With the start of the 2012 U.S Federal individual income tax return filing season about to begin it is worthwhile to review a few basic rules. Common errors that we find are failure to timely pay tax due, failure to disclose an interest in a PFIC, failure to report your vested interest in your Bermuda pension plan in the FBAR report and failure to report all foreign owned assets on Form 8938.

Automatic Extension of Time to File, Not Pay

As a resident of a foreign country you have an automatic extension of time until June 17, 2013 in which to file your 2012 U.S. tax return. This regulation does not extend the time for paying the tax due with your 2012 U.S. tax return which is April 15, 2013. 2012 tax due paid after April 15, 2013 is subject to both penalty and interest for the late payment of tax. And if you are paying estimated income taxes your 2013 first quarter payment is also due on April 15, 2013.

Are You A U.S. Beneficiary of a Bermuda or Foreign Trust?

Do you receive a Foreign Grantor Trust Beneficiary Statement or Foreign Non-Grantor Trust Beneficiary Statement from the trustee? You should have.

A trustee has a basic duty under both United Kingdom and United States trust law to keep proper trust accounts. This is more than a duty to keep financial statements; it is a duty to keep capital and income in accordance with applicable law. The information provided to the U.S. beneficiary by the trustee must allow the U.S. beneficiary to identify what portion of the distribution is current income, which portion is accumulated income and which portion is a return of capital.

If the information you receive from the trustee does not allow you to do that, the Internal Revenue Service will assume that the distribution consists entirely of accumulated income which usually results in adverse tax consequences. Consequently, if you are you a U.S. beneficiary of a foreign trust it is incumbent upon you to obtain either a Foreign Grantor Trust Beneficiary Statement or Foreign Non-Grantor Trust Beneficiary Statement from the trustee and obtain an assurance from the trustee that the information contained therein is in accordance with U.S. fiduciary accounting principles.

Passive Foreign Investment Company (PFIC) and Form 8621

Generally, a U.S. person that is a direct or indirect shareholder of a PFIC must file Form 8621 for each tax year under the following three circumstances:

Receives certain direct or indirect distributions from a PFIC,

Recognizes gain on a direct or indirect disposition of PFIC stock,

Is making an election reportable in Part II of the form.

Starting with the 2012 tax year, an individual must now file a separate Form 8621 for each PFIC in which stock is held directly or indirectly. Most U.S. taxpayers likely never heard of a PFIC and those that did would likely feel that it does not apply to them. To the contrary, if you reside outside the U.S. you likely own an interest in a PFIC. Confused? Do you have a money market account at one of the local Bermuda banks or do you own shares in a foreign mutual fund? If so, you likely own shares in a PFIC.

 Foreign Bank and Financial Accounts (FBAR) Form 90-22.1

The law requires that the maximum amount in the account (in the currency of that account) be reported for each account. While this is not a problem in Bermuda, a common error we find is where the foreign exchange rate fluctuates throughout the year. A common tendency is to identify the day that the foreign currency converted to U.S. dollars on that day, is the highest. The correct way is to identify the day that the foreign currency was at its highest and then to convert it to U.S. dollars using the December 31, 2012 conversion rate. Illogical, but correct.

An open question relates to what constitutes a foreign financial account. The U.S. Treasury had indicated that if you have a vested interest in a Bermuda pension or retirement plan that such plan must be included in the FBAR filing.

Form 8938 Statement of Specified Foreign Financial Assets

The requirements for filing Form 8938 are much broader than that for filing an FBAR. In addition to the information included in the FBAR an individual must also report foreign financial assets held for investment and not held in an account maintained by a financial institution. Included in this definition is stock or securities issued by a non-US person, notes, bonds, loans between individuals, life insurance policies or annuities with a cash value, an interest in a foreign estate or foreign trust and foreign deferred compensation and foreign retirement plans.

If you are employed by a foreign corporation you should also report your interest in an employee stock purchase plan, restricted stock units, the value of your performance retention plan, supplemental executive retirement plan, stock options, etc.

Valuation of assets differ from the FBAR in that you must value assets at the end of the taxable year and convert into U.S. dollars and value assets as of the maximum fair market value of the assets at any time during the year and convert to U.S. dollars at the end of the taxable year. Form 8938 has a 40% accuracy penalty.

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.

The tax advice given by this column is, by necessity, general in nature. You should, of course, check with your own U.S. tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances.