Question: Jim and Sarah are U.S. citizens who reside in the United States and file a joint federal income tax return. They have $5,000 in foreign bank accounts. Jim and Sarah also have $200,000 in foreign stocks issued by a foreign corporation, which is directly held be the couple and is not in a U.S. financial institution.

Could Jim and Sarah have a Form 8938, Statement of Specified Foreign Financial Assets, reporting requirement, but not a Report of Foreign Bank and Financial Accounts (FBAR) filing requirement using FinCEN Form 114?

Answer: Yes, a taxpayer could have a Form 8938, filing requirement but not an FBAR filing requirement. This is due to differences in the threshold requirements and types of reportable assets for each form. A taxpayer might have foreign assets that meet the Form 8938 filing thresholds (e.g., foreign stock held directly) but do not qualify as foreign financial accounts. Since FBAR only covers foreign financial accounts, these types of foreign assets would not trigger an FBAR filing.

1. Types of reportable assets:

   a. Form 8938: Covers a broader range of foreign financial assets, including interests in foreign entities and certain foreign non-account assets like foreign stocks held directly.

   b. FinCEN 114 (FBAR): Limited to foreign financial accounts, such as bank accounts, brokerage accounts and similar types of accounts with a financial institution.

   2. Threshold differences:

      a. Form 8938: For specified individuals, the thresholds are as follows: If an unmarried or married filing separate (MFS) taxpayer living in the U.S. has assets over $50,000 on the last day of the tax year, or $75,000 at any time during the tax year, they must file. For married taxpayers filing jointly (MFJ), these limits are $100,000 on the last day of the tax year or $150,000 at any time during the tax year. These amounts increase for U.S. citizens/resident aliens living abroad. For unmarried or MFS taxpayers, the threshold is $200,000 on the last day of the tax year or $300,000 at any time during the tax year. For MFJ taxpayers, the thresholds are $400,000 on the last day of the tax year and $600,000 at any time during the tax year.

      b. FinCEN Form 114 (FBAR): Required if the aggregate value of foreign financial accounts exceeds $10,000 at any point during the calendar year. There are no differences in thresholds whether the taxpayer is married filing a joint return, married filing a separate return or an unmarried taxpayer.

The IRS released Form 15620, Section 83(b) Election, a new form for taxpayers to use when making an election under §83(b). When a taxpayer makes a §83(b) election, they are notifying the IRS they wish to be taxed on property at substantial risk of forfeiture, such as restricted stock, when it is received in exchange for services and not when it vests.

Property is at substantial risk of forfeiture when a condition must be met in the future for the recipient to own the property outright. A common situation where a taxpayer receives property at substantial risk of forfeiture is when a founder or advisor to a startup company receives shares of common stock under the condition they remain with the company for a specified period of time or achieve specific performance milestones. If the recipient doesn’t meet the specified conditions, the stock recipient either surrenders the shares or must sell them back to the company at a discount.

Under §83(a), a taxpayer who receives property with a substantial risk of forfeiture as compensation in connection with services they performed is not taxed on the compensation at the time it is granted. However, a taxpayer may make an election under §83(b) to recognize the property as ordinary income on the date it is granted. A taxpayer who makes a §83(b) election may be eligible to treat the future appreciation of the property as long-term capital gains if it is held for longer than one year.

An election under §83(b) must be submitted to the IRS within 30 days of receiving the restricted property. Taxpayers who do not file within this 30-day window may not make a late election. Section 83(b) elections can’t be revoked.

Before the release of Form 15620, a taxpayer making a §83(b) election was required to draft a document explaining their election using sample language included in IRS guidance. Because the situation was explained by the taxpayer, there was a chance the IRS could reject the election for failure to include the proper language or information. Using Form 5620 ensures that taxpayers have included all of the necessary information when making their election. Taxpayers still have the option of submitting a document explaining their election to the IRS instead of using Form 15620, but it is recommended they use the form, which must be mailed to the IRS.

The question of whether a taxpayer’s activity qualifies as a business or a hobby can be a close one, but it can significantly impact their tax returns.

Below, you’ll find a few of the top questions from a recent webinar on the topic and their accompanying answers. If you choose to attend the on-demand version of this webinar, you can access the full recording and the entire list of Q&As.   

Q: Do you use three out of five years or two out of seven for agricultural businesses?

A: The two out of seven years rule applies specifically to activities involving the breeding, training, or showing of racing horses. All other agricultural activities continue to follow the three out of five years safe harbor rule.

Q: At what point do you have to report income as a hobby?

A: Technically, taxpayers should report any income they earn on their tax return, regardless of how minimal it is. This means that even income from a single sale must be reported.

Q: Just to clarify, hobby income is income LESS all expenses?

A: No. Currently, cost of goods sold (COGS) is the only expense that can reduce hobby income. COGS refers to the direct expenses associated with producing the item for sale. Other expenses are not deductible as they are considered miscellaneous itemized deductions subject to the 2% AGI limitation, which have been suspended at this time.

Q: How do hobby income, COGS and Form 1099-K, Payment Card and Third-Party Network Transactions, work together? Specifically, where do the numbers show up on the tax return?

A: Let’s say a client sells craft items on Etsy and has enough sales that a 1099-K is issued. You must determine whether the activity qualifies as a hobby or a trade or business. If it’s classified as a hobby, you report income net of COGS on Line 8j of the tax return.

To learn more about determining a not-for-profit hobby vs. for-profit trade or business, you can watch our on-demand webinar. NATP members can attend for free, depending on membership level! If you’re not an NATP member and want to learn more, join our completely free 30-day trial.