Recently, I presented a webinar for tax pro’s earning CPE credits; the topic involved our favorite character, Mr. FBAR. The FBAR, Form 114, is more formally known as the Report of Foreign Bank and Financial Accounts. The webinar will be available soon as a CPE credit “self-study” program. Send me an email if you wish to be notified when the self-study is available.
An interesting question came up during the webinar: whether an FBAR filing duty arises for a foreign individual who makes an election under IRC § 7701(b)(4), commonly referred to as the “First-Year Election”. In general, the First-Year Election is used by nonresident alien individuals who arrive in the US after the middle portion of the tax year and do not obtain a green card in that year. Since they do not obtain a green card that year, they will not qualify as a resident alien under the “Green Card Test.” Due to the limited days of physical presence in the US, they will also not qualify as a resident alien under the “Substantial Presence Test” (SPT). Since these individuals do not meet either the SPT or the Green Card Test, they are not considered US resident aliens for the tax year of arrival. They can change this result by making the First-Year Election. Under this election the individual may be considered a US resident alien for part of the tax year, as opposed to being considered a nonresident alien for the entire tax year. IRS provides a helpful International Practice Unit.
The election applies for income tax purposes, but what does making this election mean for FBAR purposes?
It is a good time to remind readers of some basics before we tackle this question.
Title 31 v. Title 26 – Bank Secrecy Act v. Internal Revenue Code
The FBAR has its genesis in the “Bank Secrecy Act” (BSA) contained in Title 31 of the United States Code. Implementing regulations (Regulations) are issued by the Financial Crimes Enforcement Network (FinCEN) of the US Treasury. The BSA was enacted in the 1970’s. The BSA is not part of the US tax laws comprising the Internal Revenue Code (IRC) which is found in Title 26 of the United States Code. While the FBAR doesn’t trigger tax since it is an information reporting form, incorrect FBAR filings or non-filing can trigger stiff penalties.
Since the FBAR is not part of the US Internal Revenue Code, one must be very careful in applying the rules. Common terms are defined differently for FBAR and US tax purposes. For example, a financial account located in a US territory or possession (e.g., Puerto Rico, Virgin Islands, Guam, American Samoa) need not be reported on the FBAR. Such accounts are treated as a US account for FBAR purposes since Title 31 defines the term “United States” as including US possessions and territories. By contrast, Title 26 defines the term “United States” as excluding US possessions and territories. As such, a financial account located in a US territory or possession will be treated as “foreign” for US tax purposes, including the duty under IRC Section 6038D to file Form 8938, with respect to so-called “specified foreign financial assets”. (My blog post here provides everything you need to know about Form 8938).
Nuances also exist in the definition of a “US person” required to file an FBAR. For FBAR purposes, the FBAR instructions provide that a “United States person means United States citizens (including minor children); United States residents; entities, including but not limited to, corporations, partnerships, or limited liability companies created or organized in the United States or under the laws of the United States; and trusts or estates formed under the laws of the United States… The federal tax treatment of an entity does not determine whether the entity has an FBAR filing requirement. For example, an entity that is disregarded for purposes of Title 26 of the United States Code must file an FBAR, if otherwise required to do so.”
By way of example, a trust created under US laws can be treated as a “foreign” trust for US income tax purposes. It may have no US income tax liability whatsoever if all income is earned from non-US sources. Yet that trust will have FBAR filing duties since it is a “United States person” under the BSA.
US “Resident” Only by Section 7701(b) Election
Let us return to the nonresident alien individual who fails to meet either the SPT or the Green Card Test for the year he arrives in the US, but who makes the First-Year Election for US income tax purposes. What are his FBAR duties?
According to the FBAR instructions, “[t]o determine if the filer is a resident of the United States apply the residency tests in [IRC § 7701(b]). When applying the residency tests, use the definition of United States in these instructions.” The First-Year Election is contained in IRC § 7701(b)(4)(B) and implemented in Treasury Regulations § 301.7701(b)-4(c)(3). As such, an individual making the election will qualify as a “resident” for FBAR purposes. Under the First-Year Election, however, an individual is treated as a resident alien for income tax purposes for only part of the tax year, i.e., only for the period covered under the election.
