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Expat Briefing Editorial Team, 21 November, 2013
Under the United States' worldwide system of taxation for individuals, Americans living abroad are in the unenviable situation of having to report and pay taxes in the US as well as in their host country. For many US expats however, things are about to get a whole lot worse thanks to the Foreign Account Tax Compliance Act, commonly known as FATCA.
What is FATCA?
Signed by President Obama in March 2010 as a revenue provision to the Hiring Incentives to Restore Employment Act, FATCA is designed to tackle the non-disclosure by US citizens of taxable income and assets held in foreign accounts. Therefore, FATCA is intended to ensure that the US obtains information on accounts held abroad at foreign financial institutions (FFIs) by US persons. Failure by an FFI to disclose information on their US clients, including account ownership, balances and amounts moving in and out of the accounts, will result in a requirement on US financial institutions to withhold 30 percent tax on US-source income.
To address situations where foreign law would prevent an FFI from complying with the terms of an FFI agreement, the United States Treasury Department has developed three model intergovernmental agreements (IGAs).
The Model 1 IGA, requires FFIs in the foreign jurisdiction to report tax information about US account holders directly to the government, which will in turn relay that information to the US Internal Revenue Service (IRS).
The Model 1A IGA is essentially the same, except that the IRS will reciprocate with similar information about account holders from the signatory country with the partner government.
The Model 2 IGA requires FFIs to report specified information about their US accounts directly to the IRS, to the extent that the account holder consents or such reporting is otherwise legally permitted, and such direct reporting is supplemented by information exchange between governments with respect to non-consenting accounts. FFIs also report to the IRS aggregate information with respect to holders of pre-existing accounts who do not consent to have their account information reported, on the basis of which the IRS may make a "group request" to the partner jurisdiction for more specific information.
As of November 14, 2013, the following countries were treated by the US Treasury as having a Model 1 IGA in effect: Denmark, France, Germany, Ireland, Mexico, Norway, Spain and the United Kingdom.
Model 2 agreements were in effect with Japan and Switzerland on the same date.
Many more IGAs are being negotiated by the US Treasury. In the past few days, France has signed a Model 1A IGA with the US, and Singapore is said to be nearing the successful conclusion of negotiations. A number of offshore financial jurisdictions are also exploring FATCA IGAs, including The Bahamas, Bermuda, the British Virgin Islands and the Cayman Islands.
How Will FATCA Affect US Expats?
In practical terms, FATCA adds yet another reporting burden on those with interests in foreign accounts. So US citizens, US individual residents, and what the IRS describes as "a very limited number of non-resident individuals" who own certain foreign financial accounts or other offshore assets (specified foreign financial assets) must report those assets on new Form 8938 'Statement of Specified Foreign Financial Assets', which must be attached to the annual US income tax return (Form 1040).
Individuals who do not have to file an income tax return for the tax year, do not need to file Form 8938, even if the value of their specified foreign assets is more than the appropriate reporting threshold. Those required to file Form 8938, do not have to report financial accounts maintained by: a US payer (such as a US domestic financial institution); the foreign branch of a US financial institution, or; the US branch of a foreign financial institution.
For individuals who are resident in the United States, if the total value of the specified foreign assets is at or below USD50,000 at the end of the tax year, there is no reporting requirement for the year, unless the total value was more than USD75,000 at any time during the tax year.
Higher asset thresholds apply to US taxpayers who file a joint tax return or who reside abroad.
Married taxpayers filing a joint income tax return and living in the US must report if the total value of their specified foreign financial assets is more than USD100,000 on the last day of the tax year or more than USD150,000 at any time during the tax year. Married taxpayers filing separate income tax returns and living in the US must report if the total value of their specified foreign financial assets is more than USD50,000 on the last day of the tax year or more than USD75,000 at any time during the tax year.
US taxpayers living abroad must file Form 8938 if they file a return other than a joint return and the total value of specified foreign assets in the foreign account is more than USD200,000 on the last day of the tax year or more than USD300,000 at any time during the year. Non-resident taxpayers filing a joint return and with specified foreign assets of more than USD400,000 on the last day of the tax year or more than USD600,000 at any time during the year must also file Form 8938.
The IRS currently defines a taxpayer living abroad as: a US citizen whose tax home is in a foreign country and who is either a bona fide resident of a foreign country or countries for an uninterrupted period that includes the entire tax year; or a US citizen or resident, who during a period of 12 consecutive months ending in the tax year is physically present in a foreign country or countries at least 330 days.
The following types of foreign assets must be reported on Form 8938:
In addition to accounts held at foreign branches of US financial institutions and US branches of foreign institutions, the following assets are not reportable under FATCA:
Penalties for failure to report foreign financial assets on Form 8938 when required under the legislation are harsh. Non-disclosure may result in a penalty of USD10,000, and an additional fine of up to USD50,000 for continued failure after IRS notification. Furthermore, underpayments of tax attributable to non-disclosed foreign financial assets will be subject to an additional substantial understatement penalty of 40 percent.
What is the Timetable for FATCA?
Final regulations for the implementation of FATCA were issued by the US Treasury and IRS in January 1, 2013. From August 2013, FFIs have been permitted to use an on-line portal for FATCA registration. Under current timelines, FFIs must fulfil their due diligence and withholding requirements to comply with FATCA by July 2014 (a deadline extended by six months) ready for the first reports to reach the IRS by March 31, 2015, regarding accounts maintained during 2014.
However, according to the IRS, individuals should already be filing their Form 8938. Reporting applies for specified foreign financial assets in which the taxpayer has an interest in taxable years starting after March 18, 2010. The IRS states that for most individual taxpayers, this means they should have started filing Form 8938 with their 2011 income tax return.
