I was driving with a colleague in the Okanagan recently, cedars and hemlocks framing our view around each curve in the road. As we reached the crest of a rise, we had a magnificent view back across the valley, seeing now the canopy of the forest where previously only the tree trunks could be distinguished during the winding trek.
That kind of trees-and-forest distinction came to mind this past January after thumbing through the just-released 543 pages of regulations under FATCA – the Foreign Account Tax Compliance Act – lacking the exhilaration of ‘magnificence’ however. For those subject to US tax reporting, this is the cold new reality of holding investments abroad, with foreign financial institutions (FFIs) now obliged to report client accounts to the US Internal Revenue Service (IRS).
If one doesn’t step back to get some perspective, there really is a risk of getting lost in the minutia. Thus with as little jargon manageable and only a critical few acronyms among the dozens developing, here is an eagle-eye view of the FATCA forest.
Requirement and rationale
In tax parlance, ‘compliance’ basically means adequate information reporting to identify income sources, and of course payment of associated taxes. In most tax systems, this is dependent to a large extent upon taxpayers self-reporting their income.
For employment income, there are well-established systems of checks and balances that both compel and confirm compliance. With respect to investment income, the variability of forms and fluidity of funds raise greater monitoring and quantification challenges for tax authorities.
FATCA is the latest information gathering tool the IRS will have at its disposal to facilitate US tax compliance. It imposes greater reporting obligations upon US taxpayers holding investment accounts outside the US, and upon the institutions where those investments are held.
Subject to reporting?
As elsewhere, the United States levies tax on both domestic and foreign income. However, whereas most jurisdictions only tax residents, the US also taxes its citizens wherever they may be.
For most Canadian financial advisors, the clients affected by FATCA will be Canadian-resident US citizens, including individuals born in the US who have not renounced citizenship. It also includes green card holders, corporations, estates, trusts, and possibly Canadian snowbirds (though this last group will likely be able to use the Canada-US treaty to be treated as solely Canadian).
Using the term “US Reportable Account”, the net is cast very wide in terms of what is subject to reporting. It includes savings, deposit, chequing and brokerage accounts, as well as investment funds, insurance contracts with cash surrender values, and annuity contracts.
The new reporting regime
The imminence of an increased degree of compliance has been discussed for many years, eventually culminating with the passage of FATCA within the Hiring Incentives to Restore Employment (HIRE) Act in 2010. With the publication of the January 2013 regulations, implementation is now in full swing.
Each country will need to negotiate an intergovernmental agreement (IGA) with the IRS in order for its FFIs not to be subject to 30% withholding tax on their US source payments and those of their clients. A given IGA will either require an FFI to report to its own tax authority or to the IRS directly. At time of writing, Canada’s IGA has not yet been completed.
FFIs will have to begin reporting on new client/account openings beginning January 1, 2014, with reporting on existing accounts phased in through 2015. The initial threshold account level demanding reporting is $50,000. The FFI is required to annually report the holder’s name, address, US taxpayer information number (TIN), account number, and account balance at year-end (or at account closing if that applies).
At the self-reporting level
Non-resident US taxpayers are already required to file an annual tax return with the IRS, whether or not tax is due. As well, where at least $10,000 is held in foreign financial accounts in a given year, there is an existing and continuing obligation to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR). The FBAR must be received by mail at the Department of the Treasury by June 30.
Under FATCA, US taxpayers who hold an aggregate of $50,000 in foreign accounts will be required to file a new Form 8938 Statement of Specified Foreign Financial Assets with their annual tax return. (Non-residents should consult a tax professional to obtain advice whether they may be entitled to a higher threshold of $200,000 or more before being required to report.)
While FBAR applies strictly to financial accounts held in foreign institutions, Form 8938 includes both foreign accounts and certain foreign non-account investment assets. Some examples of the latter category would be a foreign retirement or deferred compensation plan, a partnership interest or an interest in a foreign estate.
To reiterate, Form 8938 and FBAR are independent sets of rules, forms and departments. Complying with one of these requirements does not automatically satisfy the other. With hefty fines up to $10,000 or more and the potential for criminal sanctions, it is critical for affected US taxpayers to understand and comply.
As clear as … ?
As we launch into the FATCA era, the one thing that is clear is that paperwork will increase and scrutiny will intensify. And as a final proviso, this summary is not meant to be a complete overview of the compliance requirements, but rather to highlight the additional obligations introduced under FATCA.
For more information, straight from the primary source, consult the IRS website at http://www.irs.gov/Businesses/Corporations/Foreign-Account-Tax-Compliance-Act-(FATCA).