. a U.S. citizen, U.S. resident and green card holder) who is a shareholder of a Canadian or foreign corporation that is a specified foreign corporation, and who owned that stock on the last day in that year on which it was an SFC
  • S. shareholder is a U.S. person who owns (directly, indirectly, or constructively) 10% or more of the total combined voting power or value of stock
  • Specific foreign corporation (SFC) is a controlled foreign corporation (CFC) or a foreign corporation with respect to which one or more domestic corporations is a U.S. shareholder
  • Any non-U.S. or foreign corporation not incorporated in the U.S. is a CFC, as long as more than 50% of the votes or more than 50% of the worth is controlled by “United States shareholders.
  • ” For example, if you are a U.S. citizen living in Canada who has formed your own incorporated family business, you must complete this form
  • Category 2 Filer: A U.S. citizen or resident who is an officer or director of a Canadian or foreign corporation in which a U.S. person has acquired stock which constitutes 10% or more of the total combined voting power or value of stock (directly, indirectly, or constructively) (the 10%-stock-ownership requirement)
  • or a U.S. person who has acquired an additional 10% or more (in value or voting power) of the outstanding stock of the foreign corporation
  • Category 3 Filer: A U.S. person who acquires stock in a foreign corporation which, when added to any stock owned on the date of acquisition, meets the 10%-stock-ownership requirement with respect to the foreign corporation;
  • a U.S. person who acquires stock which, without regard to stock already owned on the date of acquisition, meets the 10%-stock-ownership requirement with respect to the foreign corporation;
  • or a U.S. person who disposes of sufficient stock in the foreign corporation to reduce his or her interest to less than the 10%-stock-ownership requirement
  • Category 4 Filer: A U.S. person who had control of a foreign corporation during the annual accounting period of the foreign corporation.
  • Control is defined as owning more than 50% by vote or value, including indirect control.
  • Category 5 Filer (5a – Other than 5b or 5c, 5b – Unrelated U.S. shareholder & 5c – Related Constructive U.S. shareholder): A U.S. shareholder who owns stock in a foreign corporation that is a CFC at any time during the tax year of the foreign corporation, and who owns that stock on the last day in the year in which the foreign corporation is a CFC.
  • A U.S. shareholder is a U.S. person who owns (directly, indirectly, or constructively) 10% or more by vote or value of stock of a CFC, or who owns any stock of a CFC

Depending on the category of the filer, A U.S. person is required to complete some or all of following schedules.

5471 Schedules:

  • Schedule A – Stock of Foreign Corporation
  • Schedule B – Shareholders of Foreign Corporation
  • Schedule C – Income Statement
  • Schedule E – Income, War Profits, and Excess Profits Taxes Paid or Accrued
  • Schedule F – Balance Sheet
  • Schedule G – Other Information
  • Schedule H – Current Earnings & Profits (E&P)
  • Schedule I – Summary of Shareholder’s Income From Foreign Corporation
  • Schedule I-1 – Information for Global Intangible Low0Taxed Income (GILTI)
  • Schedule J – Accumulated Earnings & Profits (E&P) of Controlled Foreign Corporation
  • Schedule M – Transactions Between Controlled Foreign Corporation and Shareholders or Other Related Persons
  • Schedule N – Return of Officers, Directors, and 10% or More Shareholders of a Foreign Personal Holding Company
  • Schedule O – Organization or Reorganization of Foreign Corporation and Acquisitions and Dispositions or its Stock
  • Schedule P – Previously Taxed Earnings and Profits of U.S. Shareholder of Certain Foreign Corporations
  • Schedule Q – CFC Income by CFC Income Groups
  • Schedule R – Distributions from a Foreign Corporation

Penalties:

The fine for failing to file Form 5471 on time is US$10,000 in the event of first instance, but if the form isn’t filed within 90 days of an IRS request to submit it, the penalty may be as much as US$50,000.

If the IRS identifies a U.S. person is an entity, it automatically applies the penalty. If a US citizen is identified an individual, the IRS will not automatically (yet) impose the penalty; nevertheless, there is a risk that it may be imposed.

