[Federal Register Volume 81, Number 35 (Tuesday, February 23, 2016)]
[Rules and Regulations]
[Pages 8835-8840]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-03795]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9752]
RIN 1545-BM54


Reporting of Specified Foreign Financial Assets

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations providing guidance 
regarding the requirements for certain domestic entities to report 
specified foreign financial assets to the Internal Revenue Service. 
These regulations set forth the conditions under which a domestic 
entity will be considered a specified domestic entity required to 
undertake such reporting. These regulations affect certain domestic 
corporations, partnerships, and trusts.

DATES: Effective date: These regulations are effective on February 23, 
2016.
    Applicability date: For dates of applicability, see Sec. Sec.  
1.6038D-2(g) and 1.6038D-6(e).

FOR FURTHER INFORMATION CONTACT: Joseph S. Henderson, (202) 317-6942 
(not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Background

    Section 6038D was enacted by section 511 of the Hiring Incentives 
to Restore Employment (HIRE) Act, Public Law 111-147 (124 Stat. 71). 
Section 6038D(a) requires certain individuals to report information 
about specified foreign financial assets. Section 6038D(f) provides 
that, to the extent provided by the Secretary in regulations or other 
guidance, section 6038D shall apply to any domestic entity which is 
formed or availed of for purposes of holding, directly or indirectly, 
specified foreign financial assets, in the same manner as if the entity 
were an individual.
    On December 19, 2011, the Department of the Treasury (Treasury 
Department) and the Internal Revenue Service (IRS) published temporary 
regulations (the ``2011 temporary regulations'') (TD 9567) and a notice 
of proposed rulemaking by cross-reference to temporary regulations 
(REG-130302-10) in the Federal Register (76 FR 78553 and 76 FR 78594, 
respectively) addressing the reporting requirements under section 
6038D. The notice of proposed rulemaking also included proposed Sec.  
1.6038D-6, which set forth the conditions under which a domestic entity 
will be considered a specified domestic entity and, therefore, required 
to report specified foreign financial assets in which it holds an 
interest. Corrections to the 2011 temporary regulations were published 
on February 21, 2012, in the Federal Register (77 FR 9845). Corrections 
to proposed Sec.  1.6038D-6 were published on February 21, 2012, and 
February 22, 2012, in the Federal Register (77 FR 9877 and 77 FR 10422, 
respectively). The 2011 temporary regulations were issued as final 
regulations (TD 9706; 79 FR 73817) on December 12, 2014 (the ``2014 
final regulations''). The Treasury Department and the IRS did not adopt 
proposed Sec.  1.6038D-6 (REG-144339-14) as a final regulation at that 
time.
    The Treasury Department and the IRS received written comments on 
proposed Sec.  1.6038D-6. All comments are available at 
www.regulations.gov or upon request. Because no requests to speak were 
received, no public hearing was held. After consideration of the 
comments received, the Treasury Department and the IRS adopt proposed 
Sec.  1.6038D-6 as a final regulation with the modifications described 
herein.

Summary of Comments and Explanation of Revisions

I. Organizational Changes Regarding the Reporting Threshold

    Proposed Sec. Sec.  1.6038D-6(b)(1)(i) and 1.6038D-6(c)(1) provide 
that, in order to be treated as a specified domestic entity, an entity 
must have an interest in specified foreign financial assets (excluding 
assets excepted under Sec.  1.6038D-7T) that exceeds the reporting 
threshold in Sec.  1.6038D-2T(a)(1). Under the proposed regulations, a 
domestic entity applies the reporting threshold in Sec.  1.6038D-
2T(a)(1) to determine whether it is a specified domestic entity. In 
making this determination, the proposed regulations require a 
corporation or partnership to take into account the aggregation rules 
in proposed Sec.  1.6038D-6(b)(4)(i). Proposed Sec. Sec.  1.6038D-
6(b)(1)(i) and 1.6038D-6(c)(1), however, suggested that a specified 
domestic entity is required to again apply Sec.  1.6038D-2T(a)(1) to 
determine whether it has a reporting requirement.
    The Treasury Department and the IRS did not intend for domestic 
entities to apply the reporting threshold described in Sec.  1.6038D-
2(a)(1) twice in order to determine their section 6038D reporting 
responsibilities. Therefore, these final regulations eliminate the 
requirement to apply Sec.  1.6038D-2(a)(1) as part of determining 
whether an entity is a specified domestic entity. Instead, a domestic 
entity that meets the definition of a specified domestic entity, which 
under these final regulations is determined without regard to whether 
the reporting threshold in Sec.  1.6038D-2(a)(1) is met, applies the 
reporting threshold under Sec.  1.6038D-2(a)(1) once, as part of 
determining whether it has a filing obligation. The aggregation rule 
for corporations and partnerships and the rule excluding assets 
excepted under Sec.  1.6038D-7 from the reporting threshold have been 
moved to Sec.  1.6038D-2(a)(6). These changes are organizational and no 
change is intended to the substantive reporting requirements for a 
specified domestic entity.

