Earlier this week, I participated in to a teleconference sponsored by the Society of Trust and Estate Practitioners and the International Law section of the American Bar Association. The conference addressed the expanded offshore asset disclosure requirements brought into effect by the Foreign Account Tax Compliance Act (FATCA). (For background on FATCA see here, here, and here.)
FATCA imposes a 30% withholding tax on many types of U.S-source income and gross sales proceeds to what the law calls “foreign financial institutions” (FFIs) and “non-financial foreign entities” (NFFEs). FATCA’s withholding provisions will be phased in beginning Jan. 1, 2014 and come fully into effect one year later. To avoid this tax, FFIs and NFFEs must function as unpaid IRS informants. FFIs and NFFEs are defined so broadly that FATCA potentially impacts every foreign financial institution or non-financial entity in the world that receives, directly or indirectly, most types of U.S. source income.
FFIs include not only banks, but virtually all foreign investment vehicles, both publicly and privately traded. Non-U.S. insurance companies, mutual funds, broker-dealers hedge funds, private equity funds, and small family-owned and family-managed funds, are all FFIs. To avoid the 30% withholding tax on U.S. source income or gross sales proceeds, FFIs must certify that they don’t accept business from U.S. persons, or alternatively, enter into a one-sided information agreement with the IRS. Among other provisions, such agreements must require FFIs to request waivers from account holders of any applicable foreign secrecy law and to close any account for which holders refuse to provide such waivers.
Alternatively, FFIs may elect to apply the withholding requirements that pertain to U.S. payers of dividends, interest, gross sales proceeds, etc. Under this election, FFIs must provide full Form 1099 reporting for all payments to specified U.S. persons. All U.S. and foreign-source amounts (including gross proceeds) would be reportable.
FFIs must additionally disclose the name, address, and taxpayer identification number (TIN) of each direct or indirect U.S. person with a greater than 10% ownership interest in the FFI, as well as the account balance and the gross receipts and gross withdrawals or payments from the account. Those FFIs engaged in trading or investment must report with respect to a U.S. person holding any level of ownership, no matter how insignificant the percentage or minor the value.
NFFEs are “any foreign entity which is not a financial institution.” Thus, NFFEs include offshore corporations, offshore trusts, personal investment companies, and many other types of entities. To avoid 30% withholding, each NFFE must certify that it has no substantial (more than 10%) direct or indirect U.S. ownership. Those NFFEs that meet the 10% threshold must identify all U.S. citizen, resident, or U.S. domiciled owners.
It’s no surprise that in anticipation of these severe rules coming into effect, thousands of offshore service providers have “fired” their U.S. clients. Indeed, the option to ditch U.S. customers to avoid FATCA’s draconian compliance regime is specifically written into the law. FATCA’s intent is not only to discourage U.S. persons from investing offshore, but more fundamentally, to discourage offshore businesses from offering financial services to U.S. citizens or permanent residents. These severe requirements are nothing less than a de facto form of foreign exchange controls.
Self-Disclosure Rules Under FATCA
However, the focus of this week’s conference was on the added offshore disclosure obligations that FATCA imposes on individuals, and soon-to-come, what the IRS calls “specified domestic entities.” This latter category includes certain domestic corporations, domestic partnerships and domestic trusts, but not domestic estates.
Joseph Henderson, an attorney with the IRS Office of Associate Chief Counsel (International), answered questions put to him by a panel of tax experts and conference participants. Henderson is a principal drafter of the temporary regulations issued last month for Form 8938, “Statement of Specified Foreign Financial Assets.” U.S. taxpayers with interests in such assets that meet applicable filing thresholds must file this form annually with their personal tax return, beginning with 2011 tax returns.
Your obligation to file Form 8938, Mr. Henderson stressed, is entirely separate from your obligation to file Form TD F 90-22.1, the “foreign bank account reporting” form (FBAR), with a deadline of June 30 for reportable accounts held the preceding year. (For more information on the FBAR, click here.) You must report some foreign assets on one form, some on the other form, and some on both.
The major source of this confusion is that the reporting obligations for each form are contained in different code sections of federal law. The FBAR requirements are in Title 31; the FATCA requirements in Title 26. If this causes monumental confusion to law-abiding taxpayers…well, too bad!