What About FBAR?
US citizens are already required to report certain information to the IRS about foreign bank accounts by filing the Report of Foreign Bank and Financial Accounts, or FBAR, every year.
US persons are required to file FBARs annually if they have a financial interest in or signature authority over financial accounts, including bank, securities or other types of financial accounts, in a foreign country, if the aggregate value of these financial accounts exceeds USD10,000 at any time during the calendar year.
Unfortunately, FATCA merely supplements, rather than replaces, FBAR reporting, so that those affected by FATCA reporting will usually have to file under both regimes.
When FATCA was first enacted, the few people who knew about it expected that it would fail to be implemented, not least because its extra-territorial reach meant that it was unrealistic and impractical to try. They didn't reckon on the resolve of a government determined to aggressively crack down on tax avoidance and evasion, however. What's more, tax avoidance has become a global issue since FATCA was signed into law over three years ago, and by dangling the carrot of reciprocity in front of foreign governments, the US Treasury has seemingly persuaded many of them to sign its IGAs. Moreover, FATCA fits very nicely into the growing framework of international information exchange systems, allowing tax authorities to access information on non-resident taxpayers in more countries than ever before. Indeed, many governments have seen FATCA as an opportunity to develop information sharing regimes of their own. The UK for one is signing "son of FATCA" agreements with its offshore territories, while five European Union member states (France, Germany, Italy, Spain and the UK) have launched a pilot scheme based on the FATCA Model 1 IGA that will allow their tax authorities to automatically share information with one another.
However, one unintended consequence of FATCA's spread throughout the world for US citizens is that banks and financial institutions are simply refusing to accept American clients because of the compliance burden involved (it has been said that complying with FATCA has cost the financial sector upwards of USD7bn). It is not clear how widespread this practice has become, but anecdotal evidence suggests that it is definitely taking place.
Because of concerns expressed by US expats, the US Treasury has inserted a provision in the model IGAs bestowing certain benefits on FFIs which do not discriminate against US citizens. However, it is unclear at the moment how effective this clause will turn out to be.
US expats are also attempting to persuade the US Government to exempt them from the FATCA reporting requirements if they bank with local institutions, and last month American Citizens Abroad (ACA), the campaign group for US expats living around the globe, wrote to the Treasury to propose a 'same-country' exception under the FATCA withholding and reporting rules. The main purpose of such a rule would be, as ACA put it, to "alleviate to some degree the problem of Americans being locked out of banking relationships due to banks' reactions to FATCA."
Given that a 'same-country' exemption would be unlikely to deprive the US Treasury of much revenue, it would presumably stand to lose very little by putting in place such a rule. However, logic and proportionality are not words that are readily associated with a law that is expected to yield at best about USD2bn in additional tax for an overall cost, both on governmental and private sector resources, of considerably more than that. So US expats should not hold their breath waiting for the right answer to the ACA's request from the Treasury!
It has also been suggested that FATCA is responsible for a sharp rise in the number of Americans renouncing their citizenship, which looks to be about the only way to escape the US's all-encompassing tax net. There was a six-fold increase in the number of American citizens living abroad who gave up their United States passports in the second quarter of this year, compared to the same three months in 2012 according to figures provided by the IRS. Also, American expatriates who renounced their citizenship during the three months to end-June 2013 rose sharply to 1,130, from 679 in the previous quarter and only 189 in the same period last year.
With millions of Americans residing abroad these numbers are quite small, and giving up a US passport is not a decision to be taken lightly. There could in fact be several reasons for the sudden spike in citizenship renunciations, including mere coincidence. However, campaigners against FATCA say that it is no accident that more and more Americans are handing back their passports as FATCA becomes grim reality.
It seems to have taken some time, but opposition to FATCA is becoming hardened and more organized. Importantly, this includes within the US Congress, where mainly Republican Congressmen have spoken out against the law. Indeed, Senator Rand Paul, a Kentucky Republican, has followed words with deeds by introducing a bill in Congress to repeal the anti-privacy provisions of FATCA, which would effectively make the whole law redundant.
However, there are convincing grounds to suggest that the Treasury is overstepping its authority with the way it is implementing FATCA, and that many of its actions to date are illegal. The original legislation makes no mention of allowing the Treasury to negotiate agreements with foreign governments, let alone reciprocity. Furthermore, as things currently stand, only the US Senate can approve or reject foreign agreements, and none of the IGAs have been put before Congress. These concerns were pointed out by Rep. Bill Posey, a Florida Republican on the House of Representatives Financial Services Committee, in a letter to Treasury Secretary Jack Lew earlier this year.
The US Treasury is also the subject of a lawsuit from the banking associations of Florida and Texas, who argue that FATCA breaks laws in the areas of public administration and financial regulation, and that the US Government failed to take into consideration the possible economic impact of FATCA. In the lawsuit, the banks claim that non-residents have pulled around USD100m from the US banking system.
So FATCA Will Be Stopped Then?
Possibly. But there is no guarantee. While most Democrats in their hearts probably know FATCA is, as Rand Paul says, "a text book case of a bad law," they are unlikely to side with the Republicans and vote to repeal it given the current divisions in Congress. And the Democrats control the Senate, which would have to approve any legislation affecting FATCA. With the mid-term elections on the horizon in late 2014, the composition of Congress could change, but there's as much of a chance that the Democrats will strengthen their hold in the Senate as the Republicans gaining control of Congress. Besides, President Obama, who signed the legislation, is unlikely to put his name to a law repealing it, and he will be in the White House for another three years. So for the foreseeable future at least, US citizens everywhere are going to have to get used to FATCA.