 

Form 5472, “Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business”

Form 5472 is used to report the information that must be provided in connection with reportable transactions during the tax year of a reporting corporation with a foreign or domestic related party. It’s critical to submit the Form (exceptions apply) for each reportable transaction with each affiliated party.

A reportable transaction is defined as a monetary and certain non-monetary transaction that occurs between the reporting company, a 25% foreign owner, and any foreign or domestic party related to the owner. These transactions cover, but is not limited to, the following payments: sales of inventory, real estate transactions, cost sharing arrangements, rents and royalties, management fees and commissions, loans, capital contributions and distributions and any services rendered.

There is no de minimis threshold for reportable transactions. Even, a loan of $5 made by a Canadian shareholder to a U.S. affiliate might necessitate the filing of Form 5472.

This form allows the IRS to scrutinize for transfer pricing concerns.

Penalties:

Any reporting corporation that does not submit the Form 5472 on time and in accordance with regulations will be levied a fine of $10,000. An additional penalty of can be imposed if this form is not submitted in a timely manner once notification by the IRS has been provided.

 

Form 8621, “Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund”

A Form 8621 must be filed by a United States person who is a direct or indirect shareholder of a passive foreign investment company (a “PFIC”) for each individual PFIC with which they have an interest in (there are in fact five circumstances under which filing is necessary). There is no requirement for a minimum ownership stake. If you own 1 share in a PFIC, you would have a filing obligation.

PFIC:

A foreign corporation is a PFIC if either at least 75% of the corporation’s gross income for its taxable year is passive investment income, or (ii) at least 50% of the average percentage of assets owned by the foreign corporation during the taxable year are assets that generate passive income or are kept for the purpose of generating passive revenue.

For US tax purposes, Canadian mutual funds trusts, mutual fund corporations, exchange traded funds, and corporate class assets may be classified as PFICs and reported on Canadian T3 or T5 tax slips.

Penalties:

Depending on the PFIC regime in effect, penalties associated with Form 8621 might be more orless severe. A minimum penalty of $10,000 may be imposed in most cases.

 

Form 8858, “Information Return of U.S. Persons With Respect to Foreign Disregarded Entities and Foreign Branches”

Form 8858 must be filed by certain U.S. persons that own a foreign disregarded entity (FDE) or operates a foreign branch (FB), or that own interests in tax owners of a FDE or FB.

For this form purposes:

  • Ownership means ownership in assets and liabilities for U.S. tax purposes
  • Foreign Disregarded Entity (FDE) is an entity that is not created or organized in the U.S. and that is disregarded as an entity separate from its owners for U.S. income tax purposes
  • Canadian Unlimited Liability Company (ULC) owned by the U.S. person(s) is treated as a FDE for U.S. tax purposes
  • Foreign Branch (FB) is essentially any qualified integral business option carried on by a US person outside the United States, or any foreign activity constituting a trade or business for which a separate set of books and records is maintained.
  • S. citizens living in Canada who earn rental income or self-employed income or own and control private corporations in Canada or abroad are considered to be having a foreign branch (FB) in Canada

Filing Requirement:

  • A U.S. person who is a tax owner of an FDE or operates an FB at any time during the U.S. person’s tax year
  • A U.S. person that directly (or indirectly through a tier of FDEs or partnerships) is a tax owner of an FDE or operates an FB
  • Certain U.S. persons that are required to file Form 5471 with respect to a controlled foreign corporation (CFC) that is a tax owner of an FDE or operates an FB at any time during the CFC’s annual accounting period
  • Certain U.S. persons that are required to file Form 8865 with respect to a controlled foreign partnership (CFP) that is a tax owner of an FDE or operates an FB at any time during the CFP’s annual accounting period
  • A U.S. partnership that directly (or indirectly through a tier of FDEs or partnerships) is a tax owner of an FDE or operates an FB

Penalties:

Penalty for not filing Form 8858, Information Return of U.S. Persons With Respect to Foreign Disregarded Entities, can vary depending on the circumstances.

