As of March 2010, binding on the U.S. taxpayer is section 6038D of the Internal Revenue Code, otherwise known as “Information with Respect to Foreign Financial Assets”. The legislative act behind the law is referred to as the Foreign Account Tax Compliance Act, or in short, FATCA. By enacting FATCA the Congress handed the IRS an important tool in its ongoing campaign to tax the "wealth by stealth". This law is not a substitute for the still compulsory – thus parallel - reporting requirement under the 1970 Foreign Transactions Reporting Act (which covers filing of FBARs, i.e. FinCEN forms 114). Under FATCA, foreign financial institutions (FFIs) that fail to provide information about their U.S. account holders may face a 30% withholding tax on any interest income, dividends, rents, or royalties sourced in the United States, as well as face a 30% withholding on proceeds from the sale of stock or debt of a U.S. issuer. The FFIs that do enter into an agreement with the IRS, are required, among other things, to withhold 30% from all passthrough payments made to noncompliant U.S. account holders.
Who is affected by FATCA?
All U.S. citizens, resident aliens, and nonresident aliens for whom an election under IRC 6013(g) or (h) is in effect that have specified foreign financial assets and that have crossed a certain monetary threshold. You need to report your foreign financial assets on Form 8938 (Statement of Specified Foreign Financial Assets). Unlike the FBAR, which is filed separately with the U.S. Treasury, the 8938 needs to be flied with your income tax return.
If you live in the U.S., the triggering thresholds are:
The aggregate value of your foreign financial assets was over $50,000 (over $100,000 if married filing jointly) at the end of the year or over $75,000 (over $150,000 if married filing jointly) at any time in the year.
If you live abroad, the triggering thresholds are:
The aggregate value of your foreign financial assets was over $200,000 (over $400,000 if married filing jointly) at the end of the year or over $300,000 (over $600,000 if married filing jointly) at any time in the year.
What constitutes a specified foreign financial asset?
Financial accounts in foreign institutions (not to include accounts at foreign branches of U.S. banks), foreign retirement accounts, cash value of foreign-issue insurance policies, cash value of foreign-issued annuities, interest in foreign hedge funds, interest in foreign private equity funds, interest in foreign mutual funds, precious metals and precious metal certificates held in a foreign country, shares of foreign stock not held in an account, interest in a foreign partnership, funds in a foreign based deferred compensation plans, bonds kept in a foreign country, as well as interest in certain foreign trusts and estates, all need to be included when computing the aggregate fair market value of your foreign financial assets. This list may not be a complete list of all financial assets that may be deemed as falling under FATCA reporting requirements.
Your foreign residence is not among the reportable assets. The accounts over which a taxpayer has a mere signature authority, but lacks actual ownership, are not reportable (these, however, would still need to be reported on the FBAR). The accounts located at a foreign branch of a U.S. bank or at a U.S. branch of a foreign bank are not required to be reported under FATCA. The U.S. Treasury's definition of an account can be found in the Treasury Regulation §1.1471-(5)(b).
Let us examine the following scenario:
Robert and Heather are U.S. citizens who currently reside in Stuttgart, Germany. They file a joint tax return. On August 31st they owned (jointly or separately) the following financial assets:
Jointly, a checking and savings account at Julius Bär Bank in Switzerland with a balance of $95,000;
Jointly, an investment in a German hedge fund valued at $184,000;
Jointly, a checking account at Citibank N.A. in Geneva with a balance of $23,000;
Robert has an account at HSBC in Boston with a balance of $17,000;
Robert has an insurance policy issued in Luxembourg with a cash surrender value of $125,000;
Heather owns 2,000 shares of XYQZ foreign corporation stock worth $78,000. The stock is kept at a Stuttgart branch of the Baden-Württembergische Bank;
Heather has accumulated $109,000 in a deferred compensation plan that was established and is maintained in Grand Cayman.
By December 31, the entire hedge fund investment was transferred to a firm in the U.S.; the balance of the Julius Bär Bank account diminished to $55,000; Heather's deferred compensation account grew to $130,000; and the foreign corporation stock appreciated to $82,000. Only the assets under captions “1,” “2,” and “5” through “7” would be classified as foreign financial assets. Under these specific circumstances, Robert and Heather would not be required to file an 8938. However, if on August 31st, Robert’s account at HSBC was located in London rather than Boston, the couple would have $608,000 in foreign financial assets at one point during the year and thus be responsible for reporting them under the FATCA requirements. When in doubt as to the extent of your total foreign financial assets, you might want to err on the side of caution. The IRS provides ample amount of information about FATCA on its website (irs.gov).
Note: the penalties for not complying with FATCA provisions are very severe.
For not disclosing a foreign bank account with a balance of $200,000 for a period of 6 years, the taxpayer could be potentially fined $600,000 (the greater of $100,000 or 50% of the balance, per year, up to 6 years).
Furthermore, an omission of an amount in excess of $5,000 that is attributable to one of the asset categories falling under section 6038D on any return filed after March 18, 2010, or on any return for which a period of section 6501 assessment has not expired, will extend the civil statute of limitations to six years.
The presented here information is not intended to be “written advice concerning one or more Federal tax matters” subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.
The information contained herein is of a general nature and based on authorities that are subject to change. Moreover, the information is presented here for educational purposes and is not specific to any individual’s personal circumstances. As such, this information should not be used for the purpose of avoiding penalties that may be imposed by law. A determination as to how your specific circumstances may relate to the presented material should be made by means of a consultation with your tax adviser.
Cezary Tchorznicki, CPA LLC does not provide legal or investment advice.