FATCA: A new era of financial transparency

The IRS's powerful new tool chips away at bank secrecy.

Since 2008, the U.S. government has been aggressively moving against U.S. taxpayers who have undeclared foreign accounts. Through a variety of mechanisms, the government has obtained information about U.S. account holders and their assets from jurisdictions previously thought nearly impenetrable. These recent developments portend the eventual erosion of traditional concepts of bank secrecy and increased transparency among nations regarding financial information.

One manifestation of this activity is the Foreign Account Tax Compliance Act (FATCA), which was signed into law in early 2010 as part of the Hiring Incentives to Restore Employment Act, P.L. 111-147. FATCA seeks to promote compliance with U.S. law by requiring foreign financial institutions to report information regarding U.S. persons maintaining accounts, and by directing that U.S. taxpayers report certain specified foreign financial assets with their tax filings. For financial institutions and many other foreign businesses and individuals, it is one of the most important (and complex) tax laws to go into effect in many years. The IRS has issued guidance on FATCA, and more is undoubtedly forthcoming. FATCA takes direct aim at U.S. taxpayers who have not properly reported their foreign financial accounts and certain other non-U.S. assets.


There are a variety of reporting requirements for U.S. citizens and residents, including individuals, corporations, partnerships, trusts, and estates, involving foreign accounts and other non-U.S. holdings. The willful failure to comply with these requirements can be prosecuted as criminal offenses under U.S. law and subject the persons involved to substantial civil money penalties. Nonwillful conduct can result in the assessment of tax, interest, and penalties. The statute of limitation for criminal tax offenses is six years. The statute of limitation on civil penalties varies by the specific penalty involved, but the most serious of the civil penalties either have a six-year or, if no return was filed, no statute of limitation.

For federal income tax purposes, U.S. taxpayers are required to report and pay tax on their worldwide income, including reporting investment income earned on financial accounts located outside the United States. U.S. tax reporting also requires taxpayers to disclose the existence of any foreign accounts on their U.S. tax return. Schedule B, Interest and Ordinary Dividends, of Form 1040, U.S. Individual Income Tax Return, and other tax forms require filers to check a box indicating whether they have signature authority or a financial interest in any foreign accounts and, if so, to list the names of the countries where the account or accounts are held. Beginning with the 2011 tax year, Schedule B asks taxpayers whether they are required to file a Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (commonly called FBAR). Also new for 2011, the Schedule B instructions explain that even if taxpayers do not have to file an FBAR, if they have specified foreign assets, they must file a Form 8938, Statement of Specified Foreign Financial Assets, with their income tax return.

FBARs must be filed by June 30 following each calendar year. They are not filed with a tax return; they go to a separate IRS service center in Detroit. There are no extensions to the deadline, and the mailbox rule does not apply—the form must be received by the due date. A nonwillful failure to file an FBAR can be penalized up to $10,000 per violation, but a willful failure to file can result in a civil penalty of as much as 50% of the value of the foreign account, with no cap for each violation, per year. Thus, a taxpayer with a substantial unreported foreign account may face the prospect of a civil penalty for a multiyear, willful failure to file the FBAR that might exceed the balance of the entire account. To collect this massive penalty, however, the IRS must sue to collect and has the burden of proving willfulness by clear and convincing evidence; the presumption of correctness normally accorded to IRS assessments does not apply (Chief Counsel Advice 200603026).

There are other reporting obligations where compliance failures can trigger substantial penalties. Foreign gifts or bequests and distributions from and relationships with foreign trusts are reportable on Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, or 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner, and one’s ownership of a foreign company is generally reportable on Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations. Other reporting requirements include filings in connection with owning interests in foreign partnerships (Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships) and with transfers to foreign corporations (Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation). Where there has been a failure to file any of those forms, there is no statute of limitation, so in theory, the IRS can reach back many years if it chooses to impose civil penalties in these cases.


