In the Internal Revenue Service's continuing efforts to close the tax gap by ferreting out overseas income of U.S. citizens and residents, the IRS recently rolled out further guidance on the requirements of the Foreign Account Tax Compliance Act. On Jan. 17, 2013, final regulations were issued with respect to reporting and withholding regimes being imposed on foreign financial institutions, or FFIs. In companion Notice 2013-10, the IRS also announced a deferral of the effective date for identifying specified domestic entities required to report foreign financial assets under FATCA.
Lest tax practitioners think that a focus on foreign financial institutions is not of too much concern to them, keep in mind that the objective of collecting information from these foreign financial institutions is to gather information on U.S. account holders of these FFIs, and the information being reported to the IRS may well concern your individual clients.
FATCA had two key approaches to combating non-reporting of income from offshore assets. One was to expand the FBAR obligation to report foreign bank accounts into an income tax obligation to report foreign assets as part of the tax return. This obligation has now been in effect for individuals for a couple of years. The second was an obligation for foreign financial institutions to assemble and report information on U.S. account holders. In order to ensure compliance by foreign financial institutions beyond the jurisdiction of U.S. courts, a withholding tax was imposed on payments going from the U.S. to non-complying FFIs.
As the IRS worked to implement the requirements FATCA imposed on foreign financial institutions, it encountered problems that FFIs were encountering with their own governments with respect to violation of domestic privacy laws and disclosure of banking information. The IRS therefore began working with foreign governments to develop intergovernmental agreements to enable foreign financial institutions to comply with reporting requirements while staying within the framework of their domestic requirements.
FINAL FATCA REGULATIONS
The final FATCA regulations delay some of the reporting deadlines to give foreign financial institutions more time to develop compliance techniques and to get more intergovernmental agreements in place. The due diligence, documentation and reporting requirements imposed on FFIs are clarified to put the maximum emphasis on those accounts most at risk of involving unreported income. This involves relaxation of some of the evidentiary requirements and extension of the validity of some documentary evidence.
The regulations also try to simplify the process for a foreign financial institution to register and enter into an agreement with the IRS to avoid withholding. The IRS is developing a portal to facilitate communications between the IRS and registering FFIs or their agents. The regulations also provide clarification of what types of financial institutions are covered by the disclosure and reporting requirements. Refund procedures are provided for withheld sums. The rigidity of the forms of reporting are also relaxed.
The IRS is working with over 50 foreign governments to implement procedures for FATCA compliance. The model agreements, or IGAs, take three basic forms:
- Model 1: The FFI reports to the domestic government, which reports to the IRS in a reciprocal arrangement.
- Model 1B: The FFI reports to the domestic government, which reports to the IRS in a non-reciprocal arrangement.
- Model 2: The FFI reports directly to the IRS.
The IRS already has seven agreements in place (at press time) with the number growing weekly. A Model 1 reciprocal agreement was the first put in place with the U.K. Agreements have also been reached with Denmark, Mexico, Ireland, Spain, Switzerland and Norway. The IRS has stated that negotiations are far along with a number of other countries. Some countries are still expressing reservations about the IGAs.
Notice 2013-10 delays until at least tax years starting on or after Jan. 1, 2013, the effective date for the regulations used to identify those specified domestic entities required to report foreign financial assets under FATCA. These domestic entities include certain domestic corporations, partnerships and trusts. Although these reporting requirements are already in effect for individuals, the IRS acceded to concerns that had been expressed about the ability of these entities to gather the information in time to report with respect to the 2012 tax year.
As tax practitioners watch the expanding foreign asset reporting requirements come into effect, they will want to keep their clients apprised of the growing volume of information available to the IRS concerning foreign assets held by U.S. citizens and residents. A voluntary disclosure program remains in effect for taxpayers to come forward and disclose foreign accounts before the IRS has identified them through other means.
It appears that many foreign governments are also falling into place in terms of cooperating with the IRS to disclose information held by their financial institutions. Some foreign financial institutions are sending communications to U.S. account holders with respect to either closing those accounts or providing information about impending disclosures.
While there are a number of reporting delays provided for in the final FATCA regulations, taxpayers and their advisors should recognize that the hiding of assets and income overseas is likely to become more and more difficult as time passes, and the foot faults in overlooking disclosure responsibilities will become more difficult for the IRS to excuse.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.