  • The penalty for failing to file the form on time is $10,000 per tax year, and an additional $10,000 penalty may apply for each 30-day period or part thereof that the failure continues, beginning 90 days after the taxpayer is notified of the delinquency.
  • In addition, if the failure to file is due to intentional disregard of the filing requirement, the penalty can be increased to $100,000 or 10% of the value of the foreign disregarded entity.

 

Form 8865, “Information Return of U.S. Persons With Respect to Certain Foreign Partnerships”

This form is the partnership equivalent of Form 5471.

U.S. citizens who meet specific criteria for at least one of four categories of filers outlined below must complete Form 8865 to accurately report information pertinent to controlled foreign partnerships, transfers made to foreign partnerships, or reporting of acquisitions, dispositions or changes in foreign partnership interests.

  • Category 1 Filer: A U.S. person who controlled a foreign partnership at any time during the partnership’s tax year. i.e., owned more than 50% of a foreign partnership at any level throughout the fiscal year. Additional rules may apply.
  • Category 2 Filer: A U.S. person who hold at least 10% interest in the foreign partnership during any point of its tax year while it is controlled by U.S. persons each owning at least a 10% interest. Additional rules may apply.
  • Category 3 Filer: A U.S. person who contributed property during their tax year to a foreign partnership in exchange for an interest in that partnership if that person owned directly or constructively at least a 10% interest in the foreign partnership immediately after the contribution or the value of the property contributed exceeds U.S. $100,000
  • Category 4 Filer: A U.S. person who acquires, disposes, or makes changes in foreign partnership interests. Additional rules may apply.

Penalties:

Depending on the category of the filer, penalties can be imposed in the range from US $10,000 (up to a maximum of US $50,000 after an IRS request to file notice has been received) to a fine equal to 10% of the fair value of the property contributed to the partnership (may subject to potential US $100,000 limit unless the failure is due to intentional neglect).

 

Form 8938, “Statement of Specified Foreign Financial Assets”

An IRS Form 8938 filed with U.S. 1040 personal income tax return is similar to an FBAR. As the Form FBAR is not submitted with the IRS, a U.S. citizen taxpayer may be FBAR compliant but still fail to disclose foreign income earned from foreign financial accounts and assets on their 1040 personal income tax return. Form 8938 was created to deter this.

Filing Threshold:

Form 8938 is required to be filed by a U.S. citizen living in Canada or abroad:

  • if filing a joint return and the total value of your specified foreign asset is more than $400,000 on the last day of the tax year or more than $600,000 at any time during the year, or
  • filing a return other than a joint return and the total value of your specified foreign assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the year

There are two main distinctions between Form 8938 and the FBAR. The Form FBAR reports other person’s financial accounts (i.e. signing authority or other authority) while Form 8938 only reports the taxpayer’s sole accounts and/or joint accounts with US citizen spouse. The FBAR, on the other hand, is much more limited in scope, covers only financial accounts, whereas Form 8938 is more comprehensive in that it covers financial assets as well.

A foreign financial asset that is not a foreign financial account is a private company share. Other possible foreign assets may cover an interest in foreign trust, a foreign estate, a foreign deferred compensation plan, a foreign pension plan or foreign life insurance policy.

Penalties:

A U.S. citizen who fails to file Form 8938 may be fined up to $10,000 and may face a additional penalty of up to $50,000 if he/she continues to neglect to submit this form after IRS notice for request to file. Any tax underpayment due to undisclosed assets may be subject to a 40% penalty, as well as special statute of limitation rules.

It is recommended that US citizens living in British Columbia should consult with a tax professional who is familiar with the tax laws in both Canada and the US including the US-Canada Tax Treaty to ensure that all filing requirements are met and to take advantage of any available tax planning opportunities.

Raj Pandher is a qualified CPA (cross border tax accountant), an associate member of Society of Trust and Estate Practitioners (STEP) Canada and a Certified Executor Advisor (CEA) who assists the U.S. citizens living in Canada with their U.S. income tax return filing including foreign information return reporting.