II. Elimination of Principal Purpose Test

    Proposed Sec.  1.6038D-6(b)(1)(iii) provides that a corporation or 
partnership is treated as formed or availed of for purposes of holding, 
directly or indirectly, specified foreign financial assets if either: 
(1) At least 50 percent of the corporation or partnership's gross 
income or assets is passive; or (2) at least 10 percent of the 
corporation or partnership's gross income or assets is passive and the 
corporation or partnership is formed or availed of by a specified 
individual with a principal purpose of avoiding section 6038D (the 
principal purpose test). Under proposed Sec.  1.6038D-6(b)(1)(iii), all 
facts and circumstances are taken into account to determine whether a 
specified individual has a principal purpose of avoiding section 6038D.
    The Treasury Department and the IRS believe that a 50-percent 
passive assets or income threshold appropriately captures situations in 
which specified individuals may use a domestic

[[Page 8836]]

corporation or partnership to circumvent the reporting requirements of 
section 6038D. Furthermore, the Treasury Department and the IRS have 
concluded that taxpayers should be able to determine their reporting 
requirements under section 6038D based on objective requirements rather 
than a subjective principal purpose test. Therefore, these final 
regulations eliminate the principal purpose test for determining 
whether a corporation or partnership is a specified domestic entity. 
However, the Treasury Department and the IRS will continue to monitor 
whether domestic corporations and partnerships not required to report 
under these final regulations are being used inappropriately by 
specified individuals to avoid reporting under section 6038D. If 
needed, the Treasury Department and the IRS may expand the definition 
of a specified domestic entity in future guidance.

III. Definition of Passive Income

    Proposed Sec.  1.6038D-6(b)(2) defines ``passive income'' by 
listing specific items of income that are treated as passive. Following 
the issuance of proposed Sec.  1.6038D-6(b)(2), on February 15, 2012, 
comprehensive regulations (77 FR 9022 (REG-121647-10)) were proposed 
under sections 1471 through 1474, which were also enacted as part of 
the HIRE Act that enacted section 6038D. A definition of passive income 
was included in the proposed regulations under section 1472 for 
purposes of identifying certain active nonfinancial foreign entities 
(NFFEs), which are excepted from withholding under section 1472(a) and 
therefore do not have to report their substantial U.S. owners in order 
to avoid withholding. The definition of passive income in proposed 
Sec.  1.1472-1(c)(1)(v) contained a list of items that was similar, 
although not identical, to the list contained in proposed Sec.  
1.6038D-6(b)(2). On January 28, 2013, the proposed regulations under 
sections 1471 through 1474 were finalized (78 FR 5874, TD 9610). In the 
final regulations, the Treasury Department and the IRS clarified the 
scope of the definition of passive income, made modifications in 
response to comments received, and moved the provision to Sec.  1.1472-
1(c)(1)(iv)(A). In addition, exceptions for look-through payments and 
dealers were added in Sec.  1.1472-1(c)(1)(iv)(B).
    The definitions of passive income under sections 1472 and 6038D 
serve a similar function, which is to identify entities that have a 
high risk of being used for tax evasion and to reduce compliance 
burdens for active entities. Therefore, these final regulations in 
Sec.  1.6038D-6(b)(2) adopt several of the modifications to the term 
``passive income'' that were included in Sec.  1.1472-1(c)(1)(iv)(A). 
Specifically, these modifications: (1) Clarify that ``dividends'' 
includes substitute dividends and expand ``interest'' to cover income 
equivalent to interest, including substitute interest, (2) add a new 
exception for certain active business gains or losses from the sale of 
commodities, and (3) define notional principal contracts by adding a 
reference to Sec.  1.446-3(c)(1). In addition, these final regulations 
add the exception for dealers that is described in Sec.  1.1472-
1(c)(1)(iv)(B)(2).
    In addition, the proposed regulations under both sections 1472 and 
6038D excluded from the definition of passive income rents or royalties 
derived in the active conduct of a trade or business conducted by 
employees of the relevant entity. A comment submitted in response to 
proposed Sec.  1.6038D-6(b)(2)(iii) expressed concern that the 
exception applies only to rents and royalties derived in an active 
trade or business conducted exclusively by a corporation's or 
partnership's employees, and noted that it is difficult to find a trade 
or business that is conducted solely by a business's employees. These 
final regulations provide, consistent with Sec.  1.1472-
1(c)(1)(iv)(A)(4), that rents and royalties derived in the active 
conduct of a trade or business conducted ``at least in part'' by 
employees of the corporation or partnership will not be considered 
passive income.
    The exception for certain look-through income from related persons 
in Sec.  1.1472-1(c)(1)(iv)(B)(1) is not adopted in these final 
regulations because Sec.  1.6038D-6(b)(3)(ii) already eliminates 
passive income or assets arising from related party transactions for 
purposes of applying the passive income and asset thresholds to a 
corporation or partnership with related entities.
    Finally, the proposed regulations did not specify how to determine 
whether 50 percent of a corporation's or partnership's assets are 
passive assets. The Treasury Department and the IRS believe that the 
weighted average test for active NFFEs in the regulations under section 
1472 provides an administrable way to determine the passive asset 
percentage. Therefore, these final regulations provide that the passive 
asset percentage is determined based on a weighted average approach 
similar to the rule in Sec.  1.1472-1(c)(1)(iv). Under this test, 
corporations or partnerships may use either fair market value or book 
value (as reflected on the entity's balance sheet and as determined 
under either a U.S. or an international financial accounting standard) 
to determine the value of their assets. Corporations or partnerships 
may be required to substantiate their determination of the passive 
asset percentage upon request by the IRS. See section 6001.

