If you have an interest in a foreign bank account you may be subject to reporting requirements. There are two pieces of legislation that relate to these accounts. The Bank Secrecy Act requires that certain financial accounts based in foreign countries be reported to the Department of Treasury. This act has been in place for a number of years and is commonly known as FBAR (Report of Foreign Bank and Financial Accounts). The Foreign Account Tax Compliance Act (FATCA) was enacted in 2010 with the intent of identifying American account holders in foreign bank and requiring payment of taxes on income from these investments.
Foreign Bank Account Reporting
If you have a financial interest or signature authority over a foreign financial account you may be required to file Form TD F 90-22.1 with the Department of Treasury. Note that this is not an income tax form and is not filed with the 1040. The due date for the return is June 30 of the year following the calendar year being reported. This is known as the Report of Foreign Bank and Financial Accounts and does not require the payment of taxes.
A foreign financial account includes any savings or checking deposit in an account maintained with a foreign financial institution. This includes savings and checking accounts in addition to any account in which the account has an equity interest in the fund, such as a mutual fund. It does not include ownership of individual bonds, notes, or stock certificates held by the owner. A foreign country is defined for this purpose as all geographical areas outside the United States, the commonwealth of Puerto Rico, the commonwealth of the Northern Mariana Islands, and the territories and possessions of the United States.
Who Must File
There are two basic requirements for filing if you have a foreign financial account. First, this applies to “United States persons.” A United States person includes a citizen or resident of the United States, a domestic partnership, a domestic corporation, and a domestic estate or trust. If you are a United States person, you must also have “signature or other authority over an account.” This means the authority to control the disposition of money by signing a check or similar document. Authority also exists if the person can exercise that power through direct communication with the financial institution.
The second requirement is that the account must be reported if the aggregate value of foreign financial accounts in which there is a financial interest exceeds $10,000 at any time during the calendar year. This requirement has a couple of provisions that can be easily overlooked. First, the accounts are reportable if the value exceeds $10,000 at any time during the year. Not the average balance for the year. For example, if $12,000 were deposited into an account one morning, then withdrawn the following day, a reporting requirement would be triggered, as the value of the account exceed $10,000. Secondly, the reporting requirement is for the aggregate value of all foreign financial accounts. Thus if there were two accounts, and the value of those combined accounts exceeded $10,000 at any time, the reporting requirement is triggered.
Reporting Issues and Penalties
As mentioned, the FBAR is not an IRS form and is sent to the Department of Treasury. The report is due June 30 and cannot be extended. Form TD F 90-22.1 is available at www.irs.gov as well as the Department of Treasury Financial Crimes Enforcement Network website (www.fincen.gov).
All foreign accounts should be reported to the IRS. On the 1040, Schedule B, Part III, lines 7a and b are required if you had over $1,500 of taxable interest or ordinary dividends or had a foreign account. In addition if you received a distribution from a foreign trust or were a transferor or grantor of such a trust you must complete lines 7 a and b. Schedule B of the 1041, 1065, and 1120 have similar requirements. If required to check “yes” on these boxes, a failure to do so is interpreted as a willful failure to file if a TD F 90-22.1 is required. In these cases, the reporting is limited to the existence of the accounts. These accounts must be reported in detail on the TD F 90-22.1 if you are required to file the form.
Although there is no tax associated with TD F 90-22.1, there are significant penalties for not filing the return. These penalties can be civil or criminal. A willful failure to file may carry a criminal penalty of up to $250,000 and/or up to five years in prison. Each missing FBAR is a separate crime. A civil willful failure to file carries a penalty of up to $100,000 or 50% of the highest balance in each unreported account for the year. If it can be demonstrated that the failure to file was not willful, the penalty would be much lower, frequently $10,000.
There are three important points about the penalties.
- Penalties are assessed per account, not per return.
- Penalties apply for each year of each violation.
- Penalties can apply to each person with a financial or signature authority over the account.
It is readily apparent that the penalties can escalate quickly and can substantially exceed the balance in the foreign accounts.
Foreign Account Tax Compliance Act
The Foreign Account Tax Compliance Act (FATCA) was enacted in order to combat U. S. tax evasion by taxpayers holding investments in foreign accounts. This is somewhat controversial, as it raises privacy issues, especially for those having dual citizenship. It has been referred to as the “Global Tax Evasion Law.” A number of European banks and financial institutions have been closing brokerage accounts for all U. S. customers due to perceived “onerous” U. S. regulations. There are three components to the Act. The original effective date was January 1, 2014, but the IRS has delayed implementation. Institutions now have until January 1, 2017, to begin withholding U. S. tax from clients’ investment gains. However, procedures to meet FATCA reporting requirements must be in place by January 1, 2014. One problem is that the IRS has not issued final FATCA laws, so the industry does not know what specific requirements it faces.
The first section requires foreign financial institutions (FFI) to undertake certain identification and due diligence procedures in an effort to discover any U. S. account holders. U. S. account holders are defined as U. S. persons or foreign entities with substantial U. S. ownership. For any accounts that have been so identified, the FFI is to report annually to the IRS the balances, receipts, and withdrawals from these accounts. The IRS is empowered to require participating FFI’s to withhold and pay to the IRS 30 percent of any payments of U. S. source income made to non-participating FFI’s, individual accountholders who have not provided sufficient information to determine if they are a U. S. person, and foreign entity account holders failing to provide sufficient information about the identity of its substantial U. S. owners.
This section of FATCA is by far the most controversial, with significant push-back from banking and government officials who are balking at requiring them to become “extensions of the IRS” and assuming a significant financial burden in attempting to comply. Seven countries have entered into model agreements to cooperate with the U. S. on FATCA. Discussions with other countries are under way. Some countries, such as China, have flatly refused stating that “China’s banking and tax laws and regulations do not allow Chinese financial institutions to comply.” In other countries, legal action has been initiated to stop FFIs from compliance.
The second section focuses on the account holders themselves. It requires disclosure of foreign assets by filing Form 8938 with the annual 1040. Threshold amounts for filing the form depend on filing status and residency.
|Filing Status||Living in the U. S.||Not Living in the U. S.|
|Single or Married filing separate||Balance of $50,000 on last day of year or
$75,000 at any time during the year.
|Balance of $200,000 on last day of year or $300,000 at any time during the year.|
|Married filing jointly
|Balance of $100,000 on last day of year or $150,000 at any time during the year.||Balance of $4000,000 on last day of year or $600,000 at any time during the year.|
The determination of living or not living in the United States is made by applying the bona fide residence or physical presence test applicable to the foreign earned income exclusion.
The third section of FATCA closes a tax loophole that investors had used to avoid paying taxes on dividends by converting them into non-taxable dividend equivalents.
There is concern that the United States has gone too far with the provision of this act, to the extent that some push back is anticipated from foreign governments. According to the Treasury Department, they are currently in negotiation with at least 40 countries for FATCA agreements. Thus far, only the United Kingdom and Switzerland have finalized a FATCA pact, but France, Germany, Italy, Spain, and Japan have pending agreements.
It seems, though, that many institutions are waiting for the final rules before taking radical actions. Once the IRS comes out with those rules, the foreign financial institution landscape will begin to clear. Or at least, we can hope.