Watch Out For FATCA: The Long Arm of the IRS Now Reaches Overseas

Watch Out For FATCA: The Long Arm of the IRS Now Reaches Overseas

600px-US-InternalRevenueService-SealOffshore bank accounts are popular in spy movies, but since last July they’ve gotten a different kind of attention. Thanks to the U.S. government’s Foreign Account Tax Compliance Act (FATCA), this tax season could be a bloodbath for some investors.

You may not know about FATCA, but your bank sure does. FATCA requires many foreign financial institutions (including banks, custodial institutions such as mutual funds, as well as hedge funds, private equity funds, and insurance companies) to divulge the identities and account information of U.S. customers with sizeable accounts that previously may have remained hidden.

Congress enacted FATCA in 2010 as part of the Hiring to Restore Employment (HIRE) Act, and its goal is to find people who are using foreign bank accounts to evade taxes. The law went into effect on July 1, 2014. FATCA requires foreign financial institutions to enter into “disclosure noncompliance agreements” with the U.S. Treasury. That means coughing up account numbers, balances, names, addresses and other information about Americans with over $50,000 in an account there. Individual taxpayers also have to reveal their foreign-account assets via IRS Form 8938.

Trying to get around FATCA by moving assets to a foreign country or bank that doesn’t honor FATCA is a rapidly disappearing option. So far, more than 80 nations, including the well-known tax havens of Switzerland, the Bahamas, and the Cayman Islands, as well as 77,000 financial institutions have come on board (see who they are here and here), mostly because they can’t afford not to: the U.S. government will levy a 30% tax on everything flowing from the United States to a noncompliant institution. In other words, FATCA effectively freezes the financial institution out of the U.S. market.

For individuals, the penalty for not filing a Form 8938 is $10,000 — and the price tag goes to $50,000 if you continue to avoid filing. Getting caught understating your assets will win you a penalty equal to 40% of the amount of underpayment. Do it fraudulently, and the penalty rises to 75%. Even imprisonment is a potential punishment.

This isn’t just a problem for individuals — it’s also a problem for banks, because if any of their employees have been helping investors evade taxes, there’s little legal protection for them. According to one report, the IRS runs a whistleblower reward program and an overseas undercover operations designed to induce bankers, investment advisors, lawyers and others to engage in tax fraud. Generally, financial institutions are looking at transactions going all the way back to at least mid-2008.

The IRS was offering what vaguely resembled an amnesty program through its “2012 Offshore Voluntary Disclosure Program,” which assessed up to a 27.5% penalty on undisclosed offshore assets. But it turns out that was just the “nice” version. In June 2014, the IRS upped the penalty to 50% if it is already investigating you or your financial institution (see the IRS’s FAQs on that here).

To be sure, FATCA doesn’t make it illegal to put money in a foreign bank. But it does make it illegal to do so secretly. And that’s why as of June 2014, the IRS says, over 45,000 people have disclosed foreign assets and have paid about $6.5 billion in back taxes, interest, and penalties.

FATCA clearly has a huge reach around the world and massive cash-raising prowess. But it also faces withering criticism, particularly because it effectively taxes American citizens and permanent residents even if they live, work, vote, and already pay taxes in their “home” countries. If you’ve never even been to the United States but have American parents, even you may soon find yourself getting out the checkbook.

Another criticism is that FATCA turns financial institutions around the globe into extensions of the IRS, forcing the banks to pay the costs of investigating American tax evasion. And then, of course, there are the privacy concerns.

There’s a lot more to FATCA than what we can describe here, which is why you shouldn’t construe this post as legal or tax advice, and you shouldn’t take any action without consulting a qualified tax advisor or attorney. The FATCA fallout has only just begun.