IV. Annual Determination of Specified Person's Interest in a Domestic 
Partnership

    Proposed Sec.  1.6038D-6(a) provides that whether a domestic 
partnership is a specified domestic entity is determined annually, and 
proposed Sec.  1.6038D-6(b)(3)(ii) provides that a partnership is 
closely held if at least 80 percent of the capital or profits interest 
in the partnership is held directly, indirectly, or constructively by a 
specified individual on the last day of the partnership's taxable year.
    A commenter recommended that a partner's interest in a partnership 
should be calculated on a year-by-year basis for purposes of 
determining whether a domestic partnership is a specified domestic 
entity. The comment noted that it is often difficult to determine the 
precise capital or profits interest of a partner because it may shift 
depending on the performance of the partnership.
    The requirement to determine a partner's capital or profits 
interest on a particular day is present in other provisions of the 
Internal Revenue Code, Treasury regulations, and published guidance, 
and the Treasury Department and the IRS believe it is an appropriate 
measure of an individual's economic interest in a partnership and, in 
general, is not overly complex. Accordingly, these final regulations 
retain the rule in the proposed regulations for determining if a 
domestic partnership is closely held.

V. Clarification to Aggregation Rules

    Proposed Sec.  1.6038D-6(b)(4) provides aggregation rules for 
purposes of applying proposed Sec.  1.6038D-6(b)(1)(i), the Sec.  
1.6038D-2(a)(1) reporting threshold, and the passive income and asset 
thresholds under proposed Sec.  1.6038D-6(b)(1)(iii). The proposed 
regulations provide that, for purposes of applying proposed Sec.  
1.6038D-6(b)(1)(i) and the reporting threshold, all domestic 
corporations and domestic partnerships that have an interest in 
specified foreign financial assets and are closely held by the same 
specified individual are treated as a single entity, and each such 
related corporation or partnership is treated as owning the specified 
foreign financial assets held by all such related corporations or

[[Page 8837]]

partnerships. Similarly, the proposed regulations provide that, for 
purposes of applying the passive income and asset thresholds, all 
domestic corporations and domestic partnerships that are closely held 
by the same specified individual and connected through stock or 
partnership interest ownership with a common parent corporation or 
partnership are treated as a single entity, and each member of such a 
group is treated as owning the combined assets and receiving the 
combined income of all members of that group.
    The Treasury Department and the IRS have determined that it is not 
necessary both to treat a group as a single entity and to attribute the 
assets or income of members of the group to an entity. Therefore, these 
final regulations simplify the aggregation rules by eliminating the 
reference to treating all domestic corporations and partnerships as a 
single entity.

VI. Domestic Trusts

    Proposed Sec.  1.6038D-6(c) provides that a trust described in 
section 7701(a)(30)(E) is a specified domestic entity if and only if 
the trust has one or more specified persons as a current beneficiary. 
The term current beneficiary means, with respect to the taxable year, 
any person who at any time during such taxable year is entitled to, or 
at the discretion of any person may receive, a distribution from the 
principal or income of the trust (determined without regard to any 
power of appointment to the extent that such power remains unexercised 
at the end of the taxable year). The Treasury Department and the IRS 
intend that a specified domestic entity include a trust whereby a 
specified person has an immediately exercisable general power of 
appointment, even if such specified person is not technically a 
beneficiary. Therefore, these final regulations clarify that the term 
current beneficiary also includes any holder of a general power of 
appointment, whether or not exercised, that was exercisable at any time 
during the taxable year, but does not include any holder of a general 
power of appointment that is exercisable only on the death of the 
holder.

