FATCA Reporting of Compensatory Foreign Stock Option on Form 8938

My earlier blog post covered some US tax issues faced by the individual granted options on foreign company stock by his non-US employer.  When it comes to foreign information return reporting, the grant of options to an employee on foreign stock can get confusing.  Is an option granted to an employee with respect to foreign stock reportable on Form 8938 as a “Specified Foreign Financial Asset”?  What if the employee has no plans to exercise the option?

The Basics

Let’s cover some basics about Form 8938 before addressing the reporting of options on foreign company stock issued to an employee.

It’s always important to know the Internal Revenue Code section involved. Here, IRC Section 6038D(a) is the relevant section. Generally, it requires an individual who holds any interest in a specified foreign financial asset (SFFA) during the taxable year to attach Form 8938 to that individual’s income tax if certain dollar thresholds are met.

Who Must File Form 8938?

Assuming a dollar threshold for the total value of SFFAs held during the tax year is met, so-called “specified individuals” must file Form 8938, including:

• A US citizen (sounds simple enough, but who can be a US citizen may surprise you).
•  A “resident alien” of the United States for any part of the tax year (this means the individual meets either the so-called “green card” test or “substantial presence” test). Read about these tests here and  here.
• A nonresident alien who makes an election to be treated as a resident alien for purposes of filing a joint income tax return.

Filing becomes mandatory once certain dollar thresholds in aggregate fair market value of the SFFAs are exceeded during the tax year. The thresholds depend on one’s filing status and whether the “specified individual” is living abroad or in the United States. For example, the current thresholds for those living abroad are set out below.

• Single taxpayers and married taxpayers filing separately: $200,000 on the last day of the tax year or $300,000 anytime during the tax year; and
• Married taxpayers filing jointly: $400,000 on the last day of the year or $600,000 anytime during the year.

What is a Specified Foreign Financial Asset?

Examining Code Section 6038D and the final Treasury Regulations for a comprehensive definition of a SFFA is an exercise in and of itself.  The Code section’s definition of a SFFA appears more concise, but the Treasury Regulations expand upon it and take a more sweeping approach.

Code Section 6038D(b) defines a SFFA as:

For purposes of this section, the term “specified foreign financial asset” means—

(1) any financial account…. maintained by a foreign financial institution…, and

(2) any of the following assets which are not held in an account maintained by a financial institution….

(A) any stock or security issued by a person other than a United States person,

(B) any financial instrument or contract held for investment that has an issuer or counterparty which is other than a United States person, and

(C) any interest in a foreign entity ….

The Treasury Regulations in Section 1.6038D-3, flesh things out more fully and in addition to foreign financial accounts, the regulations provide a nonexclusive listing of examples of other SFFAs:   

(b) Other specified foreign financial assets –

(1) In general. Except as otherwise provided in this section, a specified foreign financial asset includes any of the following assets that are not financial accounts and that are held for investment and not held in an account maintained by a financial institution –

(i) Stock or securities issued by a person other than a United States person (including stock or securities issued by a person organized under the laws of a U.S. possession);

(ii) A financial instrument or contract that has an issuer or counterparty which is other than a United States person …. and

(iii) An interest in a foreign entity.

“(d) Examples. Examples of assets other than financial accounts that may be considered other specified foreign financial assets include, but are not limited to—

(1) Stock issued by a foreign corporation;

(2) A capital or profits interest in a foreign partnership;

(3) A note, bond, debenture, or other form of indebtedness issued by a foreign person;

(4) An interest in a foreign trust;

(5) An interest rate swap, currency swap, basis swap, interest rate cap, interest rate floor, commodity swap, equity swap, equity index swap, credit default swap, or similar agreement with a foreign counterparty; and,

(6) Any option or other derivative instrument with respect to any of the items listed as examples in this paragraph or with respect to any currency or commodity that is entered into with a foreign counterparty or issuer.”

What about Compensatory Options on Foreign Stock?

Based on the regulations, a compensatory option on foreign stock could be as described in (b)(1)(iii), that is, a financial contract that has an issuer or counterparty which is other than a United States person.  It could also qualify under (d) item 6. That is, an option on stock issued to an employee by a foreign corporation “may be considered” a SFFA.  The question for the tax pro is when and under what circumstances will such an option be considered a SFFA, reportable on Form 8938?

Based on the proposed and temporary Section 6038D regulations, vested and unvested stock as well as stock options were considered SFFAs for purposes of reporting on Form 8938. However, the final regulations at Section 1.6038D-2(b)(2) clarified that only vested property is considered a reportable asset for purposes of Form 8938:

“(2) Property transferred in connection with the performance of services. A specified person that is transferred property in connection with the performance of personal services is first considered to have an interest in the property for purposes of section 6038D on the first date that the property is substantially vested (within the meaning of § 1.83-3(b)) or, in the case of property with respect to which a specified person makes a valid election under section 83(b), on the date of transfer of the property.”

Unvested shares and options generally may be disregarded for purposes of Form 8938 until the time of vesting, unless the individual makes a valid election to include the assets in income under Code section 83(b).  When it comes to employee stock options the tax pro must examine all of the facts.  For example, can the option be transferred prior to exercise? If so, it may be considered a reportable asset for Form 8938.  Typically, the compensatory option is not transferable and vesting will not occur until exercise of the option.

Questions and More Questions

Questions certainly remain as to the precise parameters as to what constitutes a SFFA.

For example, certain assets are exempt such as an interest in a social security, social insurance, or other similar program of a foreign government.  On the other hand, US individuals are required to report on the Form 8938, their interest in a non-United States employee benefit plan – this could include foreign retirement and pensions and similar plans. In my years of experience, I have come across numerous foreign plans but the nuances can leave the professional with many concerns as to proper classification of the program.  It gets confusing how to classify such items and my advice would be to err on the side of caution, reporting if one is in doubt.

The IRS has issued some basic Questions and Answers regarding Form 8938.  Instructions to Form 8938 are also very helpful. Reading these resources amplifies how complex the issues can easily become.  Get the best tax help to avoid penalties on this one and remember, failure to file it will also result in an ‘unlimited’ statute of limitations for the relevant tax year!  Details at my post here.

Posted June 8, 2023

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