More now than ever people travel, work, and live all around the world. Therefore, understanding how to deal with foreign currency is becoming even more relevant. Taxpayers who have transactions in foreign currencies often wonder what they need to report and how they get the foreign currency into US dollars. Let’s review four of the most widely asked question regarding a taxpayer’s responsibility when dealing with foreign currency.
What is functional currency?
Generally speaking, ‘functional currency’ is the dollar for US tax purposes. That is unless you are dealing with a qualified business unit (QBU) who finds that a significant part of the business activities is conducted and recorded in the currency of the business’ economic environment.
For example, Person A is a US person who lives in Hong Kong. Person A has a business in Hong Kong that does all of the transactions in HK$ and keeps the books and records in HK$. When Person A considers the earnings and profits (E&P) for the year for US purposes, they don’t need to have converted every transaction to USD in order to report E&P. They would use the HK$ to determine the QBU’s earnings and profits and then translated to USD for reporting purposes using the appropriate exchange rate.
It is possible to make an election for a QBU to use the USD as the functional currency if they:
1) Keep the books and records in USD, AND
2) Use a method of accounting that approximates a separate transactions method.
What rate do I use to convert foreign bank account reports, income, and foreign financials?
Amounts reported on the US tax return/informational filings must be in US dollars. Payments to the IRS must also be made in USD. Usually, if your functional currency is the USD then you would translate each foreign transaction to USD at the transaction date’s spot rate. The same goes for a QBU with the USD as their functional currency.
For example, Company B is only in the US and does nearly all of their transactions in the US. Company B sells widgets and makes one sale to a Canadian company for one million Canadian dollars (CAD). Company B needs to convert the CAD into USD at the spot rate on the date they accrue the sale/receive the CAD for the sale (depending on cash v. accrual method). This is because Company B’s functional currency is the USD.
When reporting maximum foreign bank balances on the Form 114 Foreign Bank Account Report, that amount should be entered in USD by using the rate provided for the last day of that calendar year by the Treasury’s Financial Management Service.
The IRS specifies that while they as an agency have no official exchange rate that they generally accept any posted rate that is used consistently. They also provide yearly average currency exchange rates for a variety of countries.
What is the most important takeaway with foreign currency and the IRS?
It is crucial that consistency is maintained in foreign currency conversions. This means that converting the same rental property activity should not use one source in year one, another source in year two, and a third source in year three. Rather one should give time to making sure a proper source is used and then use it consistently.
To that end, make sure you are documenting your source and methodology in your records. In doing so, should your reports ever be questioned, you can demonstrate consistency and methodology with ease. It will also make preparing the following year easier if you have documented your methodology.
Where can I find the rates to convert foreign currency into USD?
These sources provide reliable currency rates:
There may be additional forms and issues that are required related to the foreign currencies. Though they may not be listed in this article, such forms may still apply given individual taxpayer’s situations. Please check out Ryan & Wetmore’s list of major international tax forms (this list is not all-inclusive and is ongoing). For many of the foreign forms, the statute for the year may not have started running if there was a form required that was not filed or was incomplete. It is very important to engage qualified tax professionals to assist with these forms.
The International Tax Team at Ryan & Wetmore is well-versed in foreign informational filings. For questions or concerns regarding your international accounts and assets, click here to email our foreign tax team. Please be aware that tax issues are complicated and may vary based on the details of your situation. For this reason, an initial phone call is generally required to obtain the facts and address the questions.
Bethany Bouw CPA, is a manager at Ryan & Wetmore and has been with the firm for over eight years. She has experience with offshore voluntary compliance and assisting taxpayers with foreign asset and entity reporting requirements.
Traci Getz CPA, is a partner with Ryan & Wetmore, P.C. Traci has over fifteen years of experience providing accounting, tax, and consulting services to small and medium-sized business owners. She works with clients to understand their accounting and tax issues while specializing in international tax, healthcare, and construction.
Our firm provides the information in this e-newsletter for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.
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