VII. Expanding the Exceptions for Domestic Entities

    Proposed Sec.  1.6038D-6(d) excepts certain entities from being 
treated as a specified domestic entity. A commenter recommended that 
the final regulations expand proposed Sec.  1.6038D-6(d) to also except 
certain domestic trusts that are not required to file a Form 1041, 
``U.S. Fiduciary Income Tax Return,'' or any information returns. The 
Treasury Department and the IRS do not adopt this comment because the 
2014 final regulations already address the commenter's concerns. The 
2014 final regulations provide in Sec.  1.6038D-2(a)(7) that a 
specified person, including a specified domestic entity, is not 
required to file Form 8938, ``Statement of Specified Foreign Financial 
Assets,'' with respect to a taxable year if the specified person is not 
required to file an annual return with the IRS with respect to that 
taxable year. In the case of a specified domestic entity, the term 
``annual return'' means an annual federal income tax return or 
information return filed with the IRS, including returns required under 
section 6012. See Sec.  1.6038D-1(a)(11). A Form 1041 is an annual 
return for purposes of Sec.  1.6038D-1(a)(11) of the final regulations.
    A commenter recommended that the final regulations except publicly 
traded partnerships from being specified domestic entities because they 
are similar to publicly traded corporations described in section 
1473(3), which are excepted from the definition of specified domestic 
entity under proposed Sec.  1.6038D-6(d)(1). The Treasury Department 
and the IRS do not adopt this comment. The requirement under proposed 
Sec.  1.6038D-6(b) that to be a specified domestic entity at least 80 
percent of the capital or profits interest in a partnership must be 
held by a specified individual on the last day of the partnership's 
taxable year establishes appropriate general criteria that, as a 
practical matter, should exempt most publicly traded partnerships from 
being specified domestic entities.
    A commenter recommended that the final regulations except an 
employer trust established for the benefit of more than a minimum 
number of employees, such as 50, from being a specified domestic entity 
even if the employer trust holds stock of a foreign company. The 
Treasury Department and the IRS believe the exception under proposed 
Sec.  1.6038D-6(d)(1) for domestic entities that are not ``specified 
United States persons'' pursuant to section 1473(3), together with the 
exception for trusts whose trustees satisfy the supervisory oversight 
requirements and the income tax and information return filing 
requirements under proposed Sec.  1.6038D-6(d)(2), are sufficiently 
broad to except employer trusts that represent a low risk of tax 
avoidance from characterization as a specified domestic entity. 
Therefore, this comment is not adopted.

Special Analyses

    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required.
    It is hereby certified that these regulations will not have a 
significant economic impact on a substantial number of small entities 
within the meaning of section 601(6) of the Regulatory Flexibility Act 
(5 U.S.C. chapter 6). In the case of domestic corporations and 
partnerships, these regulations apply only when two separate tests are 
met. The first requires that at least 80 percent of the entity must be 
owned, directly, indirectly, or constructively, by a specified 
individual, generally a U.S. citizen or resident. The second test 
compares the entity's business income and assets with its passive 
income and assets. If more than 50 percent of the entity's annual gross 
income for the year is active business income and more than 50 percent 
of its assets for the taxable year are assets that produce or are held 
for the production of active income, then the entity is not subject to 
the reporting requirements under section 6038D. This two-part test 
reduces the burden imposed by these final regulations on domestic small 
business entities because closely-held domestic corporations and 
partnerships that are predominantly engaged in an active business 
generally will be excluded from reporting. Furthermore, small not-for-
profit organizations that are tax-exempt under section 501(a) of the 
Internal Revenue Code and small governmental jurisdictions are not 
subject to these regulations.
    For closely-held domestic corporations and partnerships that meet 
both tests, these final regulations limit the burden imposed. First, 
reporting is required only when the aggregate value of the entity's 
interests in specified foreign financial assets exceeds the reporting 
threshold under Sec.  1.6038D-2(a)(1). Second, the final regulations 
exclude the value of specified foreign financial assets reported on one 
or more of the following forms from being taken into consideration in 
determining whether the small entity satisfies the reporting threshold 
under Sec.  1.6038D-2(a)(1): Form 3520, ``Annual Return To Report 
Transactions With Foreign Trusts and Receipt of Certain Foreign 
Gifts``; Form 3520-A, ``Annual Information Return of Foreign Trust With 
a U.S. Owner''; Form 5471, ``Information Return of U.S. Persons

[[Page 8838]]

With Respect To Certain Foreign Corporations''; Form 8621, 
``Information Return by a Shareholder of a Passive Foreign Investment 
Company or Qualified Electing Fund''; or Form 8865, ``Return of U.S. 
Persons With Respect to Certain Foreign Partnerships.'' Third, small 
entities that hold specified foreign financial assets generally will be 
excepted from reporting such assets if the assets are reported on one 
or more of the these forms, thereby further limiting the burden imposed 
by the final regulations on small entities. Therefore, a Regulatory 
Flexibility Analysis under the Regulatory Flexibility Act is not 
required. Pursuant to section 7805(f) of the Code, the notice of 
proposed rulemaking preceding this regulation was submitted to the 
Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small business.

Drafting Information

    The principal author of these regulations is Joseph S. Henderson, 
Office of Associate Chief Counsel (International). However, other 
personnel from the IRS and Treasury Department participated in their 
development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry for Sec.  1.6038D-6 in numerical order to read in part as 
follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.6038D-6 is also issued under 26 U.S.C. 6038D.


