FATCA: Foreign Account Tax Compliance Act
- Last updated on . Written by Offshore Protection.
What Is It and Why Is It Important for US Citizens?
The introduction of new FATCA reporting requirements by the IRS in 2010 has had major implications for all US citizens holding foreign assets of any kind. Many have been caught unawares by these rules and have fallen into unintentional non-compliance.
In this article we give an overview of what FATCA is and its various rules and implications. We also discuss why it is important for US citizens to fully understand and familiarise themselves with these rules to avoid unwanted consequences.
What Is the Foreign Account Tax Compliance Act (FATCA)?
The Foreign Account Tax Compliance Act (FATCA) is a United States tax law that requires US citizens to file annual reports on any foreign account holdings they have which exceed certain prescribed thresholds.
FATCA legislation was first passed into law in 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act. FATCA was introduced to improve tax compliance by US citizens holding assets abroad.
A major motivation for the implementation of FATCA was the 2009 UBS offshore banking scandal, whereby the Swiss banking giant agreed to pay $780 million in fines to the IRS and reveal the identities of thousands of US tax evaders. The scandal showed that a large number of US citizens were attempting to evade taxes by keeping large, unreported asset holdings in secret Swiss bank accounts.
The FATCA legislation put forth new self-reporting requirements for US citizens on their foreign asset holdings, and imposed harsh penalties for non-compliance. Furthermore, FATCA imposed a legal mandate on all foreign financial institutions to clearly identify which of their clients are US citizens and submit all information on those clients’ accounts directly to the IRS. The mandate is supported with severe means of enforcement to ensure that foreign institutions will comply.
FATCA legislation also increased the penalties on taxpayers who do not fully comply with all particular tax rules applying to foreign financial assets. This means that FATCA has not only introduced new legislation and reporting requirements, but has also forced US citizens to become aware of, and adhere to, pre-existing tax reporting rules that were previously ignored and, for the most part, unenforceable.
The purpose of FATCA is fairly obvious. It was introduced so as to eradicate tax evasion by US citizens and corporate entities which are investing or earning taxable income abroad. Under FATCA, it is not illegal to hold an offshore account or assets abroad, but failure to properly disclose it is illegal. This is because US citizens are required to pay taxes to the IRS on all income and assets irrespective of where they are held/earned and regardless of whether they are US residents or living abroad.
FATCA has deeper links with HIRE, in that part of the reason for its introduction was to fund the costs of the business incentives that HIRE introduced. The revenue generated from the additional taxes paid due to FATCA legislation has been used to pay for these various hiring incentives offered in the HIRE act.
FATCA requires that the IRS Form 8938 must be filed by any US taxpayer who owns foreign financial assets with a total worth of $50,000 or more on the final day of the tax year, or worth more than $75,000 at any point of time during the year. Bank deposits, stocks, bonds, and any other financial instruments all add to this total asset calculation. Exceptions include assets that are held in a foreign branch of a US institution or in a US branch of a foreign institution.
For US citizens whose permanent residence is outside of the US, the reporting thresholds are increased to $200,000 and $300,000 respectively. According to the IRS, “You are considered to live abroad if you are a U.S. citizen whose tax home is in a foreign country and you have been present in a foreign country or countries for at least 330 days out of a consecutive 12-month period.” All reporting thresholds are doubled if you file jointly with a spouse.
The FATCA form 8938 is an additional requirement to the pre-existing FBAR report that must be filled for foreign assets in excess of $10,000. FATCA also stipulates that Form 8621 (Passive Foreign Investment Company; PFIC) must be filed every year for each PFIC investment, where before it was only required in the years that the PFIC investment made a distribution. Along with the implementation of FATCA, the statute of limitation for IRS audits of tax returns where foreign-sourced income was listed was extended from 3 years to 6 years.
In theory, these reporting requirements seem relatively straightforward. However, in practice things can be far more confusing and complex. Firstly, FATCA has once again made relevant numerous old foreign tax reporting laws that officially remained in force before but were “obsolete” and safely ignored. Secondly, it is difficult to determine what exactly falls within the definition of “foreign assets”. The IRS defines foreign assets as any foreign: pensions, stockholdings, partnership interests, financial accounts, mutual funds, issued life insurance, hedge funds, real estate held through a foreign entity. This is a broad list where mistakes can easily be made.
Penalties for Non-Compliance
FATCA imposes harsh penalties for non-compliance. The minimum penalty is $10,000 for “non-wilful” failure to file, with an additional penalty of up to $50,000 for continued failure to file after the IRS notification. There is also a penalty of up to 40% of the undisclosed asset values for an understatement of the tax attributable to them. The penalties for “wilful” non-compliance may include criminal charges in addition to the aforementioned fines. All penalties are in addition to the tax and interest due on the undisclosed assets.
FATCA did not add to or change the existing penalties associated with failure to report under FBAR and PFIC holdings; however, it has led to a significantly increased enforcement of these reporting requirements and so has increased the incidence of such penalties. As such, US citizens must educate themselves about the serious penalties connected to these other reporting requirements required of Americans with foreign assets, and ensure they are also compliant with these pre-existing rules.
Americans living abroad who were unaware of the new reporting requirements and wish to now become compliant can do so by filing under the Streamlined Filing Procedures. This is an IRS program that allows unintentionally non-compliant taxpayers the chance to catch up on their previous filings without being forced to pay late penalties. If you become aware that you have been non-compliant up until now, it is important to file through this program at the earliest to avoid paying penalties.
Why Is It Important for US Citizens Living Abroad?
Understanding the new reporting requirements of FATCA and associated penalties for non-compliance is important for all US citizens, but especially for those who own significant foreign asset holdings and even more so for American citizens living abroad. Not only do these US citizens need to be aware of the reporting requirements associated with FATCA itself, but also with other foreign asset reporting requirements that they may have safely overlooked in the past.
The danger of unknowingly being in a state of non-compliance with FATCA and other reporting requirements is a real one and can result in serious penalties. It is not a valid excuse to simply say that you were not aware of these rules. Previous rules such as FBAR and PFIC reporting that were wilfully ignored, even by tax professionals, need to be fully understood and adhered to since FATCA’s introduction.
Furthermore, Americans need to understand the implications that FATCA has had on foreign financial institutions. FATCA reporting requirements for overseas banks are quite onerous, and as a result many have simply refused to take any US citizens as clients. The same is true for various other types of investment firms and financial institutions. This is an unfortunate situation that has limited the options available to US citizens in respect of offshore financial services.
The consequences of FATCA for US citizens cannot be understated. It has introduced a vast and significant set of rules and mandates that have affected individual taxpayers and foreign financial institutions alike. It is especially important for US citizens abroad and all those holding foreign assets to ensure they fully understand all aspects of FATCA and take the necessary steps to ensure they are compliant. They must also prepare for any other potential adverse effects (e.g., their foreign financial institutions no longer accepting them as a client).
The complexity of FATCA tax reporting requirements, along with pre-existing requirements such as FBAR and PFIC, are beyond what an individual taxpayer can hope to decipher and adhere to on their own. As such, it is extremely important to consult with a tax professional if you think that there is even a small chance that FATCA applies to your situation. They can help you determine whether or not it is relevant for you, as well as help you become fully compliant in the most tax-efficient manner in the event that it does.