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Taxpayers Strained by New FATCA Requirements

April 16, 2012

With the April 17 deadline to file income tax returns now upon us, U.S. taxpayers with foreign financial assets are finding out that they need to file some extra forms this year.

The Foreign Account Tax Compliance Act, FATCA for short, requires any taxpayers to disclose on their tax returns for the tax year 2011 the location and amount of their foreign assets in excess of $50,000, or $100,000 for married couples.

The new requirement is in addition to the obligation to file a Report of Foreign Bank and Financial Accounts, commonly known as an FBAR.

Alan I. Appel

The new FATCA requirement to disclose foreign assets means certain taxpayers who have foreign assets and income need to consider enrolling in the IRS’s Offshore Voluntary Disclosure Program, according to Bryan Cave LLP attorney Alan I. Appel. He chairs the U.S. Activities of Foreigners and Tax Treaties Committee of the American Bar Association’s Section of Taxation and is also an adjunct professor of law at New York Law School.

“Right now, there are several aspects of FATCA,” he said in an interview last week. “For the first time with tax returns that are due on April 17, taxpayers are required to file a Form 8938 disclosing specified foreign financial assets.”

The FBAR, which is filed with the Treasury Department rather than the IRS, is not the same as FATCA but “a very close cousin,” according to Appel.

“Then we’ve got the question of FATCA for swap transactions under [Section] 871(m),” Appel pointed out. “We also have a 30 percent tax on withholding payments to foreign financial institutions and non-financial foreign entities.” The latter is not an immediate concern since it does not go into effect for over a year, but it is still raising a lot of red flags.

“The FATCA withholding doesn’t go into effect until Jan. 1, 2014, and that’s designed to have foreign banks and other foreign entities that have U.S. taxpayers who have accounts be disclosed,” said Appel. “These foreign banks, which are called foreign financial institutions, or FFIs, and also foreign entities that are not banks—called non-financial foreign entities, or NFFEs—have to enter into a compliance agreement with the IRS starting Jan. 1, 2013, that they’ll agree to basically [disclose] the names, Social Security numbers and account balances of U.S. [account holders] every year,” said Appel. “And if they don’t enter into this agreement and they invest in U.S. stocks or securities, or have any U.S. source income, then there’s going to be a 30 percent withholding tax on all payments, including interest, rents, royalties, and things like that.”

While those provisions don’t take effect until Jan. 1, 2014, Appel believes they are already having a major chilling effect on the rest of the world.

“They don’t know how they’re going to comply with this, they don’t want to comply with this, and the big backlash is that they don’t want to do business with U.S. depositors any longer,” he said. “We’ll see how long that lasts. But that is the law. It’s not going away. The Treasury Department and the IRS have done what they could to make the law palatable. They didn’t write the law. The law was written by Congress, and we entered into a multilateral agreement with five different countries so the disclosure information could be made to the governments of those countries, instead of to the IRS. Those countries can then disclose it to the IRS. There are 400 pages of proposed regulations issued that we’re now preparing comments for as part of the American Bar Association taxation section. That’s a big job.”

However, the expanded reporting requirements for U.S. taxpayers with foreign assets who need to make a voluntary disclosure are probably the greatest concern in the near term.

“What’s affecting taxpayers immediately is a very sensitive situation,” said Appel. “You have a lot of U.S. taxpayers that have offshore bank accounts and foreign assets. For years and years there’s been a question on the tax return asking whether you have signatory or other authority over a foreign financial account that has a balance of $10,000 or more, yes or no. Most people checked no, even if they had it. Some picked yes. If yes, you were supposed to file the FBAR form, not part of the tax return, where you listed the name of the bank and the account balance, and it was supposed to be filed every year. Not to file it was a crime, and the penalty was the greater of $100,000 or 50 percent of the balance in the account every year. So the penalty over two years would wipe out the account. It was also considered a felony crime, punishable by five years in prison.”

Once the IRS and the Justice Department began cracking down in recent years on secret bank accounts at UBS and other Swiss banks, the FBAR form began to be used more often, particularly by taxpayers taking advantage of the various Offshore Voluntary Disclosure Programs offered by the IRS, promising reduced penalties for coming forward voluntarily.

“The IRS is now up to its third voluntary disclosure program, and it’s saying, ‘Come in and pay the tax, the interest, the one-shot penalty of 27.5 percent of the highest amount of the financial account assets, and we won’t prosecute you criminally, and you won’t be subject to the more draconian penalties,’” said Appel. “I think 30,000 taxpayers came in and the IRS got a lot of information on the banks, and it’s now going after a lot of other banks as a result of this.”

This year, for the first time, as a result of FATCA and Section 6038(D) of the Tax Code, U.S. taxpayers have to file a Form 8938 with their tax return reporting their specified assets. “If they have assets of over $50,000 abroad, or $100,000 in the case of a married couple—and it’s higher if the U.S. people live abroad because you have more assets abroad—you have to disclose these assets on your Form 1040 by attaching this schedule,” said Appel.

