The BIG BROTHER of Financial Laws
Enacted in 2010 by the 111th United States Congress, the Foreign Account Tax Compliance Act (FATCA) is one of the most sweeping pieces of tax legislation in history. It is draconian to say the least, and its implications should be understood by all US taxpayers.
US taxpayers have long been required to report their foreign bank and financial accounts on the FBAR (now FinCEN Form 114) once they have an aggregate value over USD 10,000 at any point during a tax year. The FBAR is reported directly to the US Treasury, not the IRS. Importantly, FATCA has not altered this reporting requirement and it is still an important part of filing your annual taxes.
It is also worth noting that failure to file the FBAR in a timely manner can result in civil penalties and criminal prosecution. Non-willful failure can carry a USD 10,000 per year fine, while willful failure to file can lead to penalties of USD 100,000 or 50 percent of the balance in an unreported foreign account, per year, for up to six tax years.
FATCA is designed to “combat tax evasion by US persons holding investments in offshore accounts” and goes far beyond the FBAR. Instead of relying on individuals to self-declare their assets, FATCA requires that Foreign Financial Institutions (FFI) report the details of accounts held by US taxpayers directly to the IRS.
Yes, that’s right. Whether you like it or not your bank or investment company is now telling the IRS about your financial assets regardless of whether you want them to or not.
When FATCA was introduced the reception from foreign financial institutions was lukewarm at best. There is a significant cost to collecting and reporting the data to the IRS on an annual basis. At first they baulked and many refused to comply with the new regulations. This rebellion was swiftly quelled by the IRS by imposing a 30 percent withholding tax on the sale of any US asset by a foreign financial institution that did not comply with FATCA. For better, or worse, the modern financial world still operates largely in USD, and this penalty was not something that any major foreign financial institution could stomach.
The result: based on a list published in December 2015 there are now 182,649 compliant organizations’ in 227 financial jurisdictions freely reporting information directly to the IRS about their US account holders.
The bottom line: FATCA is here to stay and US taxpayers need to be aware of how it will effect them.
How Will FATCA Effect You?
FATCA requires that all US taxpayers report the foreign bank and financial accounts on the new 8938 form if they have an aggregate balance that exceeds set thresholds:
• For expats filing an individual tax return the threshold is USD 200,000 in aggregate balance at the end of the year, or USD 300,000 at any point during the year.
• For expats filing a joint tax return the threshold is USD 400,000 in aggregate balance at the end of the year, or USD 600,000 at any point during the year.
It should be noted that if you are resident in the US and have foreign bank and financial accounts, the thresholds for an individual return are USD 50,000 at the end of the year and USD 70,000 at any point during the year. It is widely expected that the limits for expatriates may come down to these levels in time. In fact, some foreign financial institutions have already stated they will declare accounts at these lower thresholds if they were opened after the 2014 date when FATCA came into effect.
The penalties for failing to comply with FATCA are severe. The maximum penalty for failing to file the 8938 form is USD 60,000 for each foreign asset that you failed to report. Furthermore, virtually hidden inside the 1,113-page Fixing America’s Surface Transportation Act (FAST Act), signed in December 2015, is the new 7345 section to the Internal Revenue Code. This new provision gives the State Department, at the direction of the IRS, the ability to revoke, refuse to issue, or rescind the passport of anyone who has a delinquent tax liability of USD 50,000 or more. This should be a major wake up call to all US taxpayers, especially those living abroad; resistance is futile.
Outside of the new filing requirements, FATCA has also had a significant impact on the regulatory environment for US financial institutions. We were recently made aware of a circular that presidential candidate Hilary Clinton sent around where she acknowledged, “FATCA’s intent was to catch wealthy tax cheats hiding money abroad. But in practice, banks are refusing to provide average law-abiding Americans abroad the basic financial services they need because of the compliance requirements of FATCA.”
