by Wassim Malas
In the age-old game of cat-and-mouse between the IRS and tax evaders, the U.S. government just added a new tool to its arsenal. As part of the ongoing effort to improve tax compliance (and more importantly collection) involving foreign financial assets and offshore accounts, the United States in 2010 enacted The Foreign Account Tax Compliance Act (FATCA). In addition to closing certain tax loopholes, FATCA hopes to advance this general goal by imposing additional offshore reporting requirements on both U.S. taxpayers and foreign financial institutions.
In the past few years, a good number of CPAs have called our office with questions regarding the Foreign Bank Account Report (FBAR) and Offshore Voluntary Disclosure Initiative (OVDI). However, even more former clients of CPAs have called our office upset and injured because their accountant was unaware about the FBAR requirement and/or the OVDI program. Hopefully we’ve learned from past mistakes. Let’s try to understand the newest U.S. law on offshore reporting, FATCA, before it’s too late.
What is FATCA?
FATCA was introduced in 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act. Under FATCA, certain U.S. taxpayers holding financial assets outside the U.S. must report those assets to the IRS on a new IRS form (Form 8938). For most U.S. taxpayers, these reporting requirements start in the 2011 tax year. In other words, when you file your federal income tax return this year for 2011, you must attach a completed Form 8938 along with it.
FATCA applies to specified foreign assets; whereas the FBAR only applied to specified foreign accounts. Although the two overlap, the FATCA requirement to file IRS Form 8938 in no way eliminates or changes the FBAR requirement to file Treasury Form 90-22.1.
In addition to imposing additional offshore reporting requirements on U.S. taxpayers, FATCA also creates a separate set of reporting rules for foreign financial institutions (FFIs). Under FATCA, FFIs will be required to report information to the IRS about their financial accounts held by (1) U.S. taxpayers or (2) foreign entities in which U.S. taxpayers hold a substantial ownership interest.
While the FFI-specific rules do not come into effect until 2013, you should not wait until then before taking any action if you have undisclosed assets overseas. If an FFI reveals information that results in undisclosed foreign income or assets, you may be subject to severe penalties and/or criminal tax evasion.
FATCA and the U.S. Taxpayer
FATCA applies to U.S. taxpayers holding foreign financial assets with an aggregate value above set thresholds. You are considered a “U.S. taxpayer” if you are a U.S. citizen, U.S. resident alien, or nonresident alien who elected to be taxed as U.S. residents. It generally does not matter how long you’ve been living outside the U.S. or when you last paid U.S. taxes – if you fit the above description, there’s a good chance FATCA applies to you.
Being a U.S. taxpayer with some foreign financial assets does not necessarily mean you must file additional paperwork for your 2011 tax return. Rather, individuals must file Form 8938 with the IRS only if their specified foreign financial assets have an aggregate fair market that either exceeds (1) $50,000 on the last day of the tax year, or (2) $75,000 at any time during the year. If you are married filing jointly, the total value must either exceed (1) $100,00 on the last day of the tax year, or (2) $150,000 at any time during the tax year.
U.S. taxpayers living abroad are entitled to more lenient filing requirements. You are treated as a taxpayer living abroad if either your “tax home” is in a foreign country of which you are a bona fide resident for the entire tax year or, in the alternative, you physically spent 330 consecutive days in a foreign country for the entire tax year. Taxpayers living abroad must file Form 8938 if, at a minimum, their specified foreign assets are either (1) more than $200,000 on the last day of the tax year, or (2) more than $300,000 at any time during the tax year.
These offshore filing requirements may unnerve a good number of U.S. taxpayers with real estate** overseas, especially those with dual citizenship. However, FATCA does not apply to all foreign assets, just “specified foreign financial assets.” These assets include (1) any financial account maintained by an FFI; (2) any stock or securities issued by foreign persons; (3) any financial instrument or contract held for investment that was issued by a non-U.S. person; and (4) any interest in a foreign entity. If you are not sure whether or not you must report your foreign assets on Form 8938 this year, please give us or your accountant a call.
