With the 2010 tax year coming to close, tax information which will need to be reported on a 2010 US Federal individual income tax return will begin to arrive in your mailbox in January 2011. As all US citizens and resident aliens residing abroad have an extended due date of June 15, 2011 in which to file their 2010 individual tax return and until June 30, 2011 in which to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts, care should be taken that all information you receive next month be reviewed and catalogued so that you are not scurrying for this information 6 months from now.

Particular care should be given to obtaining information required by tax laws passed earlier this year. As noted in a column earlier this year, The Hiring Incentives to Restore Employment (HIRE) Act signed into law on March 18, 2010 incorporates provisions of the Foreign Account Tax Compliance Act of 2009, which has far-reaching implications for foreign financial institutions that may have U.S. clients and for Bermuda trusts with U.S. beneficiaries. A summary of some of the provisions is set forth below.

Foreign Financial Accounts

Every foreign financial institution was encouraged to enter into an agreement with the United States that would require it to:

• Obtain information regarding each holder of each account to determine if the account is a U.S. account;
• Comply with verification and due diligence procedures set by the United States;
• For every U.S. account, annually report to the IRS information regarding account holder, balances, income and withdrawals;
• Withhold 30 percent on all payments to recalcitrant account holders and to other foreign financial institutions that have not entered into such an agreement;
• Provide any other information regarding the account requested by the United States and;
• Insist that the owners of U.S. accounts waive local bank secrecy laws, and close the accounts of those who refuse to do so.

Foreign financial institutions that refuse to enter into such an agreement are subject to withholding of 30 percent on all payments to them of U.S. source dividends, interest and similar investment income, and on the gross proceeds of all sales of U.S. securities and other assets that produce interest or dividends.

U.S. citizens are now going to have to be more prudent in the reporting of interest income from foreign banks as well as filing Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts. While many foreign banks do not provide year end statements as to interest income received by an account holder, this information is usually reported on monthly or quarterly bank statements. And if your foreign financial institution complies with the law and lets the US Treasury know the balances in your accounts and the amount of interest income paid to you, the U.S. Treasury will likely program this information in their computers and will be looking for a match when you file your tax return.

New Foreign Bank and Financial Accounts Filing Requirement

In addition to the annual filing of filing Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts, the new law will now require a U.S. person to disclose on their 2010 Form 1040 specified foreign financial assets that exceed $50,000.  Specified foreign financial assets include foreign depository or custodial accounts, foreign stock or securities, financial instruments or contracts issued by or having a counterparty that is not a U.S. person, and any interest in a foreign entity.

Failure to make this disclosure in your 2010 tax return will result in a new accuracy-related penalty of $10,000 and a 40% penalty will apply to any actual underpayment of taxes attributable to undisclosed foreign financial assets, and the statute of limitations has been extended to six years in certain cases.

Foreign Trust Provisions

The provisions regarding foreign trusts have been amended to broaden the U.S. grantor trust rules as applied to a U.S. grantor of a foreign trust, tax U.S. beneficiaries on uncompensated use of trust property, and tighten the foreign trust reporting rules applicable to U.S. grantors and beneficiaries alike.

The U.S. Internal Revenue Code (the Code) is now reconciled with Treasury regulations, which provide that a foreign trust created by a U.S. person is deemed to have a U.S. beneficiary (even when the interest of a U.S. person is contingent on a future event) unless for that taxable year there is a specified class among whom discretionary distributions may be made, none of whom is a U.S. person. There is now a rebuttable presumption that every foreign trust created by a U.S. person has U.S. beneficiaries.

There is now a requirement that a U.S. grantor provide information requested by the IRS with respect to the foreign trust, in addition to ensuring the foreign trust files an annual information report.

Uncompensated Use of Trust Property by U.S. Beneficiaries

This new rule is likely to have a major effect on U.S. beneficiaries of a Bermuda trust that owns the residence in which they live. Effective March 18, 2010 the new law treats the use of real or tangible property held in a foreign trust as a trust distribution to a U.S. beneficiary, U.S. grantor or related person if fair market rent is not paid. So if you are a U.S. beneficiary living in a home that is owned by a foreign trust you now have to either immediately pay fair market value rent to the trust, or be deemed to have received a distribution from the foreign trust equal to the fair market rental value of the property.

This new law will also affect US beneficiaries of foreign trusts that have purchased vacation homes in the United States that are occasionally used by U.S. beneficiaries.

This provision will result in many U.S. beneficiaries having to file a Form 3520 in 2010 to report such deemed distributions. Failure to report transfers to, or distributions from, foreign trusts, will now carry a minimum penalty of $10,000 and a maximum penalty that could be greater than the value of the transfer or distribution. 

Passive Foreign Investment Company (PFIC)

A U.S. shareholder with an interest in a Passive Foreign Investment Company (PFIC) must now file an annual information return, regardless of whether a taxable event has taken place in that year.

Pursuant to the requirements relating to practice before the Internal Revenue Service, any tax advice in this communication is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties imposed under the United States Internal Revenue Code, or (ii) promoting, marketing or recommending to another person any tax related manner.