On January 3, 2013, Switzerland’s oldest bank, Wegelin & Co. (“Wegelin”), pled guilty to assisting U.S. taxpayers in hiding more than $1.2 billion in assets from the Internal Revenue Service (“IRS”). Wegelin is the first foreign bank to plead guilty to U.S. tax evasion charges. In 2009, United Bank of Switzerland (“UBS”) faced charges of helping U.S. taxpayers conceal nearly $20 billion from the IRS. UBS was able to enter into a deferred prosecution agreement and charges against it were subsequently dismissed. While UBS was too big to fail Wegelin was not as fortunate. The charges against Wegelin (and UBS) came on the heels of the IRS’s concentrated efforts to identify undisclosed offshore bank accounts and foreign-held assets. This crackdown has already forced taxpayers, and financial institutions alike, into attempts at compliance. Thousands of Americans have participated in voluntary disclosures in hopes of minimizing penalties and avoiding criminal prosecution.
The Foreign Account Tax Compliance Act (“FATCA”) has recently become a source of frustration for taxpayers with foreign bank accounts and assets. FATCA took effect on January 1, 2013 as part of the Hiring Incentives to Restore Employment Act signed into law on March 18, 2010. It has made significant changes for information reporting of foreign-held assets. Primarily, the Department of the Treasury is recruiting foreign banks to do their dirty work. The Department of the Treasury is asking foreign banks to report income derived from U.S. citizen held accounts, or be subject to a 30 percent withholding, that would take effect January 1, 2014. By filing a Foreign Financial Institution (“FFI”) Agreement with the IRS, the FFI agrees to identify U.S. citizen held accounts, comply with due diligence procedures, and IRS reporting requirements. Certain transactions with FFIs that do not participate in FATCA and recalcitrant account holders will give rise to a requirement that the FFI withhold 30 percent of income derived from a U.S. citizen held account. FFIs that do not sign an agreement (non-participating FFIs) will also be subject to 30 percent withholding beginning January 1, 2014.
The initial step for FFIs is to identify its U.S. account holders. IRS Notice 2011-34 lists six indicia that an FFI should use to determine which of its existing accounts are considered to have U.S. status: U.S. citizenship or green card status, U.S. birthplace, U.S. residence or correspondence address, standing instructions to transfer funds to an account maintained in the U.S., an “in care of” address or a “hold mail” address that is the sole address with respect to the client, or a power of attorney or similar authority granted to a person with a U.S. address. Once the FFI identifies its U.S. account holders, it must report the name, address, and TIN of each account holder, the account number and value at year end, as well as any gross dividends, interest, and other income paid or credited to the account.
In addition to imposing a 30 percent withholding tax on undisclosed income from assets held by foreign banks, owners of foreign-held assets that are valued above the reporting threshold must report those assets on the new Form 8938 which must be attached to the taxpayer’s annual tax return. If you are not married, you satisfy the reporting threshold only if the total value of your specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year. Married taxpayers filing a joint income tax return satisfy the reporting threshold only if the total value of their foreign financial assets is more than $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year. Taxpayers living outside of the U.S., and who meet one of the presence abroad tests, have a higher reporting threshold. Unmarried taxpayers satisfy the reporting threshold if the total value of their foreign financial assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the tax year. Married taxpayer filing a joint income tax return satisfy the reporting threshold if the total value of their foreign financial assets is more than $400,000 on the last day of the tax year or more than $600,000 at any time during the tax year.
If a U.S. taxpayer fails to disclose a foreign asset on Form 8938, he or she is subject to a $10,000 failure to file penalty and additional penalties of up to $50,000 for continued failure to file after the taxpayer has been notified by the IRS. I.R.C. § 6038D(d). Underpayment of the tax due as a result of income derived from undisclosed foreign accounts will subject taxpayers to a 40 percent accuracy related penalty on the tax deficiency. In addition, failure to file Form 8938, failure to disclose assets, and failure to pay related taxes, could result in criminal penalties.
The FATCA regulations are implemented in addition to reporting foreign bank accounts on Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR). This means that taxpayers must disclose foreign bank accounts and foreign-held assets under both FBAR and FATCA to avoid potential civil and criminal penalties. While there is an apparent overlap, FBAR reporting is required when a taxpayer has an interest in a foreign bank account that had a balance in excess of $10,000 at any point in the tax year. FATCA reporting is generally required if an individual taxpayer had an interest in a foreign financial account or asset that exceeded $50,000 on the last day of the tax year or exceeded $75,000 at any point during the tax year. Separate penalties apply for failure to file the FBAR form.
As a result of the many complexities created by FATCA, many Canadian and European banks have been closing and denying new brokerage accounts for U.S. customers. FATCA requires foreign financial institutions to report financial accounts of U.S. taxpayers directly to the IRS. Foreign financial institutions are required to withhold and pay to the IRS 30 percent of income derived from U.S. sources. The long-term success of FATCA in achieving its goal of identifying U.S. assets being held abroad will be somewhat dependent on how these foreign financial institutions cooperate with the IRS. According to a press release from November 8, 2012, the Department of the Treasury has thus far engaged more than fifty countries in its efforts to improve international tax compliance.
In early 2012, the U.S. Treasury Department issued a joint statement with France, Germany, Italy, Spain, and the United Kingdom regarding a possible intergovernmental approach to combating international tax evasion. While cooperation from other countries is critical to the success of FATCA, it remains to be seen how an intergovernmental approach will be implemented. For now, the IRS still has to execute Exchange of Information treaties when seeking information about a specific taxpayer from a foreign government.