FATCA and US Financial Reporting

The 2010 United States Foreign Account Tax Compliance Act, better known as FATCA, requires foreign financial institutions to report to the IRS the names of their U.S. account holders. This will most probably begin in July 2014.

Banks and other financial institutions in most countries, including Israel, have indicated that they will comply with FATCA.

U.S. taxpayers worldwide have always been required to report their foreign accounts on their annual FBAR (FinCEN 114) report. In addition, since 2011, similar information is reported on Form 8938 (attached to Form 1040) for higher account balances.

US Persons (US citizens and green card holders) who are required to submit an FBAR or 8938, but haven’t, can face severe fines and even criminal charges in extreme cases.

Who is required to report?

FBAR

US Persons, who at any time during the year had more than $10,000 in all non-US financial institutions combined, must file the FBAR Report.  Financial institutions include banks, brokerage accounts, certain pension funds and “keren hishtalmut” funds. Accounts include those owned jointly and even accounts owned by others for which you have signatory power over. The FBAR is an annual report due June 30th with regard to accounts during the previous calendar year. In contrast to tax returns, there are no extensions allowed for reporting the FBAR. The FBAR must be filed electronically at http://bsaefiling.fincen.treas.gov/NoRegFBARFiler.html or by your tax professional.

Form 8938

US Persons living abroad who are required to file tax returns will have to add Form 8938 to their 1040 if the total account balance of all non-US financial institutions combined exceeds $200,000 at year end, or, more than $300,000 at any time during the year.. These amounts are double for married couples filing a joint return. Amounts are substantially lower for US residents.

Penalties

Penalties for failure to file the FBAR or Form 8938 are severe and can, in extreme situations, even include criminal sanctions.

If the IRS considers the failure to file an FBAR as non-willful, the fine can reach as high as $10,000 for each year that the report was not filed. The penalty for willful failure to file is the greater of $100,000 or 50% of the maximum amount held in all non-U.S. accounts during the year. For example, if a taxpayer has $200,000 in foreign accounts for six years and does not file the FBAR form or report income earned by the account each year, the IRS could assess a $600,000 FBAR penalty.

The penalty for failure to file Form 8938 is generally $10,000 per year.

The good news, however, is that if you can show reasonable cause for failure to file the reports, then the penalties can often be abated.

What should you do if you haven’t reported in the past

There are several approaches one can take in dealing with their overdue obligation with the IRS:

  • Offshore Voluntary Disclosure Program
  • Streamline Procedure
  • Quiet Disclosure

The Offshore Voluntary Disclosure Program

Beginning in 2009, the IRS established a series of “Offshore Voluntary Disclosure Programs” to encourage taxpayers to come forward and disclose their non-U.S. accounts, pay reduced penalties, and avoid criminal prosecution. The current program requires taxpayers to file delinquent FBARs and amended income tax returns including income which was not previously declared (i.e., interest, dividend and capital profit), if any, and pay tax and penalties going back eight years. In order to be eligible for this program, a request for participation in the program must be filed before the IRS contacts the taxpayer regarding delinquent returns, and before a foreign financial institution reports to the IRS.

Taxpayers must also pay a single FBAR penalty equal to 27.5 percent of the highest aggregate balance held outside of the U.S. over the previous eight years. In addition, while the normal FBAR penalty applies only to non-U.S. financial accounts, the voluntary disclosure penalty applies to the value of any foreign assets that either produced undeclared income or were purchased with undeclared funds. For example, if the taxpayer has rental property overseas and did not declare the rental income, the value of the rental property will be included in the penalty calculation.

As the penalty under the voluntary disclosure program applies only once, rather than each year, it may significantly reduce the taxpayer’s potential FBAR penalties.

The Streamline Procedure

The Streamline process allows “low risk” taxpayers who have not lived in the US at any time since the beginning of 2009, to apply for a reduced reporting requirement which includes tax returns for the past three years and FBAR reports for the past six years.

Low risk refers to most taxpayers who owe less than $1,500 of tax per year. There are other criteria, as well, that must be checked before submitting reports using the Streamline procedure.

Quiet Disclosure

This method is simply filing all tax returns and FBARs that are delinquent. The advantage to this is that for taxpayers who either owe no tax or small amounts of tax, it will probably not raise any red flags. The downside of this approach is that it does not provide any protections that the formal voluntary disclosure program might provide, or any built-in compromise to reduced FBAR penalties.

Which Method is Best for You?

Taxpayers Should Act Quickly to Evaluate which Approach Best Suites Their Needs

FATCA will force most non-U.S. financial institutions worldwide to disclose account information on their account holders who are US citizens beginning in this summer. These U.S. taxpayers, many of whom may not even be aware of their obligation to disclose the accounts, may be running out of time to take appropriate action before the IRS takes its own. Remember, once your bank reports to the IRS, it will be too late to use the Voluntary Disclosure or Streamline reporting options. The quiet approach, as well, will likely be more risky.

Time is running out. If you haven’t been compliant in your reporting to the US, the best course of action in order to avoid potentially heavy fines from the IRS is to begin reporting immediately. Your tax professional can help you decide the best approach to take, but the most important piece of advice is to NOT procrastinate.