In the four years since FATCA was enacted, being sure your clients comply with all the foreign reporting rules has become more complicated.
Due to the upcoming implementation of the Foreign Account Tax Compliance Act (FATCA, P.L. 111-147), with its large civil penalties and possible criminal sanctions, U.S. taxpayers have been more forthcoming in reporting their non-U.S. income and assets, whether voluntarily or when requested by a foreign financial institution (FFI).
FATCA, set to take effect worldwide on July 1, 2014, aims to discourage offshore tax evasion by establishing enhanced due-diligence and information-reporting requirements for both individuals and foreign banks and providing the IRS with an increased ability to identify U.S. tax evaders concealing money in foreign accounts and investments.
Since FATCA was enacted in March 2010, the United States has signed intergovernmental agreements (IGAs) with many countries through which FFIs will exchange information with the IRS about their U.S. accounts. In turn, the United States will provide information about certain account holders who are nationals of those countries to their respective authorities on a reciprocal basis.
There are two types of IGAs, Model 1 and Model 2 agreements. The biggest difference between the two is the Model 1 IGA envisions direct reporting between contracting countries, whereas the Model 2 IGA involves direct reporting from FFIs to the IRS. As of this writing, 28 countries have signed Model 1 IGAs, and five have signed Model 2 IGAs. On June 2, the IRS reported that more than 77,000 FFIs had registered under FATCA.
Following is a summary of IRS guidelines created to ensure that all U.S. taxpayers adhere to their obligations to report their worldwide income and financial assets.
Foreign bank account reporting form
The Currency and Foreign Transactions Reporting Act, also known as the Bank Secrecy Act (BSA), P.L. 91-508, requires U.S. financial institutions to assist U.S. government agencies in detecting and preventing money laundering by keeping records of cash purchases of negotiable instruments, filing reports of cash transactions over $10,000, and reporting suspicious activities that might indicate money laundering, tax evasion, or other criminal activities.
In addition, the BSA requires U.S. persons holding any financial interest in, or signature or other authority over, a bank, securities, or other financial account in a foreign country to report those accounts to the U.S. government if the aggregate value of the accounts exceeds $10,000 at any time during a tax year by filing Financial Crimes Enforcement Network (FinCEN) Form 114, Report of Foreign Bank and Financial Accounts (FBAR), with Treasury. (FinCEN Form 114 was formerly Form TD F 90.22-1, which was required until June 30, 2013.)
After the 9/11 terrorist attacks, the BSA was amended and incorporated into Title III of the USA Patriot Act of 2001, P.L. 107-56. The Patriot Act established FinCEN as a bureau of Treasury with the mission “to safeguard the financial system from illicit use and combat money laundering and promote national security through the collection, analysis, and dissemination of financial intelligence and strategic use of financial authorities.”
In 2003, the IRS was given the task of enforcing the FBAR rules and authorized to assess and collect civil penalties (Internal Revenue Manual §4.26.16). Currently, a taxpayer is subject to civil penalties of $10,000 per unreported account for a nonwillful violation (unless the taxpayer had reasonable cause for the violation), while willful violators may be subject to a penalty of $100,000 or 50% of the unreported account’s value (31 U.S.C. §5321(a)(5)(A)).
In 2012, the IRS began offering taxpayers with undisclosed income and assets in offshore accounts the opportunity to participate in the Offshore Voluntary Disclosure Program (2012 OVDP) to become current on their filing obligations. Unlike programs offered in 2009 and 2011, the IRS has not set a deadline to end the 2012 OVDP, but taxpayers should be careful, as the IRS may change the provisions of the 2012 OVDP at any time (e.g., by increasing penalties or limiting eligibility to certain types of taxpayers) or end it altogether.
In addition to the 2012 OVDP, the IRS also offers a streamlined program for U.S. taxpayers, or dual citizens, living abroad. Under this procedure, taxpayers who are considered to have a low compliance risk, who have not complied with their income tax and foreign information returns, now have the opportunity to comply with their U.S. filing obligations without facing penalties. And on June 3, IRS Commissioner John Koskinen announced that the IRS is considering a program to make it easier for U.S. citizens living abroad who are not willfully hiding overseas assets to become compliant with U.S. tax law.