0
Par. 2. Section 1.6038D-0 is amended by:
0
1. Revising the entry for Sec.  1.6038D-1(a)(12).
0
2. Adding entries for Sec.  1.6038D-2(a)(6)(i) and (ii).
0
3. Revising the entry for Sec.  1.6038D-6.
    The revisions and additions read as follows:


Sec.  1.6038D-0  Outline of regulation provisions

* * * * *


Sec.  1.6038D-1  Reporting with respect to specified foreign financial 
assets, definition of terms.

    (a) * * *
* * * * *
    (12) Specified domestic entity.
* * * * *


Sec.  1.6038D-2  Requirement to report specified foreign financial 
assets.

    (a) * * *
* * * * *
    (6) * * *
    (i) Specified individual.
    (ii) Specified domestic entity.
* * * * *


Sec.  1.6038D-6  Specified domestic entities.

    (a) Specified domestic entity.
    (b) Corporations and partnerships.
    (1) Formed or availed of.
    (2) Closely held.
    (i) Domestic corporation.
    (ii) Domestic partnership.
    (iii) Constructive ownership.
    (3) Determination of passive income and assets.
    (i) Definition of passive income.
    (ii) Exception from passive income treatment for dealers.
    (iii) Related entities.
    (4) Examples.
    (c) Domestic trusts.
    (d) Excepted domestic entities.
    (1) Certain persons described in section 1473(3).
    (2) Certain domestic trusts.
    (3) Domestic trusts owned by one or more specified persons.
    (e) Effective/applicability dates.
* * * * *

0
Par. 3. Section 1.6038D-1(a)(12) is revised to read as follows:


Sec.  1.6038D-1  Reporting with respect to specified foreign financial 
assets, definition of terms.

    (a) * * *
* * * * *
    (12) Specified domestic entity. The term specified domestic entity 
has the meaning set forth in Sec.  1.6038D-6.
* * * * *

0
Par. 4. Section 1.6038D-2 is amended by:
0
1. Redesignating the text of paragraph (a)(6) as paragraph (a)(6)(i) 
and adding a paragraph heading to newly redesignated paragraph 
(a)(6)(i).
0
2. Adding paragraph (a)(6)(ii).
0
3. Revising paragraph (g).
    The additions and revision read as follows:


Sec.  1.6038D-2  Requirement to report specified foreign financial 
assets.

    (a) * * *
    (6) Aggregate value calculation in case of specified foreign 
financial asset excluded from reporting--(i) Specified individual. * * 
*
    (ii) Specified domestic entity. The value of any specified foreign 
financial asset in which a specified domestic entity has an interest 
and that is excluded from reporting on Form 8938 pursuant to Sec.  
1.6038D-7(a) (concerning certain assets reported on another form) is 
excluded for purposes of determining the aggregate value of specified 
foreign financial assets. For purposes of determining the aggregate 
value of specified foreign financial assets, a specified domestic 
entity that is a corporation or partnership and that has an interest in 
any specified foreign financial asset is treated as owning all the 
specified foreign financial assets (excluding specified foreign 
financial assets excluded from reporting on Form 8938 pursuant to Sec.  
1.6038D-7(a)) held by all domestic corporations and domestic 
partnerships that are closely held by the same specified individual as 
determined under Sec.  1.6038D-6(b)(2).
* * * * *
    (g) Effective/applicability dates. This section, with the exception 
of Sec.  1.6038D-2(a)(6)(ii), applies to taxable years ending after 
December 19, 2011. Section 1.6038D-2(a)(6)(ii) applies to taxable years 
beginning after December 31, 2015. Taxpayers may elect to apply the 
rules of this section, with the exception of Sec.  1.6038D-2(a)(6)(ii), 
to taxable years ending on or prior to December 19, 2011.

0
Par 5. Section 1.6038D-6 is added to read as follows:


Sec.  1.6038D-6  Specified domestic entities.

    (a) Specified domestic entity. A specified domestic entity is a 
domestic corporation, a domestic partnership, or a trust described in 
section 7701(a)(30)(E), if such corporation, partnership, or trust is 
formed or availed of for purposes of holding, directly or indirectly, 
specified foreign financial assets. Whether a domestic corporation, a 
domestic partnership, or a trust described in section 7701(a)(30)(E) is 
a specified domestic entity is determined annually.
    (b) Corporations and partnerships--(1) Formed or availed of. Except 
as otherwise provided in paragraph (d) of this section, a domestic 
corporation or a domestic partnership is formed or availed of for 
purposes of holding, directly or indirectly, specified foreign 
financial assets if and only if--
    (i) The corporation or partnership is closely held by a specified 
individual as determined under paragraph (b)(2) of this section; and
    (ii) At least 50 percent of the corporation's or partnership's 
gross income for the taxable year is passive income or at least 50 
percent of the assets held by the corporation or