This gets a bit confusing as to what and how to report foreign accounts for the individual making the First-Year Election. What if he closed many foreign accounts just prior to the elected residency period? Are these accounts counted for purposes of computing the $10,000 threshold? If the threshold is met regardless, are these accounts reported on the FBAR since they were in existence for part of the calendar year to which the FBAR relates? Ah, the joys of being Mr. FBAR! With all this confusion it is no small wonder he can collect so much in penalties.
According to the preamble to the final FBAR regulations (“Preamble”), “FinCEN believes that individuals who elect to be treated as residents for tax purposes under section 7701(b) should file FBARs only with respect to foreign accounts held during the period covered by the election.” The Preamble is here see page 10,238, excerpt below. Evidently, many tax pro’s were confused on this issue. At least the Preamble provides some help!
“[C]ommenters sought clarification on the treatment of individuals who make certain elections under section 7701(b) of the Internal Revenue Code. FinCEN believes that individuals who elect to be treated as residents for tax purposes under section 7701(b) should file FBARs only with respect to foreign accounts held during the period covered by the election”.
The lesson here: Look first to Title 31 when it comes to FBAR issues. Title 26 may be implicated as well, but the first port of call is the BSA and its regulations. The other lesson: It’s complicated. Engage a tax professional with the proper international experience to assist with such US tax and FBAR matters.
Want more information about FBAR? Check the FBAR category on my US international tax blog. Need help with FBAR matters? Send an email to arrange a consultation firstname.lastname@example.org
Posted June 2, 2022
All the US tax information you need, every week –
Named by Forbes, Top 100 Must-Follow Tax Twitter Accounts @VLJeker
Named by Bloomberg, Tax Professionals to Follow on LinkedIn
Subscribe to Virginia – US Tax Talk to receive my weekly US tax blog posts in your inbox. My blog specializes in foreign and US international tax issues.
You can access my papers on the Social Science Research Network (SSRN) at https://ssrn.com/author=2779920
5 thoughts on “US Residency “First Year Election” and FBAR – The Devil is in the Details”
Please send me a notification when the Report of Foreign Bank and Financial Accounts webinar will be available soon as a CPE credit “self-study” program. Many Thanks
Hi Chet – My.CPE advised the FBAR self-study should be live next week. YOu can check their website and if having trouble finding it, let me know. I am presenting a live webinar re expatriation on June 16 — relinquishing US citizenship and LTR status (green card holders with 8 tax years having the gc status). If you have clients who are gc holders, you should definitely attend this webinar.
Hi Chet – the FBAR self-study is now live. Here’s the direct link to the self-study course: https://my-cpe.com/self-study/everything-you-need-to-know-about-report-of-foreign-bank-and-financial-accounts-fbar
Hi! I would like to be notified when the self-study is available. Thanks!
Marissa Mata, CPA
(210) 694-5945, fax (210) 694-5958
E-MAIL NOTICE – This transmission may be: (1) subject to the Accountant-Client Privilege, (2) an Accounting/Tax Prep Work Paper, or (3) strictly confidential.
As required by U.S. Treasury Regulations governing tax practice, you are hereby advised that any written tax advice contained herein was not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding tax penalties that may be imposed under the Internal Revenue Code.
The information contained in this e-mail is confidential information intended only for the use of the intended recipient or agent responsible to deliver it to the intended recipient. You are hereby notified that any dissemination, distribution or copying of this communication is strictly prohibited. If you have received this communication in error, please reply immediately and notify the sender (only) and delete the message &/or notify us by telephone at (210) 694.5945.
Hi Marissa – the FBAR self-study is now live. Here’s the direct link to the self-study course: https://my-cpe.com/self-study/everything-you-need-to-know-about-report-of-foreign-bank-and-financial-accounts-fbar