Any U.S. person with a direct or indirect financial interest or having signature authority of a non-U.S. bank or financial account may be subject to FBAR filing. (For an in-depth discussion of the FBAR filing requirements, including the requirement that the form now be e-filed, see Nakamura “Foreign Bank Account Reporting,” Corporate Taxation Insider (April 24, 2014).)
Statement of specified foreign financial assets
FATCA requires U.S. taxpayers to report their interest in specified foreign financial assets (SFFAs) with their individual income tax returns using Form 8938, Statement of Specified Foreign Financial Assets. Filing thresholds depend on whether the taxpayer lives within or outside the United States, but the thresholds generally start with foreign assets over $50,000.
An individual must disclose the foreign asset’s maximum value during the tax year and provide specific information based on the asset type. This form does not eliminate the requirement to file an FBAR, which must be filed separately with FinCEN, although the information required by both forms is often identical.
Similar to the FBAR filing requirement, U.S. citizens, green card holders, nonresident aliens who have elected to be treated as resident aliens, and those who are resident aliens for any part of the tax year are subject to this requirement. To date, this filing obligation only applies to individuals. The IRS anticipates issuing regulations that will require a domestic entity to file Form 8938 if the entity is founded to hold SFFAs exceeding the appropriate reporting threshold.
An SFFA is any foreign account maintained by an FFI as defined in Sec. 1471(d)(5), including depository or custodial accounts; stock or securities issued by a non-U.S. person; any financial instrument or contract held for investment that has an issuer or counterparty other than a U.S. person; an interest in a foreign retirement or deferred compensation plan; any interest in a foreign-issued insurance contract or annuity with a cash-surrender value; and an interest in a foreign entity, such as a corporation, partnership, or foreign trust.
A beneficial interest in a foreign trust or estate is not an SFFA unless the individual knows or has reason to know of the interest. If a person receives a distribution from the foreign trust or estate, he or she is considered to have actual knowledge of the interest. The maximum value of an interest in a foreign trust is equal to the amounts actually received by the individual during the tax year plus the value on the last day of the tax year of any mandatory distributions.
A taxpayer who has already reported assets that are considered SFFAs on Forms 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, 3520-A, Annual Information Return of a Foreign Trust With a U.S. Owner (Under Section 6048(b)), 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund, 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships, or 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans, does not have to duplicate the information on those forms, but he or she should indicate on Form 8938 the number of each of those forms that were filed.
An SFFA does not include financial accounts held at a foreign branch of a U.S. financial institution; financial accounts held at a U.S. branch of an FFI; foreign financial accounts for which the individual has signature authority (no beneficial interest); indirect interests in foreign financial assets through an entity; U.S. mutual funds investing in foreign stocks and securities; foreign real estate held directly; or foreign currency held directly.
Similar to other foreign informational forms, the penalties for failure to file Form 8938 under FATCA are also severe. The IRS may impose a civil penalty from $10,000, with a maximum penalty of $60,000 (for 2014) and criminal penalties.
With FATCA imposing a significant disclosure burden on FFIs and the IRS’s newly delegated authority to enforce stringent rules against U.S. taxpayers who fail to disclose their foreign financial assets, individual taxpayers find themselves relying more and more on their accountants to ensure that the appropriate information is reported to the respective tax authorities and institutions.
Certain foreign institutions are also requesting copies of filed FBARs and affidavits from accountants to ensure that account holders comply with U.S. reporting rules. The days of secret foreign accounts are over.
The IRS is guaranteed to eventually obtain information on U.S. holders of foreign accounts as foreign institutions do not wish to miss out on any future business in the United States. Practitioners should work to help taxpayers who are reluctant to face the consequences of earlier nondisclosures by emphasizing that they do not want to shift the burden to their heirs if the IRS discovers unreported accounts in the future.
This article was originally published by AICPA on June 12, 2014. Click here to view original article.