For a few years now, the IRS has been issuing an annual “dirty dozen” list of tax schemes—and failure to disclose foreign funds is one of the items on the list. The IRS reminds taxpayers that failure to report foreign income and assets is a common scheme that can bring severe consequences, including civil and criminal sanctions. Taxpayers with undisclosed foreign accounts should remember that, because of Foreign Account Tax Compliance Act (FATCA), the IRS will get information through third-party reporting. But what is FATCA?
FATCA was enacted in 2010 to prevent tax evasion by U.S. persons holding accounts and other financial assets offshore. Generally, U.S. citizens and residents—and certain domestic corporations, partnerships, and trusts—report their foreign assets to the IRS on Form 8938, Statement of Specified Foreign Financial Assets.
The FATCA reporting obligation is imposed on U.S. citizens and tax residents only if they meet a certain threshold. The reporting threshold for unmarried taxpayers living in the U.S. is triggered when the total value of their “specified foreign financial assets” (financial accounts, stock, interest in foreign entities, life insurance, annuities, etc.) are greater than $50,000 on the last day of tax year, or more than $75,000 at any time during the tax year. For married taxpayers living in the U.S. filing jointly, the obligation is triggered if the total value of specified foreign financial assets is greater than $100,000 on the last day of the tax year, or more than $150,000 at any time during the tax year. For married taxpayers living in the U.S. and filing separately (i.e. not jointly), their foreign assets must be reported if the total value of those specified foreign financial assets are greater than $50,000 on the last day of tax year, or more than $75,000 at any time during the tax year.
However, taxpayers living abroad are subject to different standards. Unmarried taxpayers living abroad must meet their reporting obligations only if they have specified financial assets of more than $200,000 in value on the last day of the tax year or more than $300,000 at any time during the tax year. In the case of those taxpayers living abroad who are married and filing jointly, the obligation to report is triggered if the total value of all specified foreign financial assets that the spouses own is more than $400,000 on the last day of tax year or more than $600,000 at any time during the tax year. Conversely, if the taxpayer is married, living abroad, and filing separately, the obligation is triggered if the total value of the taxpayer’s specified foreign financial assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the tax year.
Taxpayers required to report under FATCA should keep in mind that this law also requires Foreign Financial Institutions (FFI) to identify their U.S. customers. These FFIs must directly report to the IRS information about financial accounts held by U.S. taxpayers or by foreign entities in which U.S. taxpayers hold a substantial ownership interest. Some examples of FFIs are banks, investment entities, brokers, and certain insurance companies. In addition, some non-Financial Foreign Entities have similar obligations. FFIs that do not provide these reports are subject to a 30% withholding tax on any payments made to the FFI from a U.S. bank. Such payments may include dividends, interest, and insurance premiums made to non-U.S. financial institutions.
While there are legitimate reasons for maintaining financial accounts abroad, taxpayers should comply with their FATCA reporting obligations, in addition to other reporting requirements such us the FBAR filings. Remember, FBAR filings do not relieve taxpayers from the obligations to comply with FATCA filings. Taxpayers who have failed to properly report their offshore investments or pay tax on their investment income should come forward, as there are options for addressing the non-compliance.