What is FACTA?
And how does it affect Americans Abroad?
FATCA stand for Foreign Account Tax Compliance Act. The legislation was passed into law in 2010 as part of the unrelated jobs legislation known as the HIRE law. FATCA is a broad, complex set of rules designed to increase tax compliance by Americans with financial assets held outside the United States. The legislation was drawn up primarily as a response to the 2009 UBS off-shore banking scandal which revealed that many Americans were maintaining large financial holdings in secret Swiss bank accounts without reporting or paying the U.S. taxes due on those assets.
The legislation created new self-reporting requirements and increased penalties for failure to comply fully with complex reporting rules. Most importantly, the legislation imposes on all foreign financial institutions a vast new legal mandate to determine who among their clients are “U.S. Persons” and report directly to the IRS information on those clients’ accounts. This mandate is backed up by draconian enforcement mechanisms that ensure that virtually all non-U.S. financial institutions will comply. The legislation also ratcheted up penalties imposed where tax payers fail to fully comply with all the special rules that pertain specifically to non-U.S. financial assets.
Key elements of the FATCA law include more onerous reporting requirements and higher penalties. Most significantly, however, are the reporting demands placed on global financial institutions that will result in a high degree of transparency for the IRS to see non-U.S. assets and transactions of Americans.
Specifics details of FATCA that affect Americans Abroad include:
- In addition to the current Report of Foreign Bank and Financial Accounts (FBAR) reporting requirement whereby American citizens are required to report to the U.S. Department of Treasury any foreign financial assets worth more than $10,000, FATCA requires Americans to separately report foreign holdings exceeding $300,000 for US taxable person not resident in the US to the IRS on Form 8938. Both reporting requirements are triggered if assets exceed these amounts at any point in the year.
- The new IRS reporting requirements include detailed information about account holdings and transactions. Penalties for failure to file the FBAR or form 8938 start at $10,000 but can go much higher depending on account size and circumstances.
- All non-U.S. financial institutions will be required to make detailed reports to the IRS on accounts owned by U.S. persons, or be subject to a 30% withholding on all U.S. sourced payments. The implication of this provision is that non-U.S. financial institutions will either refuse to service U.S. citizens or they will comply with the strict mandatory IRS reporting requirements.
- Any U.S. Person who owns Passive Foreign Investment Companies (PFICs) must now report the onerous form 8621 on each separate PFIC investment every year, previously required only in years when distributions from PFIC were made.
- The statute of limitations for IRS audit is extended from 3 years to 6 years in cases where more than $5,000 is omitted from gross income and the sum is attributable to foreign assets.
2010 FATCA Legislation Changes the Playing Field for Americans Abroad
The full force of FATCA will come into force in stages through 2017. Foreign financial institutions have had mandatory reporting requirements since 2014. In addition to the measures relating to the implementation of the FATCA law, the IRS has significantly expanded its enforcement activity with respect to assets held by U.S. taxable persons outside of the United States. The new FATCA compliance and reporting environment fundamentally changes the investment and financial planning game for Americans abroad.
Americans with financial assets outside the US must assume the IRS has full transparency to see these assets because of FATCA. Many of the special rules that apply to foreign assets that for decades could be conveniently ignore must now be given full attention. Failure to understand and comply with these rules may result in very substantial penalties, back taxes, interests and attorney’s fees.
Steps All Americans Abroad Should Now be Taking
Here are the steps that all Americans abroad should be taking now to prepare for the impact of FATCA:
Step 1: Have a contingency plan in place for when your local banking institution informs you that as an American, you need to close your account. Compliance with complex FATCA reporting requirements will be simplified for foreign financial institutions if they can simply certify that they have no U.S. persons as clients. Americans will increasingly be forced to rely only on the largest global banking institutions for local financial transactions and banking services.
Step 2: Inventory all of your non-U.S. assets and identify which ones are subject to FATCA reporting by a foreign institution. Make sure that these assets are not PFICs or improperly reported foreign trusts. Beware: PFICs are much more common that most realize and may be lurking among your investments and even your bank accounts without you even knowing it.
Step 3: Move all of your investment accounts to U.S. financial institutions (and not just overseas branches of U.S. institutions). This will avoid all the difficulties and uncertainties of FATCA compliance for these assets. Furthermore, tax and FATCA compliance aside, there are overwhelmingly good reasons for Americans abroad to invest through U.S. institutions. U.S. securities markets, for all their faults, are still by far the most efficient and individual investor friendly in the world. A thoroughly diversified basket of global assets can be constructed within a plain vanilla U.S. brokerage account far more cost effectively than anywhere else in the world.
Step 4: Build a diversified portfolio with optimal exposure to risk and return as well as currency, given your financial situation and your long-term residency plans. Generally, younger investors should be assuming more risk in their investments to maximize long-term returns. The currency denomination of your investments should follow the principal of matching investments and liabilities, to prevent large swings in relative currency values from upending retirement plans or other savings goals.
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