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.
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.”