This is certainly true, we are aware that major financial institutions such as Fidelity and Vanguard are suspending the accounts of non-resident clients. This means that they cannot make any changes to their investment accounts until they become US residents again. There is also a growing list of mutual funds that will not accept investments from clients who have foreign addresses. This list grows and changes daily and keeping track of it is difficult.
Thankfully, there are still a number of very high quality financial institutions and investment managers that are happy to accept US expatriates as clients. If you are struggling to access the US financial system, then you should speak to a financial advisor that understands the plight of US expatriates.
What About Using Offshore Tax Havens?
As expatriates we hear the words ‘offshore investment’ a lot and many would have us believe that they hold the key to preventing the IRS from taxing your hard earned cash. In reality they present numerous complications to the US taxpayer.
First of all, virtually every offshore tax haven has signed up to FATCA and is reporting the accounts of US taxpayers to the IRS. This includes well known places such as The Cayman Islands, Isle of Man, Guernsey, Jersey, British Virgin Islands and Hong Kong to name but a few. Even the bastion of banking secrecy, Switzerland, has signed up to FATCA.
More important than this, however, is the fact that even if your money is held in an offshore jurisdiction it must still be reported as part of your annual tax return. This is not new news. But it presents significant problems to US expatriates as most foreign financial institutions will not report their accounts in an IRS compliant manner – e.g. no 1099. This means they do not benefit from the preferential taxation available in a US account and in many cases will be classed as Passive Foreign Investment Companies (PFICs) and receive punitive taxation in the form of Excess Distribution.
Holding these assets may also create further reporting requirements. For instance, every foreign mutual fund must be individually reported on the IRS form 8621 and according to the Wall Street Journal, “the IRS estimates that each form will take more than 35 hours to complete—after the taxpayer spends 11 hours to learn the requirements.”
I believe it is worth stating that as a company PFG have access to a wide range of “offshore” financial products. On the whole, there are benefits to expatriates for using such vehicles, particularly with regards to tax. However, we wholeheartedly believe these products are not suitable for US citizens and as a matter of course we do not offer them to US clients. If you are a US taxpayer and are talking to someone about any type of offshore investment, then my advice would be that you talk about the implications of doing this with a qualified US tax professional.
For all the noise surrounding FATCA, the situation for most US taxpayers is actually not much different. US taxpayers have always been, and probably always will be, subject to taxation on their worldwide income. It could be argued very legitimately that there never has been a ‘tax-haven’ available to US taxpayers. What FATCA is designed to do is root out those that have attempted to willfully hide their assets from taxation, a practice that has always brought the risk of fines and even potential jail time.
For the vast majority of people who report their income correctly nothing has changed. The most significant problem they may be facing is access to US financial products and accounts. This is certainly an issue and a somewhat unintended consequence of the legislation. However, as stated above, there are still institutions and investment managers that will take US expatriates as clients. Those who are finding this difficult should contact an advisor and seek professional help.
If you believe that your filing requirements may have changed because of FATCA then you should seek help from a qualified tax professional immediately.
About the Author
Jonathan Sykes has worked in the financial services industry in Beijing for eight years. He now heads the Beijing office for PFG. Among their many services, PFG are the only company in China to offer USA expatriates onshore, IRS-compliant, financial products. They cover all financial planning needs such as investment accounts, IRAs, 401Ks and life insurance. He welcomes any questions or emails at: Jonathan.Sykes@pfg-china.com
PFG are a financial planning and asset management firm based in China. We primarily work to help individuals with their financial planning while they are expatriates. We recognized a long time ago that US taxpayers have a very unique set of issues regarding their financial planning due to the fact they are taxed on their worldwide income at all times. This led us to form a practice within our company that was able to offer US regulated, IRS compliant, financial planning solutions to US expatriates. We come across a lot of questions about the cross border issues that US taxpayers face and over recent years FATCA has been an important issue for our clients.
Photo: Getwaypundit.com, Public Domain, and U.S. Army (Flickr)