When I first started preparing tax returns in the late 90’s, foreign account reporting was not really a concern. Rarely was there a need to check yes to the question on Schedule B (Interest and Dividend Income) of Form 1040, to indicate the taxpayer had an interest in or signature authority over a foreign account. No more. The times, as they say, are a’changing.
In the last decade the IRS has started a real push to identify U.S. taxpayers who are hiding assets offshore. Just read some of the IRS’ press releases regarding foreign accounts (see here, here and here) and it is easy to see that the IRS believes its efforts are bearing fruit. The IRS is not alone in this. The Financial Crimes Enforcement Network is also part of the enforcement effort. Combined both agencies are putting a lot of pressure on taxpayers to come clean. The two major programs dealing with foreign asset reporting are FBAR and FATCA, which stand for “Report of Foreign Bank and Financial Accounts”, and “Foreign Account Tax Compliance Act”, respectively. Taxpayers who run afoul of either reporting requirement can face severe penalties (at a minimum) or criminal prosecution (at worst), so I thought it worth a quick explanation. Not that many of my clients are of the wealthy jet-set who fly their private jets to the Caymens for sun, sin and financial shenanigans…yet.
If you possess an interest in or have signature authority over a financial account located in a foreign country then you may need to file a FinCen114 report through the Financial Crimes Enforcement Network (link is here). FinCen114 is due April 15th of each year and which is filed electronically. If you cannot meet this deadline then you can get an extension up to October 15th. The FBAR applies to both individuals and businesses (unlike FATCA, which applies only to individuals).
You are required to file under FBAR if you have an ownership interest in or signature authority over a foreign account, with an aggregate value of all such foreign accounts exceeding $10,000 US dollars, at any point, on a given day during the calendar year.
A foreign financial account is defined rather broadly and includes bank accounts, brokerage accounts, mutual funds, and trusts which are located in a foreign country. It doesn’t have to be a foreign bank to be considered located in a foreign country. So long as the branch, where the account is opened and held, is located in a foreign country it has to be reported, regardless if the branch is of a US or foreign company.
Aggregate value means the total value of all accounts over which a taxpayer has an interest in or signature account over during the year. If, on any given day, the aggregate balance of the accounts exceeds $10,000 (in terms of U.S. dollars) then a FinCen114 report needs to be filed. The taxpayer computes the aggregate amount based on 100% of the value of the account, whether or not the taxpayer’s actual ownership equal 100% of the account or not. If the account has a value denominated in a foreign currency, the taxpayer will use the conversion rates promulgated by the US Treasury to determine the value in U.S. dollars. You can find the link here for the Treasury Reporting Rates for FBAR.
Penalties for failure to file a FinCen114 or to prepare the return correctly are as follows. The IRS may assess a penalty, indexed for inflation, not to exceed $12,459 per violation for non-willful violations (meaning unintentional); if the violation is willful then this penalty increases to the greater of $124,588 or 50 percent of the balance in the account at the time of the violation, for each violation. Beyond the financial penalties, there is the potential for criminal prosecution for tax evasion, depending on the egregious nature of the violation.
FATCA or the Foreign Account Tax Compliance Act is designed to prevent tax evasion by identifying individuals who possess an interest in certain foreign financial assets. To comply with FATCA, the taxpayer submits Form 8938, Statement of Specified Foreign Financial Assets, along with his or her tax return, which is due on April 15th of each calendar year (which can be extended to October 15th). FATCA has some very complicated filing requirement, making explanation in a short blog post difficult but I will try to distill it down as best I can.
FATCA applies to certain specified U.S. taxpayers holding specified foreign financial assets outside the United States (I know that sounds redundant but that’s the IRS’ formulation and not mine). If the aggregate value of these foreign financial assets exceeds a certain dollar threshold then the taxpayer must report such assets on IRS Form 8938, as stated above.
First, FATCA applies only to specified individual, such as US citizens; resident aliens who live in the United States for any part of the tax year; nonresident aliens who elect to be treated as resident alien for purposes of filing a joint income tax return; and nonresident aliens who are bona fide residents of American Samoa or Puerto Rico. So FATCA applies to US citizens, at home and abroad, and to certain foreign citizens residing in the US, American Samoa or Puerto Rico.
Second, the specified individual must possess an interest in specified foreign financial assets. These assets are divided into two categories: either a financial account maintained by a foreign financial institution (unless it is a US Bank or the institution has a US presence) or other foreign financial assets held for investment (that are not held in an account maintained by a US or foreign financial institution). Good examples of the second category of assets are: stock or securities issued by a foreign company; an interest a foreign entity (akin to a partnership or other non-corporate interest); and a financial instrument or contract which has a foreign individual or entity as the other party or issuer.
The final requirement is that the aggregate value of the specified foreign financial assets exceeds certain thresholds established under the law. For unmarried taxpayers living in the US, the aggregate value has to exceed $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year. Married taxpayers living in the US (who file a joint return) must file a report if the aggregate value exceeds $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year (married taxpayers filing separately have to use the lower unmarried taxpayer threshold of $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year). If the taxpayer lives abroad (so US citizens only) then the thresholds increases considerably (the rules regarding taxpayers abroad can complicated so I won’t go into any detail).
Valuing foreign financial assets can be complicated and so taxpayers are allowed some leeway. For brevity purposes, I will not go into detail of how to value specified foreign financial assets; generally taxpayers are allowed to make reasonable estimates regarding an assets worth when determining whether he or she needs to make a report under FATCA.
Failure to file Form 8938 carries with it certain penalties. You can be penalized up to $10,000 for failure to file the report plus an addition $50,000 if you continue to properly file a report after the IRS notifies you. If that wasn’t enough, the IRS can assess an additional 40 percent penalty on an understatement of tax attributable to non-disclosed assets. Like the FBAR, the same threat of criminal prosecution applies depending on the circumstances.
As you can probably guess, there are areas where both FBAR and FATCA reporting requirements can apply to a single foreign financial asset. Based on what I discussed above, you can well imagine that the cost of complying with both reporting requirements can be expensive but there is no exception for a taxpayer who meets the filing requirements of both.
I suspect that most of you who are reading (this probably all of you) will never own a secret Swiss bank account or hide assets in a Cayman trust but the rules are worth reviewing. I hope you found it interesting (even if probably a bit overwhelming). You never know when that nice Nigerian prince will finally get his money out of the country. He keeps emailing me to let me know that one more check should do it… Bahamas, here I come!