[[Page 8839]]

partnership for the taxable year are assets that produce or are held 
for the production of passive income as determined under paragraph 
(b)(3) of this section (passive assets). For purposes of this paragraph 
(b)(1)(ii), the percentage of passive assets held by a corporation or 
partnership for a taxable year is the weighted average percentage of 
passive assets (weighted by total assets and measured quarterly), and 
the value of assets of a corporation or partnership is the fair market 
value of the assets or the book value of the assets that is reflected 
on the corporation's or partnership's balance sheet (as determined 
under either a U.S. or an international financial accounting standard).
    (2) Closely held--(i) Domestic corporation. A domestic corporation 
is closely held by a specified individual if at least 80 percent of the 
total combined voting power of all classes of stock of the corporation 
entitled to vote, or at least 80 percent of the total value of the 
stock of the corporation, is owned, directly, indirectly, or 
constructively, by a specified individual on the last day of the 
corporation's taxable year.
    (ii) Domestic partnership. A partnership is closely held by a 
specified individual if at least 80 percent of the capital or profits 
interest in the partnership is held, directly, indirectly, or 
constructively, by a specified individual on the last day of the 
partnership's taxable year.
    (iii) Constructive ownership. For purposes of this paragraph 
(b)(2), sections 267(c) and (e)(3) apply for the purpose of determining 
the constructive ownership of a specified individual in a corporation 
or partnership, except that section 267(c)(4) is applied as if the 
family of an individual includes the spouses of the individual's family 
members.
    (3) Determination of passive income and assets--(i) Definition of 
passive income. Except as provided in paragraph (b)(3)(ii) of this 
section, for purposes of paragraph (b)(1)(ii) of this section, passive 
income means the portion of gross income that consists of--
    (A) Dividends, including substitute dividends;
    (B) Interest;
    (C) Income equivalent to interest, including substitute interest;
    (D) Rents and royalties, other than rents and royalties derived in 
the active conduct of a trade or business conducted, at least in part, 
by employees of the corporation or partnership;
    (E) Annuities;
    (F) The excess of gains over losses from the sale or exchange of 
property that gives rise to passive income described in paragraphs 
(b)(3)(i)(A) through (b)(3)(i)(E) of this section;
    (G) The excess of gains over losses from transactions (including 
futures, forwards, and similar transactions) in any commodity, but not 
including--
    (1) Any commodity hedging transaction described in section 
954(c)(5)(A), determined by treating the corporation or partnership as 
a controlled foreign corporation; or
    (2) Active business gains or losses from the sale of commodities, 
but only if substantially all the corporation or partnership's 
commodities are property described in paragraph (1), (2), or (8) of 
section 1221(a);
    (H) The excess of foreign currency gains over foreign currency 
losses (as defined in section 988(b)) attributable to any section 988 
transaction; and
    (I) Net income from notional principal contracts as defined in 
Sec.  1.446-3(c)(1).
    (ii) Exception from passive income treatment for dealers. 
Notwithstanding paragraph (b)(3)(i) of this section, in the case of a 
corporation or partnership that regularly acts as a dealer in property 
described in paragraph (b)(3)(i)(F) of this section (referring to the 
sale or exchange of property that gives rise to passive income), 
forward contracts, option contracts, or similar financial instruments 
(including notional principal contracts and all instruments referenced 
to commodities), the term passive income does not include--
    (A) Any item of income or gain (other than any dividends or 
interest) from any transaction (including hedging transactions and 
transactions involving physical settlement) entered into in the 
ordinary course of such dealer's trade or business as such a dealer; 
and
    (B) If such dealer is a dealer in securities (within the meaning of 
section 475(c)(2)), any income from any transaction entered into in the 
ordinary course of such trade or business as a dealer in securities.
    (iii) Related entities. For purposes of applying the passive income 
and asset thresholds of paragraph (b)(1)(ii) of this section, all 
domestic corporations and domestic partnerships that are closely held 
by the same specified individual as determined under paragraph (b)(2) 
of this section and that are connected through stock or partnership 
interest ownership with a common parent corporation or partnership are 
treated as owning the combined assets and receiving the combined income 
of all members of that group. For purposes of the preceding sentence, 
assets relating to any contract, equity, or debt existing between 
members of such a group, as well as any items of gross income arising 
under or from such contract, equity, or debt, are eliminated. A 
domestic corporation or a domestic partnership is considered connected 
through stock or partnership interest ownership with a common parent 
corporation or partnership if stock representing at least 80 percent of 
the total combined voting power of all classes of stock of the 
corporation entitled to vote or of the value of such corporation, or 
partnership interests representing at least 80 percent of the profits 
interests or capital interests of such partnership, in each case other 
than stock of or partnership interests in the common parent, is owned 
by one or more of the other connected corporations, connected 
partnerships, or the common parent.
    (4) Examples. The following examples illustrate the application of 
this section:

