Foreign Account Tax Compliance Act (FATCA): Definition and Rules

What Is FATCA?

The Foreign Account Tax Compliance Act (FATCA) is a law that requires foreign financial institutions to report on the assets held by U.S. account holders. It also requires U.S. citizens and residents living at home or abroad to file annual reports on any foreign account holdings they have. The main goal of FATCA is to stop tax evasion.

The FATCA was passed in 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act, which is designed to promote transparency in the global financial services sector. Form 8938 is used to report any foreign account holdings and there are serious penalties for not reporting them.

Understanding FATCA

The Foreign Account Tax Compliance Act (FATCA) was signed into law by President Barack Obama in 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act. HIRE was largely designed to incentivize businesses to hire unemployed workers. Unemployment rates had skyrocketed during the 2008 financial crisis.

One of the incentives offered to employers through the HIRE Act was an increase in the business tax credit for each new employee hired and retained for at least 52 weeks. Other incentives included payroll tax holiday benefits and an increase in the expense deduction limit for new equipment purchased in 2010.

The Goal of FATCA: Preventing Tax Evasion

FATCA seeks to eliminate tax evasion by American individuals and businesses that are investing, operating, and earning taxable income abroad.

While it is not illegal to maintain an offshore account, failure to disclose the account to the Internal Revenue Service (IRS) is illegal since the U.S. taxes all income and assets of its citizens on a global scale.

In fact, the FATCA was at least in part created to fund the costs of the business incentives offered in HIRE. FATCA provisions require U.S. taxpayers to report all financial assets held outside of the country annually and pay any taxes due on them. The revenue stream produced by FATCA goes toward the costs of the hiring incentives offered in the HIRE Act.

Penalties are imposed on U.S. residents who do not report foreign account holdings and financial assets that exceed $50,000 in value in any given year.

Who Needs to Comply With FATCA?

Form 8938 needs to be filed by any American taxpayer with financial assets totaling $50,000 or more. Those assets may be in a bank account or may be in stocks, bonds, and other financial instruments.

There are certain exceptions. One major one is an exception for assets held in a foreign branch of a U.S. institution or a U.S. branch of a foreign institution.

Foreign Institutions

Foreign financial institutions (FFI) and non-financial foreign entities (NFFE) are required to comply with this law by disclosing the identities of U.S. citizens with accounts and the value of the assets in those accounts to the IRS or the FATCA Intergovernmental Agreement (IGA).

FFIs that do not comply with the IRS will be excluded from the U.S. market and have 30% of the amount of any withholdable payment withheld from them as a tax penalty. Withholdable payments may include income generated from the U.S. financial assets held by these banks such as interest, dividends, and periodic profits.

FFIs and NFFEs that agree to the law must annually report the name, address, and tax identification number (TIN) of each account holder that meets the criteria of a U.S. citizen as well as the account number, the account balance, and any deposits and withdrawals on the account for the year.

Individual Taxpayers Living Abroad

The IRS requires Form 8938 for taxpayers living abroad under the following circumstances:

• "You are married filing a joint income tax return and the total value of your specified foreign financial assets is more than $400,000 on the last day of the tax year or more than $600,000 at any time during the year. These thresholds apply even if only one spouse resides abroad. Married individuals who file a joint income tax return for the tax year will file a single Form 8938 that reports all of the specified foreign financial assets in which either spouse has an interest. 
• "You are not a married person filing a joint income tax return and the total value of your specified foreign financial assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the year."

The reporting thresholds for foreign assets vary based on whether you file a joint income tax return and whether you live abroad. According to the IRS:

"If you are single or file separately from your spouse, you must submit a Form 8938 if you have more than $200,000 of specified foreign financial assets at the end of the year and you live abroad; or more than $50,000, if you live in the United States. If you file jointly with your spouse, these thresholds double. You are considered to live abroad if you are a U.S. citizen whose tax home is in a foreign country and you have been present in a foreign country or countries for at least 330 days out of a consecutive 12-month period."

Individual Taxpayers Living in the U.S.

The IRS requires Form 8938 for taxpayers living in the United States under the following circumstances:

• "You are unmarried and the total value of your specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.
• "You are married filing a joint income tax return and the total value of your specified foreign financial assets is more than $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year. 
• "You are married filing separate income tax returns and the total value of your specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year. For purposes of calculating the value of your specified foreign financial assets in applying this threshold, include one-half the value of any specified foreign financial asset jointly owned with your spouse. However, report the entire value on Form 8938 if you are required to file Form 8938."

