FATCA: The Era of FATCA Compliance has Arrived

Posted by: Anne Greene    Posted Date: Mon, 06/02/2014 - 10:27am

Categories: International Asset Protection

U.S. persons with offshore accounts have likely heard the news that The Foreign Account Tax Compliance Act or “FATCA” will take full effect on July 1, 2014. While reporting offshore accounts and certain assets to the IRS has always been required, FATCA is one of the most comprehensive and global pieces of legislation to prevent noncompliance by U.S. persons. FATCA was enacted in the Hiring Incentives to Restore Employment Act of 2010 and codified in sections 1471 through 1474 of the Internal Revenue Code. In January, 2013, the Treasury Department published accompanying final regulations. The purpose of FATCA is to help prevent and locate noncompliance by U.S. taxpayers who do not report their foreign financial accounts.

One of the reasons that FATCA is so controversial is that FATCA actually imposes an obligation to report account information of U.S. taxpayers on the foreign financial institutions (“FFI”s), including the obligation to report on accounts owned by foreign entities that U.S. shareholders have a certain interest. Beginning July 1, 2014, FFIs will have to report any accounts held by U.S. persons and include in disclosure the individual’s name, address, tax identification or social security number, and account balances of all of the offshore accounts if the aggregate amount exceeds $50,000 dollars. While FFIs are not U.S. persons and under the jurisdiction of the IRS, the IRS can ‘force’ this result by making the alternative to participation damaging to the foreign institutions. Under FATCA, any non-participating FFIs will suffer from a 30% withholding tax on U.S. source payments to foreign entities. Meaning that U.S. banks would withhold 30% of a wire transfer to a non-compliant FFI, an act that makes it highly undesirable for any U.S. persons to transact business with that institution. The cost of FATCA implementation is extreme, and fall out of this implementation has included reluctance of some FFIs to continue holding U.S. client accounts. FFIs that participate in reporting are within a jurisdiction which is participating in either Model 1 or Model 2 of an intergovernmental agreement (“IGA”) with the U.S., the primary difference in these models being whether the FFI will report directly to the IRS or will report first to its own government. These agreements will determine if the U.S. banks and financial institutions need to provide reciprocal information to foreign regulatory agencies concerning the non-US citizens who hold accounts at U.S. banks. FFIs will be expected to register with the IRS and receive a Global Intermediary Identification Number (GIIN) for reporting. FFIs in a jurisdiction that is treated as not having an IGA, must register and agree to the terms of an FFI agreement in order to avoid being withheld upon. This identification of U.S. accounts is due to begin on July 1, 2014, and any country that subsequently enters into an IGA will be able to report data going back to July 1, 2014.

IRS Notice 2013-43 established a revised timeline for the phased implementation of FATCA, which began on January 1, 2014, and will be continue through 2017. The FFI agreements signed prior to June 30, 2014, will become effective that day. On July 1, 2014, new account procedures for U.S. withholding agents, participating FFIs, and registered deemed-compliant FFIs will take place and FFIs will need to disclose the U.S. person and account information to the IRS. July 2014 will also be the date that non-participating FFIs become subject to the 30% withholding on U.S. source interest, dividends, and other types of passive income, also known as “fixed or determinable annual or periodical” income. Beginning on January 1, 2015, the FFIs will be required to withdraw 30% of any yearly gains in U.S. person’s foreign accounts and submit that withholding payment to the IRS.

On May 2, 2014, the IRS issued Notice 2014-33 which allows a two year transition period for tax years 2014 and 2015. This transition period, however, does not halt the implementation of FATCA, but merely allows foreign banks to instead make a reasonable effort to comply with new FATCA requirements. It is a delay on enforcement actions taken against the FFIs and not a delay to the actual implementation. This notice is not a guarantee that information will go unreported. For that reason, taxpayers concerned about FATCA should not treat this notice as extra time to leave accounts unreported, but instead treat the upcoming months as the best time be proactive with regards to disclosing previously unreported accounts through the Offshore Voluntary Disclosure Program (“OVDP”).

For the people that are now realizing years of noncompliance, the IRS offers the OVDP. The program provides the taxpayers with a different penalty structure for assessing interest and penalties. When accepted into the OVDP, if an individual makes a truthful and timely disclosure and completely complies with any requests from the IRS, the IRS will not recommend criminal prosecution. The IRS will not accept an application from a taxpayer who is already under examination, in other words if the IRS has already detected the taxpayer’s account due to the information release from an FFI it could refuse participation in the more favorable voluntary program. Due to this discretion and the impending nature of FATCA, it is more important than ever that the taxpayer reconcile past noncompliance through the OVDP.