    Example 1. Closely held and constructive ownership. (i) Facts. 
DC1 is a domestic corporation the total value of the stock of which 
is owned 60% by A, a specified individual, 30% by B, a member of A's 
family for purposes of section 267(c)(2) who is not a specified 
individual, and 10% by FC1, a foreign corporation. DC1 owns 90% of 
the total value of the stock of DC2, a domestic corporation. FC2, a 
foreign corporation, owns 10% of DC2. Neither A nor B owns, 
directly, indirectly, or constructively, any stock in FC1 or FC2.
    (ii) Closely held ownership determination. A is considered to 
own 90% and 81% of the total value of DC1 and DC2, respectively, by 
application of the rules of section 267(c) and this section. DC1 and 
DC2 are closely held by A within the meaning of paragraph (b)(2) of 
this section because A, a specified individual, is considered to own 
more than 80% of their total value.
    Example 2. Application of aggregation rule and reporting 
threshold. (i) Facts. L is a specified individual. In Year X, L 
wholly owns DC1, a domestic corporation, and also owns a 90% capital 
interest in DP, a domestic partnership. DC1 owns 80% of the sole 
class of stock of DC2, a domestic corporation. DC1 has no assets 
other than its interest in DC2. DC2's only assets are assets that 
produce passive income, with a maximum value in Year X of $40,000 on 
October 12. DC2's assets are comprised in relevant part of specified 
foreign financial assets with a maximum value in Year X of $15,000 
on October 12. DP's only assets are assets that produce passive 
income and that are specified foreign financial assets with a 
maximum value of $90,000 in Year X on October 12.
    (ii) Specified domestic entity status--(A) DC1 and DC2. DC1 and 
DC2 are closely held by a specified individual for purposes of 
paragraph (b)(2) of this section. DC1 and DC2 are considered related 
entities that are connected through stock ownership with a common 
parent corporation under paragraph (b)(3)(iii) of this section, 
because DC1 and

[[Page 8840]]

DC2 are closely held by L, and DC2 is connected with DC1 through 
DC1's ownership of stock of DC2 representing at least 80% of the 
voting power or value of DC2. As a result, for purposes of applying 
paragraph (b)(1)(ii) of this section, each of DC1 and DC2 is 
considered as owning the combined assets, and receiving the combined 
income, of both DC1 and DC2; however, DC1's equity interest in DC2 
is disregarded for this purpose under paragraph (b)(3)(iii) of this 
section. Therefore, DC1 and DC2 each satisfies the passive asset 
threshold of paragraph (b)(1)(ii) of this section, because 100 
percent of each company's assets is passive. DC1 and DC2 are 
specified domestic entities for Year X.
    (B) DP. DP is closely held by a specified individual for 
purposes of paragraph (b)(2) of this section. DP is not considered a 
related entity with DC1 and DC2 under paragraph (b)(3)(iii) of this 
section, because DC1 and DP are not owned by a common parent 
corporation or partnership. As a result, whether the passive income 
or passive asset threshold of paragraph (b)(1)(ii) of this section 
is met with respect to DP is determined solely by reference to DP's 
separately earned passive income and separately held passive assets. 
DP holds only passive assets during Year X and therefore satisfies 
paragraph (b)(1)(ii) of this section. DP is a specified domestic 
entity for Year X.
    (iii) Reporting requirements--(A) DC1. Under Sec.  1.6038D-
2(a)(6)(ii), DC1 is not treated as owning the specified foreign 
financial assets held by DC2 and DP for purposes of applying the 
reporting threshold of Sec.  1.6038D-2(a)(1), because DC1 does not 
have an interest in any specified foreign financial assets. DC1 is 
not required to file Form 8938 because DC1 does not satisfy the 
reporting threshold of Sec.  1.6038D-2(a)(1).
    (B) DC2 and DP. Under Sec.  1.6038D-3, DC2 and DP each has an 
interest in specified foreign financial assets. For purposes of 
applying the reporting threshold of Sec.  1.6038D-2(a)(1), Sec.  
1.6038D-2(a)(6)(ii) provides that DC2 is treated as owning in 
addition to its own assets the assets of DP, and DP is treated as 
owning in addition to its own assets the assets of DC2. As a result, 
DC2 and DP each satisfies the reporting threshold of Sec.  1.6038D-
2(a)(1), because the value of the specified foreign financial assets 
each is considered as owning for purposes of Sec.  1.6038D-2(a)(1) 
is $105,000 on October 12, Year X, which exceeds DC2's and DP's 
$75,000 reporting threshold. DC2 and DP must each file Form 8938 for 
Year X to report their respective specified foreign financial assets 
in which they have an interest and disclose their maximum values as 
provided in Sec.  1.6038D-4 ($15,000 in the case of DC2 and $90,000 
in the case of DP).
    Example 3. Application of aggregation rule and entity with an 
active trade or business. (i) Facts. The facts are the same as in 
Example 2, except that DC2 also owns an active business. The assets 
attributable to the business are not passive assets and constitute 
at least 60% of the value of DC2's assets at all times during Year 
X. The income from the business is not passive income and 
constitutes at least 60% of the gross income generated by DC2 in 
Year X.
    (ii) Specified domestic entity status--(A) DC1 and DC2. DC1 and 
DC2 are considered related entities that are connected through stock 
ownership with a common parent corporation under paragraph 
(b)(3)(iii) of this section because DC1 and DC2 are closely held by 
L, and DC2 is connected with DC1 though DC1's ownership of stock of 
DC2 representing at least 80% of the voting power or value of DC2. 
As a result, for purposes of applying paragraph (b)(1)(ii) of this 
section, each of DC1 and DC2 is treated as owning the combined 
assets, and receiving the combined income, of both DC1 and DC2; 
however, DC1's equity interest in DC2 is disregarded for this 
purpose under paragraph (b)(3)(iii) of this section. As a result, no 
more than 40 percent of the value of DC1's and DC2's assets at all 
times during Year X are passive and no more than 40 percent of DC1's 
and DC2's gross income for Year X is passive. DC1 and DC2 do not 
satisfy the passive income or passive asset threshold in paragraph 
(b)(1)(ii) of this section for Year X. DC1 and DC2 are not specified 
domestic entities for Year X.
    (B) DP. For the reasons described in paragraph (ii)(B) of 
Example 2, DP is a specified domestic entity for Year X.
    (iii) Reporting requirements--(A) DC1 and DC2. DC1 and DC2 are 
not specified domestic entities for Year X, and are not required to 
file Form 8938.
    (B) DP. Under Sec.  1.6038D-3, DP has an interest in specified 
foreign financial assets. Under Sec.  1.6038D-2(a)(6)(ii), DP is 
treated as owning in addition to its own assets the assets of DC2. 
As a result, DP satisfies the reporting threshold of Sec.  1.6038D-
2(a)(1) because the value of the specified foreign financial assets 
it is considered to own for purposes of Sec.  1.6038D-2(a)(1) is 
$105,000 on October 12, Year X, which exceeds DP's $75,000 reporting 
threshold. DP must file Form 8938 for Year X to report the specified 
foreign financial assets in which it has an interest and disclose 
their maximum values as provided in Sec.  1.6038D-4, which is 
$90,000.

