The U.S. Department of the Treasury and the IRS have issued what is expected to be their final significant package of regulations implementing the Foreign Account Tax Compliance Act (FATCA). FATCA requires foreign financial institutions (FFIs) - including foreign banks, brokers, insurance companies and investment funds - to disclose to the IRS certain information about their U.S.-owned accounts. The law is intended to combat offshore tax evasion.
Although the new regulations are targeted primarily at FFIs and U.S. financial institutions that deal with them, they demonstrate the heightened scrutiny the federal government is putting on foreign accounts and, in turn, the need for individual taxpayers holding such accounts to comply with their own reporting obligations.
FATCA reporting requirements
FATCA requires FFIs to report to the IRS certain information about the financial accounts held by U.S. taxpayers or by foreign entities in which U.S. taxpayers hold a substantial ownership interest. FFIs that fail to provide the required information face significant U.S. tax penalties.
FATCA generally requires FFIs to withhold 30% on certain U.S.-connected payments to a "recalcitrant" account holder. A recalcitrant account holder is one that fails to provide the information required to determine whether the account is a U.S. account or the information required to be reported by the FFI, or to provide a waiver of a foreign law that would otherwise prevent reporting by the FFI.
The law also requires U.S. withholding agents (such as U.S. financial institutions) to withhold tax on certain payments to FFIs that don't agree to report required information to the IRS and on certain payments to certain nonfinancial foreign entities (NFFEs) that don't provide information on their substantial U.S. owners to the withholding agents. FATCA withholding on certain payments to nonparticipating FFIs, noncompliant NFFEs and recalcitrant account holders is scheduled to take effect on July 1, 2014.
In addition, the United States has pursued intergovernmental agreements with other countries to implement FATCA. Under the agreements, the partner government will require all FFIs within its jurisdiction (and not otherwise exempt) to identify U.S. accounts and report information on those accounts to the IRS.
Coordination with existing rules
The first set of new rules includes more than 50 amendments and clarifications to the final FATCA regulations that were issued in January 2013 and takes into account stakeholder suggestions regarding ways to reduce compliance burdens. For example, the regulations give certain NFFEs the ability to report information about their substantial U.S. owners directly to the IRS, rather than to withholding agents.
The second set of final rules tackles the overlap between FATCA and existing rules under the Internal Revenue Code (IRC) for due diligence, foreign reporting and withholding. Before FATCA's passage, the IRC already had several provisions on topics addressed by FATCA. Specifically, the IRC contains rules for reporting and withholding related to payments of certain U.S.-source income (for example, dividends on stock in U.S. companies) to non-U.S. persons and rules addressing the reporting and withholding requirements for various types of payments made to certain U.S. persons.
The new rules aim to coordinate the pre-FATCA regime with FATCA's requirements to reduce the burden and conform the rules for due diligence, withholding and information reporting on U.S. persons, to the extent appropriate in light of the different objectives of each rule. For example, the new rules eliminate inconsistencies in the IRC and FATCA documentation requirements (related to identification of payee status) for withholding agents and FFIs.
It's not just financial institutions that must report on foreign accounts. FATCA requires certain U.S. taxpayers holding foreign financial accounts with an aggregate value that exceeds $50,000 at the end of the tax year ($100,000 for joint filers) or with a total value of more than $75,000 at any time during the tax year ($150,000 for joint filers) to report certain information about those assets on Form 8938, "Statement of Specified Foreign Financial Assets," along with their annual tax returns. The threshold is higher for those living outside the United States.
The IRS has indicated that it will issue future regulations requiring a domestic entity to file Form 8938 if the entity is formed or used to hold specified foreign financial assets and the total asset value exceeds the appropriate reporting threshold. Until that time, only individuals must file Form 8938.
Both individuals and entities, however, may need to file Financial Crimes Enforcement Network (FinCEN) Form 114, "Report of Foreign Bank and Financial Accounts(FBAR)," which supersedes the former Form TD F 90-22.1. "U.S. persons" must file FBARs with the IRS by June 30 of the following year for each year that:
- The person had a financial interest in or signature authority over at least one financial account located outside of the United States, and
- The aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year to be reported.
The term "U.S. person" includes U.S. citizens, residents, entities (including, but not limited to, corporations, partnerships and limited liability companies), and trusts or estates. A person who holds a foreign financial account may have a reporting obligation even though the account produces no taxable income.
As information about foreign financial assets increasingly makes its way to the IRS from FFIs, the odds of falling in the agency's crosshairs by neglecting to file Form 8938 or FBAR will become greater, as will the likelihood of incurring a costly penalty.
If you hold offshore financial accounts, it's essential that you properly report the required information to the IRS. This latest round of regulations, along with the coming effective date for the withholding requirements, signals an ever tighter focus on foreign assets on the horizon.
To ensure you're in compliance, or if you have questions regarding FATCA regulations or reporting requirements , please contact your engagement partner.