FATCA applies to foreign financial institutions (FFIs) and other entities that receive payments from U.S. sources, either on their own behalf or acting as intermediaries (Secs. 1471 to 1474). “Foreign financial institutions” are defined broadly as foreign entities that (1) accept deposits in the ordinary course of a banking or similar business; (2) hold financial assets for the accounts of others as a substantial portion of their business; or (3) are engaged (or holding themselves out as being engaged) primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest (including a futures or forward contract or option) in such securities, partnership interests, or commodities (Secs. 1471(d)(4) and (5)). This definition would largely include anything that remotely resembles a bank or similar financial institution.

FATCA creates a complex withholding regime designed not so much to collect tax but rather to coerce FFIs and other entities to unearth U.S. account holders who may not be complying with U.S. tax reporting rules and to disclose information on an annual basis about those accounts. Generally, any FFI is subject to 30% withholding unless it has entered into a disclosure arrangement with the IRS. This tax would be withheld not only on U.S.-source investment income but also on any U.S.-source proceeds from the sale of many kinds of property.

To avoid withholding, an FFI is required to:

  • Obtain information about each of its account holders as is necessary to determine which accounts are U.S. accounts and to comply with the IRS’s specified verification, due-diligence, and monitoring procedures;
  • Annually report information about any U.S. account;
  • Deduct and withhold 30% of certain payments made to what are called “recalcitrant account holders,” which are persons who fail to provide information to determine whether an account is a U.S. account, or, for U.S. account holders, fail to supply their name, address, and taxpayer identification number (TIN), or fail to provide a now-required waiver from foreign disclosure laws;
  • Comply with IRS information requests; and
  • If the FFI’s local law prohibits it from reporting the required information, the FFI must either obtain a waiver of that prohibition or close the account.

Specifically, FATCA-compliant FFIs will be required to report the name, address, and TIN, as well as account-related information, for any “specified United States person” named on the account or any “substantial United States owner” of any account. A specified United States person includes any U.S. resident with the exception of, among others, publicly traded corporations and certain banks. A substantial United States owner is any person owning more than a 10% interest in any entity, or, in the case of payees primarily in the business of trading, a substantial United States owner is anyone who owns any interest in the entity, including a profits-only interest.

This information reporting and withholding regime takes effect in 2014 (although certain deadlines have been pushed back to 2015 or later; see Announcement 2012-42). The IRS has issued three rounds of technical guidance aimed at financial institutions and other entities covered by FATCA. Last year, the IRS also announced U.S. agreements with France, Germany, Italy, Spain, and the United Kingdom to cooperate on implementing FATCA and arranging automatic bilateral information exchange with the United States through the existing treaty structure. In 2012, other countries, including Switzerland, announced a FATCA information-sharing arrangement with the United States. These arrangements take one of two forms: reporting by the FFI to the U.S. government directly, or reporting by the FFI to the foreign government, which then reports to the U.S. government. More countries are expected to negotiate similar agreements with the United States.


In addition to implementing the new withholding/disclosure regime, FATCA includes other provisions aimed at improving tax compliance on issues arising from foreign accounts. These include new Form 8938, which is required beginning with the 2011 tax year. Individual taxpayers living in the United States with an interest in any “specified foreign financial assets” are required to attach a disclosure statement to their income tax returns if the aggregate value of those assets is greater than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year. Higher asset thresholds apply to U.S. taxpayers who file a joint tax return or who reside abroad. “Specified foreign financial assets” include depository or custodial accounts at FFIs, stocks or securities issued by foreign persons, any other financial instrument or contract held for investment issued by a foreign issuer or counterparty, and any interest in a foreign entity. Note that the Form 8938 supplements the existing FBAR requirements; both forms must now be filed. There are significant penalties ranging from $10,000 to $50,000 for failure to comply with this specific reporting requirement.

FATCA also extends the statute of limitation on the failure to report income from foreign assets until three years after the taxpayer files Form 8938, and the extended statute applies to the taxpayer’s entire return, not just to foreign assets.

