The U.S. Dept of the Treasury recently announced two information sharing agreements under Foreign Account Tax Compliance Act (FATCA). The agreements with Japan and Switzerland will require that their financial institutions, (1) identify U.S. accounts, (2) report certain information to the IRS , and (3) withhold a 30% tax on those financial institutions and account holders who are unwilling to provide the required information to the IRS.
These agreements are the second model of FATCA information sharing agreements, the first model being the model used between the U.S., France, Germany, Italy, Spain and the United Kingdom which requires that financial institutions provide account holder information first the respective government and then the government will provide the account holder information to the U.S.. The U.S. will reciprocate.
The “due diligence” provisions of the FATCA information sharing agreements are being implemented now, by most foreign financial institutions. Foreign financial institutions must certify to the IRS, in 2013 that they are “FATCA compliant as of January 1, 2013 on their account holder identification processes. As a result of the “due diligence” process U.S. persons with foreign financial accounts may be asked to provide tax reporting information and certify that they are in compliance with Foreign Bank Account Reporting laws (FBAR) and income tax reporting. Failure to provide the information when requested may result in accounts being closed to activity (frozen) and information reported to the IRS about the account holder as a “recalcitrant” person, ultimately subject to the 30% income tax withholding.
What is most important is that those U.S. taxpayer’s who have deferred reporting foreign accounts are going to find it harder to “hide” and the penalties more severe. Currently the IRS offers an Offshore Voluntary Disclosure Initiative which allows U.S. taxpayers to come forward and avoid prosecution and payment of income tax, interest on the tax, a 20% accuracy related penalty on the tax and a 27.5% civil miscellaneous penalty in lieu of FBAR penalties. The civil FBAR penalties depend upon whether the conduct of the taxpayer in not reporting the account is deemed willful or non-willful. If determined to be willful the penalties are the greater of $100,000 or 50% of the account balance per year. The criminal FBAR penalty guidelines are 3-5 years incarceration.
There are published exceptions to the OVDI program which may allow the taxpayer to avoid having to enter the OVDI program and still come into compliance, depending on a variety of facts and circumstances.
In addition to the risk of account information being turned over to the IRS by foreign governments or foreign financial institutions U.S. taxpayers with foreign accounts need to consider the effect of the U.S. income tax information reporting on estate and gift tax planning. As of the 2011 tax year U.S. taxpayers must report Specified Foreign Financial Assets on Form 8938. Failure to report may result in a $10,000 penalty. Put together with the pending disclosure of account information, FBAR penalties and income tax penalties not coming forward can and will likely be very risky.
Finally, an additional incentive to coming forward is the fact that U.S. estate and gift tax laws may change at the end of 2012. The U.S. taxes income and estates on the basis of worldwide assets. If the current exemptions of $5,120,000 is reduced those persons holding foreign assets in their estate or contemplating gifts will find the delay costly. But, if the same person has reported foreign accounts they should come forward first to take advantage of the current estate and gift tax exemptions.
While discovery of all unreported foreign accounts held by U.S. taxpayers (including dual nationals and Green Card holders) may not be inevitable, the risk of civil and criminal FBAR penalties, income tax penalties, including the risk of prosecution for false statement crimes, and the potential estate and gift tax cost make the cost benefit analysis of not coming forward weight in favor of disclosure.