Who Is a U.S. Person Under FATCA?

The FATCA guidelines refer to the term ‘‘United States person’’ or USP. A USP can be any of the following:

• A citizen or resident of the United States
• A domestic partnership (organized in the United States)
• A domestic corporation (incorporated in the United States)
• Any estate other than a foreign estate
• Any trust if a court within the United States is able to exercise primary supervision over the administration of the trust, and one or more United States persons have the authority to control all substantial decisions of the trust
• The United States government, a State, or the District of Columbia (including any agency, instrumentality, or political subdivision thereof)
• A client could be considered a U.S. resident for tax purposes by virtue of the time spent in the U.S. according to the substantial presence test. The test must be applied each year that the individual is in the United States.
• Students (F1, OPT, J1, Q Visas) are considered non-resident aliens for up to five years and are exempted from the substantial presence test for a period of five years.
• Teachers and researchers (J1, Q Visas) are considered non-resident aliens for up to two years and are exempted from the substantial presence test for a period of two years.
• For other H1B, L1, and other visa holders, to meet the substantial presence test, a foreign person must be physically present in the United States for at least 31 days during the current year and be physically present 183 days during the three-year period that includes the current year and the two years immediately before that, counting: (i) all the days the individual was present in the current year, and (ii) 1/3 of the days the individual was present in the year before the current year, and (iii) 1/6 of the days the individual was present in the year before last.
• F and J student visa holders are to exclude five calendar years of presence for purposes of the substantial presence test.
• J non-student visa holders are to exclude two years.

Penalties for Non-Compliance

There are penalties for failing to file Form 8938. The IRS can impose a $10,000 failure to file penalty, an additional penalty of up to $50,000 if the guilty party continues to not file after notification by the IRS, and a 40% penalty for understating taxes attributable to non-disclosed assets.

The statute of limitations is extended to six years after an entity files its return for income over $5,000 that is not reported and is attributable to a specified foreign financial asset. Also, if a party fails to file or properly report an asset on Form 8938, the statute of limitations for the tax year is extended to three years beyond the time when the party provides the required information.

If there is a reasonable cause for the failure, the statute of limitations is extended only with regard to the item or items related to such failure and not for the entire tax return.

No penalty is imposed if the failure to disclose is found to be reasonable, although this is decided on a case-by-case basis.

The Cost of Compliance

Although the price to pay for not complying with FATCA is high, the compliance costs for foreign financial institutions are also high. Nigel Green, CEO of deVere Group and co-founder of the Campaign to Repeal FATCA, estimated in 20217 that 250,000 foreign financial institutions were being impacted by FATCA's reporting requirements.

One Spanish bank stated that compliance could cost one of its local bank branches $8.5 million and a global financial institution $850 million. Estimates of the costs to U.K. financial institutions ranged from $1.1 billion to $1.9 billion.

Criticism of FATCA

Of course, there are always critics of new tax laws. The Reuters news agency reported that FATCA drew the ire of banks and business people, who termed it "imperialist." Financial institutions objected to the fact that they were expected to report on their U.S. clients or withhold 30% of the interest, dividend, and investment payments due to those clients and send the money to the IRS.

Tax lawyers at the Swiss-American Chamber of Commerce in Zurich denounced FATCA as "the neutron bomb of the global economic system" and said it would deter foreign investment in U.S. markets.

Some critics argued that the cost of implementing FATCA was too great a burden on foreign financial institutions and could even cause them to divest their U.S. assets.

The Expat View

American Citizens Abroad proclaimed that Americans residing overseas need to have assets and bank accounts in their country of residence. If these Americans are subject to Form 8938, this amounts to discrimination against Americans residing overseas because Americans residing in the United States are not required to report their assets for tax purposes. Only their income needs to be reported since federal taxes are levied only on income and capital gains.

Overall, American Citizens Abroad was of the opinion that FATCA risked a potential loss of trillions of dollars of investment in the United States, the opportunity for American companies and financial institutions to compete in a global environment, and American citizens' ability to reside and thrive overseas.

The Bottom Line

FATCA requires foreign financial institutions to report on the assets held by U.S. account holders. It also requires U.S. citizens and residents to file annual reports on any foreign account holdings they have. Filing is done by completing and sending in Form 8938. Depending on whether individuals live in the U.S. or live abroad, there are different filing requirements and holding thresholds. If you hold assets abroad, it's important to check if you need to file as there are high penalties for not doing so.