Further, the statute implements significant technical changes to the characterization and reporting requirements for foreign trusts. Among other things, it imposes new reporting requirements on any U.S. person treated as an owner of any portion of a foreign trust and creates a presumption that a foreign trust has a U.S. beneficiary unless the beneficiary submits to the IRS certain specific information to the contrary.

The international reaction to FATCA is mixed. Some argue that the legislation is, plain and simple, an act of U.S. imperialism. Other countries, however, are starting to look at FATCA as a model for their own tax enforcement, and, as noted above, the IRS has made substantial progress in reaching agreements with various countries on implementation.

Some smaller banks are concluding that they would rather not invest in the United States than be subject to the compliance costs associated with FATCA implementation. Others are seeking to eliminate any U.S. accounts to the maximum extent possible. But it is expected that most banks worldwide will comply with FATCA rather than forgo investing in the United States.

FATCA will provide much more information to the IRS about U.S. account holders than it has ever received, and with the enhanced penalties and extended statute of limitation, FATCA can be expected to result in the eventual diminishment of bank secrecy for Americans worldwide and continued enforcement in the foreign account area for years to come. Americans all over the world are beginning to get letters from their non-U.S. banks seeking information, including the filing of a Form W-9, Request for Taxpayer Identification Number and Certification, which would provide the account holder’s Social Security number, or requesting that they close their account and take their money elsewhere.

Eventually, it is expected that the statute will enable the IRS to engage in simple matching of information—the IRS could easily compare data received from foreign financial institutions about their U.S. account holders against tax returns that may or may not have a Form 8938. All the IRS needs to do then is generate a simple computer-originated inquiry, and if the taxpayer has not complied for a multiyear period, he or she would be at serious risk for a civil examination or even a criminal investigation.


FATCA is part of a broader enforcement effort undertaken by the U.S. government since 2008 against unreported foreign financial assets. Any noncompliant U.S. taxpayer who has yet to declare foreign accounts or other reportable assets should be mindful of these developments and aware of the increased global enforcement presence by the IRS, and particularly its Criminal Investigation Division, and the considerably improved cooperation among tax authorities worldwide.

The IRS has had a long-standing voluntary disclosure policy aimed at providing a path for Americans who have not filed accurate or complete returns, or who have not filed at all, to come back into the system and avoid criminal prosecution. In January 2012, the IRS announced a third voluntary disclosure program that caps civil penalties that might be imposed for unreported non-U.S. assets, and in June, the IRS released information about a limited special program, beginning in September 2012, directed at U.S. taxpayers who have resided outside the United States, who have not complied with U.S. law, and who appear to present low compliance risks for the future.

In light of FATCA and the otherwise increasing ability of the U.S. government to penetrate bank secrecy, noncompliant U.S. taxpayers should consider taking steps to come into compliance. Although there may be some financial pain associated with doing so, the ability to avoid criminal prosecution and substantial civil money sanctions in the now-enhanced enforcement environment is an important benefit to consider.


New reporting and withholding requirements in the Foreign Account Tax Compliance Act (FATCA) require foreign financial institutions to report information about their U.S. account holders.

Beginning in 2014, foreign financial institutions will be required to withhold 30% from certain payments to recalcitrant account holders.

FATCA also requires taxpayers who hold assets overseas to report these specified foreign financial assets on new Form 8938, Statement of Specified Foreign Financial Assets.

The new FATCA requirements apply in addition to the requirement to file the Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR), which also requires U.S. taxpayers to report information about their foreign financial accounts.

To implement FATCA, the United States has entered into agreements with a number of foreign governments.

Scott D. Michel ( smichel@capdale.com ) is a member of Caplin & Drysdale in Washington.

To comment on this article or to suggest an idea for another article, contact Sally P. Schreiber, senior editor, at sschreiber@aicpa.org or 919-402-4828.


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