He believes this leads to a dilemma. “All the software that you buy commercially like TurboTax have questions like that,” he said. “Let’s say a taxpayer has had a foreign account for several years and they haven’t filed an FBAR. What do they do? Do they go back and file FBARs for the prior years and make a voluntary disclosure? If they do a voluntary disclosure, do they enter the program and subject themselves to penalties? Do they try to do it quietly? The IRS has said a quiet disclosure is not a disclosure. It presents a real dilemma for them.”

He noted that when the IRS came out with the latest version of the Offshore Voluntary Disclosure Program in January, it had promised that within 30 days it would provide questions and answers to tell people whether there were any safe harbors.

“Under the old programs, there was a Q&A 17 and 18, which provided that if you paid all of your taxes and didn’t owe any tax, and all you didn’t do was file the foreign bank account report, or certain foreign trust reports, you could simply go in and give a reason as to why you didn’t file, and there would be no penalties,” said Appel. “We don’t know if that still applies to the current program because the questions and answers have not been issued yet, notwithstanding the fact that the service had promised them in early February. So the taxpayer’s dilemma becomes ‘What do I do now? I must disclose.’ First of all, a taxpayer must comply with the law, so the taxpayer files the 8938 and discloses the foreign assets. Now should they file the FBAR? They probably have to file the FBAR report for the current year, and now they have to wonder about what to do for the past years? Should they rely on the old safe harbor and make the disclosure or just comply going forward? It’s a real dilemma. There are no good answers to this.”

Still, he sees advantages in making a voluntary disclosure to the IRS. “The big advantage to the voluntary disclosure is that the taxpayer avoids criminal prosecution,” said Appel. “He basically comes clean and gets back onto the system and is not subject to the 50 percent per year penalty. So if a taxpayer has been hiding assets abroad and not reporting income, I don’t think they have any alternative but to go into the program. On the other hand, if the taxpayer was not willful, and just didn’t know about it, the taxpayer still should go into the program. Then under the program there’s a procedure where you can opt out and avoid criminal prosecution, and you’ll see how you can do on the penalties.”

A number of his clients have been taking advantage of the program. “We’ve had a fair amount of clients who have come into the voluntary disclosure program,” he said. “We also run into a lot of the accidental citizens. Americans who were born here, but don’t live here. They came here when they were young and they left, and they’re outside the U.S. They’re still U.S. citizens and subject to tax on their worldwide income and have worldwide reporting. In those cases the voluntary disclosure program has a penalty of 5 percent instead of 27.5 percent provided to clients that did not act willfully and paid all the taxes in their home countries on their income. That’s also a good thing to take advantage of. The days of a taxpayer being able to hide out are very short. The IRS is investigating a tremendous amount of banks.”

Comments (5)
Thank you for this timely article.
Just a comment:
To underscore a huge and discriminatory issue: this quote illuminates a systemic issue worthy of notice by the Taxpayer Advocate of the IRS, the Commissioner, and Congress.

The jeopardy and pitfalls are much higher for those who were born, or live, permanently, outside the US, because they must bank where they live and work. ALL of their accounts are considered 'foreign' and ALL of their accounts are subjected to this, making it much more likely to exceed the reporting thresholds, to be unaware of these forms, and to have more onerous reporting and penalties levied, because it represents 100 percent of their savings. And in many cases, ALL of their FAMILY savings because of jointly held assets; created or contributed to by a NON-US spouse.

Since the IRS has no jurisdiction over a non-US citizen who does not meet the definition of a US 'person' for taxation, they cannot compel the non-US joint account holder, and they just treat the whole thing as if it belongs to the US 'person', and they are now liable for deposits and interest and assets made by the non-US individual as well. This is particularly the case in which one spouse (usually the wife) has a lower or no income - during years doing child or elder-care. In that instance it is even more egregious because the non-US assets are being produced by non-US persons, but reported to the IRS, and potentially assessed for penalties on 'foreign' assets that have only a very tenuous connection to the US - through one account signatory.

Those born or living abroad are then subjected to exponentially more jeopardy and liability than those living inside the US with 'foreign' accounts, in spite of the entirely necessary and legitimate reasons for having them. That is an egregious systemic discrimination against those that were born and live permanently outside the US.
Posted by KMoore | Wednesday, April 25 2012 at 4:15PM ET

Thanks for this. Jim Flaherty is currently a hero up here!
After seeing the compromise involved with the 5 EU countries, there is hope that some of the more restrictive measures in this law will be lifted, hopefully for all expats, not just those here in Canada.
Posted by Patricia Moon | Friday, April 20 2012 at 12:05AM ET
Nobledreamer, the Canadian Minister of Finance, James Flaherty, said at the Bush Institute tax policy conference last week that he is in talks with Tim Geithner about these issues. Perhaps we will see a resolution or a compromise of some sort soon, though it may require Congress to amend the FATCA provisions.
Posted by MikeCohn | Thursday, April 19 2012 at 8:48AM ET
I also see that Mr. Appel is very well-versed on the ins-and-outs of this situation. I do not understand however, why he feels that those who were merely not aware of the requirement to file FBARs should enter the OVDI. There have been many accounts of such people on a blog by Tax Attorney Jack Townsend ( The situations these people have gone through, while trying to "come clean" are nothing short of horrendous.

