What Qualifies as a Financial Account for Tax Purposes?
The term "financial account" has a specific meaning under tax law. Understand how this broad definition impacts the reporting of assets you hold, both at home and abroad.
A financial account is a broad term for arrangements with financial institutions used for holding, managing, and transacting with money and other financial assets. The term covers a wide variety of instruments, each with distinct purposes. Understanding what constitutes a financial account is necessary for managing one’s finances and adhering to regulations, as the specific nature of these accounts dictates how they are treated for tax reporting.
Core Categories of Financial Accounts
Depository accounts are established to hold cash balances. Common examples are checking and savings accounts, which offer liquidity for daily transactions and savings goals. Certificates of deposit (CDs) also fall into this category, holding a fixed sum of money for a set period for a specified interest rate. These accounts are maintained by banks and credit unions.
Custodial accounts are another category, designed to hold financial assets like securities on behalf of an investor. A brokerage account is a primary example, allowing an individual to buy, sell, and hold investments such as stocks, bonds, and mutual funds. Commodity futures accounts are a more specialized type of custodial account used for trading contracts for the future delivery of physical commodities.
Retirement accounts offer tax advantages to encourage long-term savings. These include Individual Retirement Arrangements (IRAs), such as Traditional and Roth IRAs, and employer-sponsored plans like 401(k)s. The tax-deferred or tax-exempt growth of the funds distinguishes them from other account types. The rules governing these accounts are defined by the Internal Revenue Code.
Certain insurance and annuity policies are considered financial accounts if they have a cash surrender value. This value is the amount an insurer pays a policyholder upon cancellation of the policy. For instance, whole life insurance policies accumulate a cash value the owner can access. Annuity contracts can also have a cash value component reportable for tax purposes.
The definition of a financial account now includes accounts holding digital assets. An account with a cryptocurrency exchange that facilitates trading assets like Bitcoin or Ethereum is considered a financial account. These function similarly to traditional brokerage accounts but for a different class of assets.
Identifying Account Ownership and Location
The classification of a financial account depends on who owns it and where it is located. Ownership can be straightforward, such as an account held by a single individual. Accounts can also be owned jointly or held by entities like corporations, partnerships, or trusts.
A person can also have a reportable relationship with an account without being the direct owner. This occurs when an individual has a financial interest in or signature authority over an account. Signature authority means having the ability to control the disposition of the account’s assets through direct communication with the financial institution, a common scenario for corporate officers.
The location of an account is determined by the geographic location of the financial institution that maintains it, not by the owner’s citizenship or residence. An account held at a bank branch in another country is considered a foreign financial account, even if the owner is a U.S. citizen residing in the United States. Conversely, an account at a U.S. branch of a foreign bank is treated as a domestic account.
Significance for U.S. Tax Reporting
The definition of a financial account is important for U.S. tax law, which requires U.S. persons to report their worldwide income. For these purposes, a “U.S. person” includes U.S. citizens and residents, as well as domestic entities like corporations, partnerships, and trusts.
Two primary regulatory regimes mandate the reporting of foreign financial accounts: the Report of Foreign Bank and Financial Accounts (FBAR) and the Foreign Account Tax Compliance Act (FATCA). The FBAR requirement, under the Bank Secrecy Act, is intended to help the government identify potential tax evasion. It is filed directly with the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) using FinCEN Form 114. An FBAR must be filed if the aggregate value of a U.S. person’s foreign financial accounts exceeds $10,000 at any point during the calendar year.
The FATCA regime was enacted to improve tax compliance by U.S. taxpayers holding foreign financial assets. This reporting is done on Form 8938, Statement of Specified Foreign Financial Assets, which is attached to a taxpayer’s annual income tax return. FATCA reporting thresholds are higher than the FBAR threshold and vary based on filing status and residence. For a single taxpayer living in the U.S., the threshold is met if specified foreign assets exceed $50,000 on the last day of the tax year or $75,000 at any time during the year.
An individual might be required to file an FBAR, Form 8938, both, or neither, depending on their specific circumstances. Significant penalties for non-compliance make it necessary for any U.S. person with assets held outside the country to understand these reporting obligations.