    (c) Domestic trusts. Except as otherwise provided in paragraph (d) 
of this section, a trust described in section 7701(a)(30)(E) is formed 
or availed of for purposes of holding, directly or indirectly, 
specified foreign financial assets if and only if the trust has one or 
more specified persons as a current beneficiary. The term current 
beneficiary means, with respect to the taxable year, any person who at 
any time during such taxable year is entitled to, or at the discretion 
of any person may receive, a distribution from the principal or income 
of the trust (determined without regard to any power of appointment to 
the extent that such power remains unexercised at the end of the 
taxable year). The term current beneficiary also includes any holder of 
a general power of appointment, whether or not exercised, that was 
exercisable at any time during the taxable year, but does not include 
any holder of a general power of appointment that is exercisable only 
on the death of the holder.
    (d) Excepted domestic entities. An entity is not considered to be a 
specified domestic entity if the entity is--
    (1) Certain persons described in section 1473(3). An entity, except 
for a trust that is exempt from tax under section 664(c), that is 
excepted from the definition of the term ``specified United States 
person'' under section 1473(3) and the regulations issued under that 
section;
    (2) Certain domestic trusts. A trust described in section 
7701(a)(30)(E) provided that the trustee of the trust--
    (i) Has supervisory authority over or fiduciary obligations with 
regard to the specified foreign financial assets held by the trust;
    (ii) Timely files (including any applicable extensions) annual 
returns and information returns on behalf of the trust; and
    (iii) Is--
    (A) A bank that is examined by the Office of the Comptroller of the 
Currency, the Board of Governors of the Federal Reserve System, the 
Federal Deposit Insurance Corporation, or the National Credit Union 
Administration;
    (B) A financial institution that is registered with and regulated 
or examined by the Securities and Exchange Commission; or
    (C) A domestic corporation described in section 1473(3)(A) or (B), 
and the regulations issued with respect to those provisions.
    (3) Domestic trusts owned by one or more specified persons. A trust 
described in section 7701(a)(30)(E) to the extent such trust or any 
portion thereof is treated as owned by one or more specified persons 
under sections 671 through 678 and the regulations issued under those 
sections.
    (e) Effective/applicability dates. This section applies to taxable 
years beginning after December 31, 2015.

Karen M. Schiller,
Deputy Commissioner for Services and Enforcement.
    Approved: January 19, 2016.

Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2016-03795 Filed 2-22-16; 8:45 am]
 BILLING CODE 4830-01-P