Some countries, such as Canada have stated they will not collect FBAR fines (not covered under the Tax Treaty) nor will they collect taxes from any Canadian who may have been dual US-CDN at the time the tax was assessed. People are willing to never enter the US again as they simply cannot be expected to put their retirement savings at risk, for merely failing to file a form they knew nothing about.

The US Ambassador to Canada, David Jacobsen, was a focus in an article by the Globe and Mail, DEc. 2, 2011. After becoming aware of this disturbing situation, he indicated that there would be a shift in policy that the IRS would announce. He made the following points:

- If a U.S. citizen files tax returns late and owes no taxes, there are no penalties for failure to file.
- U.S. citizens who were unaware of the bank account reporting requirement can file previous reports now, along with a statement explaining why they're late. No penalty will be imposed if the IRS determines that there is reasonable cause.
- Individuals who took part in earlier amnesty programs this year and in 2009 can reapply and get back penalties already paid.

In response,IRS issued FS-2011-13 on December 7, 2011. Most professionials pointed out there was no substansive change to established policies such as the first two points above. There was no mention whatsoever regarding those who were penalized in the 2009 OVDP program. It must be pointed out that it is highly likely many came forward due to FAQ 35, which indicated "under no circumstances will a taxpayer be required to pay a penalty greater than what he would otherwise be liable for under existing statutes." Prior to the 2011 OVDI program, the IRS simply decided not to honor this in what is considered to be a bait and swith. This hardly inspires trust or confidence in anything the IRS says.

In additional to "Accidental" Americans, there are another large group of expatriates in Canada who came in the late 1960's-1970's. Many took Canadian citizenship with the clear understanding that by doing so, they would lose American citizenship. Now, 40-50 years later, they are finding out that the US still considers them citizens and they too, must file taxes and FBARS (and now, 8938). The majority of stories I have read indicate not only will they not even consider entering OVDI, they do not intend to come forward at all. They have not held US passports, paid taxes, voted or acted as Americans on any level. They certainly have not received any of the benefits of US citizenship. Many feel there is no way they will be caught. Perhaps unwise, but understandable.

All things considered, to enter OVDI only makes sense from the view that one would certainly comply since there is more or less, no other option. However, people do see other options and many are renouncing their citizenships (which does not release them from previous obligations but again, the issue of actually enforcing penalties outside of the US are considerable). The IRS would do well to realize the situation requires changes in their policies if they expect people to come forward and comply.
Posted by Patricia Moon | Wednesday, April 18 2012 at 10:58PM ET
I have to say that Mr Appel is right about a lot, but is making too general of a statement about the advantages of the IRS VD programs without recognizing the serious harm for the benign minnow expat or new immigrants who for a host of reasons might find themselves in non compliance.

They were not the target UBS type Homeland rich Whale that the VDP was designed for. Yet they are treated the same in a "one size fits all" penalty regime.

In the original 2009 OVDP, there was a FAQ 35 safe harbor relief that allowed for examiner discretion to calculate lower non willful penalties. The IRS withdrew it midstream which got them the Directive from Nina Olson of the TAS, which Shulman has chosen to ignore.

In the current program there is no such safe harbor, except that they created a back end "opt out": process that is so inefficient that if you are a minnow you can expect a 2+ year grind just to Opt Out at the end. Then you may get a regular audit with its IRM discretionary FBAR penalty relief which is often way less than even the 5% VD penalty. BTW, it is outrageous that an accidental American should even have to pay 5%!

Right now, the process is actually a disincentive to coming forward. It is leading many to do a quiet disclosures (QD) and play the lottery audit with is the same as the Opt Out. More folks living overseas are just saying "bye bye" and renouncing. New immigrants, caught up, are just walking down the jet way and going home rather than handing over family life savings to the IRS for benign failures.
If the IRS was really concerned about efficiency and compliance, they would design a front end "opt out" for minnows, while still processing the Whale under the "One size fits all". For, them the program is a pretty good deal.

Or, they should allow Minnows (actually encourage them) to do QDs without the hyperbolic threats of criminal prosecution which they don't have the DOJ resources for anyway. MAKE IT EASY! Just ask for back taxes, interest, accuracy penalties, and drop all the hyperbolic criminal threats. That is what Canada does.

Here is how their program works...

"The Voluntary Disclosures Program (VDP) allows taxpayers to come forward and correct inaccurate or incomplete information or to disclose information they have not reported during previous dealings with the CRA. Taxpayers may avoid being penalized or prosecuted, if they make a valid disclosure."

Do you think the IRS could learn something from this? No, me either, because I don't think it is in their genetic make up, and this is really NOT about compliance. It is about REVENUE!!

In that $4.4 billion of revenue, how much was penalty, and now much was taxes? They won't say. For all the offshore fuss, how much of the revenue collected is just a one off occurrence, and how much will really be reoccurring revenue in the future allowing for the foreign tax credits? No answer from our silent friends. But then, in fairness, no one is asking them
Posted by Just Me | Tuesday, April 17 2012 at 3:07AM ET
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