Foreign bank accounts and U.S. taxes

If you have an interest in a foreign bank account you may be subject to reporting requirements.

The Bank Secrecy Act requires that certain financial accounts based in foreign countries be reported. This act is commonly known as FBAR (Report of Foreign Bank and Financial Accounts).

The Foreign Account Tax Compliance Act (FATCA) was enacted with the intent of identifying American account holders in foreign banks and requiring payment of taxes on income from these investments.

Foreign Bank Account Reporting

If you have a financial interest or signature authority over a foreign financial account, you may be required to file FinCEN Report 114. This is not an income tax form and is filed separately. It does not require the payment of taxes.

Under FBAR, a foreign financial account includes any savings or checking deposit in an account in a foreign financial institution, as well as equity accounts such as mutual funds.

Assuming the existence of a foreign account, the first threshold is that the taxpayer must be a “United States Person.” This includes a citizen or resident of the United States, a domestic partnership, a domestic corporation and a domestic estate or trust having signature or other authority over the account.

The second requirement is that the foreign financial accounts must have a total value exceeding $10,000 at any time during the calendar year. Not the average balance for the year. Reporting is based on the total value of all foreign accounts.

Reporting Issues and Penalties

As mentioned, the FBAR is not an IRS form and is sent to the Department of Treasury. The report is due June 30 and may be extended for six months.

Although there is no tax associated with the form, there are significant penalties for not filing the return. A willful failure to file may carry a criminal penalty of up to $250,000 and/or up to five years in prison. A civil willful failure to file carries a penalty of up to $100,000 or 50 percent of the highest balance in each unreported account for the year.

If it can be demonstrated that the failure to file was not willful, the penalty would be much lower, frequently $10,000. The IRS can waive the penalty for taxpayers who file late and are subject to this form for the first time.

There are three important points about the penalties.

  • They are assessed per account, not per return.
  • They apply for each year of each violation.
  • They can apply to each person with financial or signature authority over the account.

It is readily apparent that the penalties can escalate quickly and can substantially exceed the balance in the foreign accounts.

Foreign Account Tax Compliance Act

The Foreign Account Tax Compliance Act (FATCA) was enacted to combat U. S. tax evasion by taxpayers holding investments in foreign accounts. The act is somewhat controversial because it raises privacy issues, especially for those having dual citizenship.

FATCA requires foreign banks to report these accounts to the IRS. A number of European banks and financial institutions have closed brokerage accounts for all U.S. customers due to “onerous” U.S. regulations.

There are three components to the act:

  1. The first section requires foreign financial institutions (FFI) to undertake identification procedures in an effort to discover any U.S. account holders. U.S. account holders are defined as U.S. persons or foreign entities with substantial U.S. ownership.

For these accounts, the FFI is to report annually to the IRS the balances, receipts and withdrawals from these accounts. The IRS may require participating FFIs to withhold and pay to the IRS 30 percent of certain payments to U. S. persons.

This section of FATCA is the most controversial, with significant push-back from banking and government officials who are balking at requiring them to become “extensions of the IRS” and assuming a significant financial burden in attempting to comply.

  1. The second section focuses on filing thresholds, which are as follows:
Filing Status Living in the U.S. Not Living in the U.S.
Single or Married filing separately Balance of $50,000 on last day of year or $75,000 at any time during the year. Balance of $200,000 on last day of year or $300,000 at any time during the year.
Married filing jointly Balance of $100,000 on last day of year or $150,000 at any time during the year. Balance of $400,000 on last day of year or $600,000 at any time during the year.

The determination of living or not living in the United States is made by applying the bona fide residence or physical presence test applicable to the foreign earned income exclusion.

  1. The third section of FATCA closes a tax loophole that investors had used to avoid paying taxes on dividends by converting them into nontaxable dividend equivalents.

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