In my last column, I talked about the uniqueness of the U.S. income tax law because it could be applied to U.S. citizens and legal residents no matter where they live (in or out of the U.S.). To make sure all applicable U.S. persons and businesses pay proper taxes, the IRS requires any foreign financial accounts to be reported if the aggregated value exceeds $10,000 under FBAR (Report of Foreign Bank and Financial Accounts). The FBAR also requires the domestic financial institutions to report the deposits of $10,000 or more to the IRS under code 31 USC 5313. But the FBAR wasn’t enough to track down financial assets hiding overseas, so Congress came up with a new law called FATCA (Foreign Account Tax Compliance Act). Under this law, the aggregated foreign financial assets of $50,000 (single living in U.S.), $100,000 (married filing joint living in U.S.), $200,000 (single living out of U.S.), and $400,000 (married filing joint living out of U.S.) on the last day of the tax year must report their foreign financial assets using Form 8938. Failing to comply with this law may result in penalties up to $50,000 for tax payers and participating foreign financial institutions will be obligated to withhold and pay over to the IRS 30% of the U.S. source income under code 26 USC 6038D.
The real unusual part of FATCA is that it requires foreign financial institutions to comply with the U.S. internal revenue service. Never mind Chinese financial institutions, but even most of the western banks such as a Canadian institution like Toronto-Dominion Bank is opposing U.S. regulations and complaining that it will cost an estimated $100 million in software and staffing costs to implement the system to comply with the U.S. regulations, according to Bloomberg News in April, 2011. Furthermore, German banks including Deutsche Bank AG and Italian Bank UniCredit SpA in Germany are canceling securities deposit accounts made by Americans because of the new U.S. regulations, according to the Business Week December 2011. Could oversea foreign financial institutions turn in their clients’ confidential information to the U.S. government agency? Doesn’t that violate their financial law if it restricts it from doing so? I am not so sure about it at this point. Even if the foreign financial institutions want to comply with the U.S. regulations, they have to first comply with their own financial regulations within their countries. If foreign financial institutions do not comply, how will the IRS enforce the regulations and penalize foreign institutions is another question. As you can see, FATCA has created complicated situations for the U.S. taxpayers, foreign financial institutions, and the administrating U.S. agency.
So you may wonder why we have FBAR in place first and then create the new FATCA. Aren’t they overlapping except for the dollar limits and foreign financial institutions’ reporting requirement? They are similar, but also very different.
For example, the beneficiaries of foreign trust could be exempt from FBAR requirement but not from FATCA if the aggregated value exceeds the limit. But the real big difference between FBAR and FATCA comes from their origin.
The FBAR reporting requirements originated from the Bank Secrecy Act, which is part of Title 31 Money and Finance Code versus Title 26 which is the Internal Revenue Code. Even though the FBAR is received and processed by the IRS, it is not part of the income tax return. For example, the only connection between your 1040 and FBAR is the question on Schedule B. And the required form TD F 90-22.1 should not be filed with your income tax return and not to be filed to the same office as the income tax return is filed. Also, the due date for TD F 90-22.1 is June 30th, not the usual due date for tax returns such as April 15th or March 15th. As you can see that since the FBAR is not an IRS code, the IRS has limited power to make the enforcement. The willful failure to comply with FBAR reporting requirement has serious penalties as mentioned above, but penalties for non-willful and negligent failure to file is substantially reduced. However, not with Title 26 IRS code. For example, the failure to comply with FATCA, the statute of limitations for penalties and taxes due could be suspended indefinitely (not usual 3 years or 6 years apply). Also, the IRS has fewer burdens to prove tax payer’s willful act vs. non-willful negligent act.
In conclusion, the excessive tax evasion, money laundering, terrorism financing, narcotics, and gun trafficking by offshore foreign accounts and assets lead to the creations of FBAR and FATCA which can impose serious penalties and fines who failed to report their foreign financial assets. How well will it serve its purpose? I guess that most of the criminals who are involved in money laundering, terrorism financing, narcotics, and gun trafficking would not care too much about missing the due date for reporting their foreign financial assets, but it will most likely have positive effect on reducing tax evasion by the average person placing their financial assets oversea and not reporting it. So please use this article as an opportunity to review your foreign financial assets and see if any of your financial assets are subject to FBAR or FATCA.
If you have questions, need additional information or would like to discuss more on the above topic, please feel free to call us and/or visit our office.
Grant Yi (Accountant)
Trimble & Company
(951) 781-2910 ext. 143
5041 La Mart Drive Ste. 110
Riverside, CA 92507