The OVDP is both a disclosure program and a penalty structure. Since the penalty is 27.5% of the highest year’s aggregate value during the period covered by the voluntary disclosure, the cost of participation could exceed the current balance of the account. The penalty is essentially calculated on the high water mark of the account or accounts for the past eight years and the revenue agent is required to assess this penalty unless the taxpayer qualifies for a reduced penalty as discussed below. Under the 2012 OVDP, the taxpayer will also be liable for the 20% accuracy related penalty for all of the years that disclosure is made, information return reporting penalties, and possible FBAR penalties. Taxpayers will be expected to have or acquire monthly statements from the foreign banks to show the highest amount that existed in the account each year and properly calculate the penalties.

Although rare, there are reduced penalty amounts within OVDP if a taxpayer qualifies. The 27.5% penalty may be reduced to 5% in three instances. First, taxpayers who may benefit from the reduced penalty meet the following criteria in which the taxpayer: did not open or cause to be opened a bank account, had infrequent contact with the account, did not withdraw more than $1,000 dollars from the account with the exception of closing the account and transferring funds to a U.S. account, and can establish that all applicable U.S. taxes have been paid on funds deposited on the account. Second, a taxpayer is who is a foreign resident and unaware of their U.S. citizenship may claim the reduced penalty. If the taxpayer takes no action upon learning of U.S. citizenship he or she will be disqualified from taking the penalty reduction. Third, taxpayers who may benefit from this 5% reduction are foreign residents who: reside in a foreign country, have made a good faith showing that they have complied with all tax reporting and payment requirements in the country of residence, and have $10,000 dollars or less of U.S. source income each year.

If a taxpayer does not qualify for the 5% penalty he or she may still try to get the penalty reduced to only 12.5% of the highest balance of the offshore account. This reduction will be available to taxpayers whose highest aggregate account balance in each of the years under disclosure was less than $75,000 dollars. This amount aggregates the fair market value of all assets in the undisclosed offshore entities and the fair market value of any foreign assets that were acquired with the improperly untaxed funds and income.

Due to the upcoming implementation of FATCA that will create a reporting obligation for FFIs, the importance of disclosure has increased. Although the OVDP penalty framework may seem extreme, this penalty is generally less severe than if the IRS discovers noncompliance and applies the available civil and criminal penalties available. These civil penalties for failure to file the FBAR include a required payment of the greater of $ 100,000 dollars or 50% of the total value of the foreign account per willful violation or a civil penalty of $ 10,000 dollars for a non-willful violation. Criminal Penalties for tax evasion , filing a false return, or failure to file an income tax return could range in potential jail terms of up to five years and fines of up to $250,000 per occurrence. Once the IRS has initiated a civil examination of the taxpayer, regardless of the purpose of the examination, the taxpayer is no longer able to elect to voluntarily disclose the foreign assets under the OVDP and will instead be subject to civil and criminal penalties. These penalties may be assessed on years outside of the eight year evaluation period of the OVDP period.

Foreign banks and financial institutions will be registered and obligated to disclose U.S. clients personal and account information beginning on July 1, 2014. U.S. persons who have been non-compliant up until this point may have gotten letters from these foreign banks requesting permission to disclose accounts or may have independently realized a lapse in compliance to the U.S. tax reporting obligations. Either way, now, before FATCA is in full force is the best time to take advantage of the Offshore Voluntary Disclosure Program. It can be helpful to engage a tax advisor or an attorney when navigating compliance and the intricacies of the OVDP and FATCA, since the OVDP requires communication with the IRS, accountants, and potentially foreign banks. If you have any questions regarding the option to participate in the Offshore Voluntary Disclosure Program please feel free to contact Nagel & Associates, LLC, (412) 749-0500 or nagellaw.com.

Anne Greene is an international asset protection and tax attorney at Nagel & Associates and currently practices in Pittsburgh, Pennsylvania. She is a graduate of Georgetown Law Center (L.L.M. in Taxation) and the University of Pittsburgh Law School.

Nagel & Associates is a law firm assisting clients in the area of asset protection cross-border transactions, global investment, taxation, immigration / emigration and estate planning. Anne can be reached via email at Agreene@nagellaw.com or at 412-749-0500.