Tax Smackdown for Foreign Banks

New IRS Powers Make Banks and Expats Squirm

Tax Smackdown for Foreign Banks
September 17, 2014

Does the acronym FATCA (Foreign Account Tax Compliance Act) sound like “fat cat” to you? It does to us, especially as this law was created to stop wealthy Americans from using foreign financial accounts to hide their wealth and evade U.S. taxes.

Passed back in 2010, but only taking effect this past July, FATCA requires foreign financial Institutions (FFIs) to report information on American citizens holding over $50,000 in their foreign accounts – including accountholder names and addresses, account numbers, and Tax ID numbers. Failure to do this results in a 30% withholding tax to the FFI on all transactions regarding U.S. securities (including sale proceeds). Foreign entities in which U.S. taxpayers hold a substantial ownership interest (10% as defined by the IRS) must also be reported.

The definition of FFI is quite broad, and may include not just banks but also stockbrokers, insurance companies, trusts, and similar organizations that hold or invest assets. FFIs must register with the IRS and receive an EIN (Employer Identification Number) to be considered a compliant “participating FFI”. Those who fail to do so will receive the dreaded NPFFI (non-participating FFI) designation and be subject to the 30% tax.

The law finally took effect this summer, and all participating FFIs were to have registered before that date.

Reporting requirements are nothing new to expats. If you are U.S. citizens living abroad and have over $10,000 in aggregate foreign accounts at any time, you are expected to file a Report of Foreign Bank and Financial Accounts (FBAR) with the Treasury Department by June 30th.

Thanks to FATCA, if you have over $50,000 in foreign assets on the last day of the year or $75,000 at any time, you also must include IRS Form 8938, “Statement of Specified Foreign Financial Assets“, with your tax return. (The form 8938 threshold is higher for singles living abroad or married but filing jointly.)

Thus, if you have sufficient overseas assets, you may be forced to file all three (FBAR, FATCA and Form 8938). Note that this information concerns total assets, not just income.

Why does the government care about foreign assets? The U.S. is unique among major nations in taxing its citizens on worldwide income, whether the citizen actually lives in the U.S. or not. Because of the inability to get information on foreign-held assets from U.S. citizens, FATCA was enacted to eliminate traditional foreign tax havens. This new information allows the IRS to determine whether assets have been properly taxed and assess penalties if necessary.

Penalties for taxpayers can be severe. Failure to file Form 8938 produces a penalty of $10,000 per year up to a maximum of $50,000. There is also a 40% penalty levied on all understated assets.

The IRS has been running an Offshore Voluntary Disclosure Program of various types since 2009 to offer lesser penalties to taxpayers who want to straighten out their affairs before the laws go into effect. FATCA law is quite complex and the voluntary disclosure rules have been changing, so if you are in potential non-compliance, you should seek professional tax help as soon as possible.

Another bit of murkiness involves the definition of a U.S. person. Not only are U.S. citizens affected, as those with dual citizenship are also included. Domestic partnerships and corporations are included, as well as non-foreign estates and trusts.

Perhaps the only thing more remarkable than the breadth of FATCA and its reach into foreign sovereignty is the degree of agreement it achieved. It is an impressive accomplishment to have the majority of worldwide financial institutions complying with U.S. law, even with the threat of a potential 30% penalty. Over 77,000 FFI’s have registered. In cases where an FFI’s compliance with FATCA would violate local laws, intergovernmental agreements (IGA’s) have been negotiated to allow the transfer of information.

Estimates of the costs and benefits of FATCA vary widely, producing the predictable amount of arguments – including disproportionate costs; ensnaring of unsuspecting well-meaning taxpayers due to the reporting complexity and breadth of definitions; information privacy and security concerns; and even concerns that FATCA will pull foreign investment out of the U.S. and fuel a flight away from U.S. securities. On the positive side, international banking transparency will be markedly enhanced.

Lawsuits and repeal efforts have little momentum, so FATCA is now upon us – and likely here to stay, much to the chagrin of American fat cats. It will be interesting to see how this helps to fill America’s coffers.

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