Whether you are completing the streamlined compliance procedures or preparing your annual tax return, if you have foreign income, you must use exchange rates. But which rate or source of rates should you use? Can you use multiple rates in the same return? Can you change rates each year to get the lowest tax? Below is a brief summary of the rules.
Form 8938 (FATCA) and FinCEN 114 (FBAR) are information returns. They provide the US government with information about your assets but do not affect your taxable income. So the exchange rate used on those forms does not affect the tax you pay.
Schedule B of your tax return is where you report the interest or ordinary dividends you received during the year, including interest or ordinary dividends from your foreign accounts. The amounts reported on Schedule B are included in your taxable income. So the exchange rate you use can have an impact on the tax you pay.
Form 8938 and FinCEN 114: Form 8938 (FATCA) and FinCEN 114 (FBAR) offer no flexibility. The instructions require the use of US Treasury Reporting Rates of Exchange unless the Treasury does not provide a rate for your particular currency. You can use another published exchange rate only if no exchange rate is provided by the Treasury. Whatever exchange rate source you use, you must use the rate in effect on the last day of the tax year for all amounts on the form, even those amounts, such as the maximum value, that may not have occurred on the last day of the year.
The historical treasury rates for use on Form 8938 and FinCEN 114 are located at the Bureau of the Fiscal Service website.
1040 Schedule B: The instructions Schedule B allow the use of exchange rates from any published source. This is true even if you filed an 8938 and/or FBAR using the Treasury rates. You must use the rate (spot, average, etc.) that is most applicable to the situation. For example, in the case of interest earned over the year, an average rate would be a correct choice. However, whatever source and scheme are used, they must be used consistently, year over year. The IRS will not allow changing rates and sources in each year to obtain the most advantageous exchange rate.