FATCA and the Foreign Financial Institution
In order to properly comply with the new FATCA reporting requirements, an FFI must enter into a “special agreement” with the IRS by June 30, 2013. Once entered into this agreement, a “participating” FFI will generally be obligated to do three major things:
1. Perform proper identification procedures with respect to its accountholders;
2. Submit annual reports to the IRS on its accountholders who are U.S. persons or foreign entities with substantial U.S. ownership; and
3. Withhold and pay 30 percent of any payments of U.S. source income (as well as gross proceeds from the sale of securities that generate U.S. source income) made to non-participating FFIs (NPFFIs), accountholders who fail to provide sufficient information about their U.S. identification, or foreign entity accountholders who fail to provide sufficient information regarding their U.S. identity.
Considering the implications of these disclosures and the onerous bookkeeping duties imposed on FFIs, it is important to understand what FATCA considers an FFI. An FFI is any financial institution that is a foreign entity (i.e. not a U.S. person). FATCA defines a “financial institution” as an entity that
1. Accepts deposits in the ordinary course of a banking or similar business;
2. Holds financial assets for the account of others as a substantial portion of its business; or
3. Is or appears to be engaged primarily in the business of investing, reinvesting, or trading in securities, partnership interests, or commodities, or any interest in such securities, partnership interests, or commodities.
Considering the global market economy we live in today, it’s needless to say FATCA will have a dramatic influence on how financial institutions like banks, insurance companies, broker/dealers, and hedge funds operate. However, since U.S. law cannot govern foreign persons, FFIs are free to choose whether or not to report their U.S. customers under FACTA.
Despite this theoretical “choice,” non-participating FFIs (NPFFIs) that do not enter into a “special agreement” with the IRS will likely suffer worse consequences in the long run by not cooperating. Under FACTA, the U.S. source income of an NPFFI is indiscriminately subject to 30 percent withholding. This means that foreign persons who are otherwise under no obligation to pay U.S. tax with accounts in NPFFIs will nevertheless still be subject to 30 percent withholding. The possible drawback of non-U.S. taxpayers withdrawing their accounts from NPFFIs may be enough of a threat to compel FATCA compliance worldwide. Only time will tell.
Take Action Now
Failure to report foreign financial assets on Form 8938 will result in a $10,000 penalty. This penalty can reach up to $50,000 if you fail to file after receiving IRS notification (additional $10,000 after initial 90-day notice from IRS; additional $10,000 for each 30-days after). More importantly, underpayments of tax attributable to non-disclosed foreign financial assets can be subject to an additional substantial underpayment penalty of 40 percent.
If you have an unreported foreign financial account or financial assets, contact a tax attorney with offshore reporting experience immediately. With new amnesty options, FBAR requirements and a brand new FATCA law now in effect, don’t try to figure out the rules yourself or rely on a preparer without offshore experience.
The tax lawyers at Mahany & Ertl can assist you with a wide range of foreign financial reporting issues. We advise individuals, businesses and accountants.
Whatever you do, don’t delay. If you have foreign financial assets subject to FACTA, your FFI may disclose your financial information to the IRS before you get the chance to do it voluntarily.
For more information about FATCA, FBAR’s and foreign reporting requirements – including the new 2012 offshore tax amnesty program – contact attorney Brian Mahany at (414) 704-6731 (direct) or by email at . All inquiries are kept in strict confidence.
Mahany & Ertl – America’s Tax Lawyers. Offices in Milwaukee, Wisconsin; Detroit, Michigan; Portland, Maine; San Francisco, California & Minneapolis, Minnesota. IRS services available nationwide.
[Ed. note: The author of this article, Wassim Malas, is our newest member of our tax team. Wassim holds both a Juris Doctorate in law and an advanced LLM degree in tax law. He is based in our Milwaukee office. This is his first article for Due Diligence.]
** [Ed. note: Since this article was posted, we have learned that although foreign real estate isn’t a “foreign financial asset”, the IRS will look at how the real estate is held. In other words, the so-called “dirt” may not be reportable but the partnership or entity that owns the property may be reportable.]