The Asset Protection Law Letter
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               THE ASSET PROTECTION LAW LETTER            

Do You (Should You) Care About FATCA?

There was a time – until very recently – when a U.S. citizen who maintained a foreign bank account but who didn't bother to pay the tax on the interest earned on that account had very little to worry about. After all, if the taxpayer himself was not going to report the income, the only other party who knew about the account was the foreign bank itself, and foreign banks don't send 1099 forms to the IRS. The only way the IRS could ever learn of the account is in the highly unlikely event that a routine audit would uncover the foreign-source income.

Some U.S. citizens (and U.S. resident aliens subject to U.S. taxes) actually didn't know that they were required to report their foreign bank accounts and their foreign income. But this class of people is limited to those who sign but don't read their tax returns. Schedule B of every individual tax return asks you to check a box "Yes" or "No" to the question whether the taxpayer has a "financial interest in or signature authority over" a bank account or other financial account located in a foreign country. Schedule B then advises you that if the answer is "Yes," you must file Form TD F 90-22.1 ("Report of Foreign Bank and Financial Accounts" or "FBAR") with the IRS. This form is the basic form for disclosing the location and amount of the foreign bank account. FBAR is due by June 30 of the following year for each account maintained in the prior year.

The penalties for checking "No" when the correct answer is "Yes," and the failure to file FBAR are very severe, and can include criminal prosecution. Even without the threat of jail, the penalties are so great they can wipe out the foreign account. But until recently the threat was more theoretical than real: The taxpayer was not about to disclose the account, and neither would the bank.

How FATCA Works

That is all about to change. With the recent enactment of The Foreign Account Tax Compliance Act ("FATCA") – which becomes operational on January 1, 2013, -- the IRS has finally figured out how to force foreign banks to reveal to the IRS the identities of their U.S. customers. Bottom line: Your foreign bank is about to turn you in.

FATCA works like this, and it's very simple: Every "foreign financial institution" ("FFI"), i.e. bank, brokerage firm, insurance company, trust company, etc. will be required to enter into a contract with the U.S. Treasury. Each contract will require the FFI to disclose the names, addresses and taxpayer ID numbers of all of its accounts that it believes are beneficially owned by U.S. persons. The FFI will also be required to disclose the amount in the account at the end of each year, and the dividends, interest or any other earnings on the account. Alternatively, the FFI could simply issue a Form 1099 to all their U.S. customers, sending a copy of the 1099 to the IRS.

If the FFI fails to enter into such a contract, then the U.S. will block 30% of any funds originating from the U.S. destined for the FFI. For example, assume SwissBank Inc. fails to enter into an agreement with the Treasury. SwissBank, Inc. owns 100 shares of Microsoft stock. Microsoft declares a $1 per share dividend. SwissBank, Inc. receives $70, and the IRS receives the balance. In light of the substantial holdings that foreign banks have in U.S. treasuries and equities, a foreign bank will more likely either enter into the required agreement with the Treasury or stop dealing with U.S. customers than forego 30% of the earnings on their U.S. investments.

In order to obviate having to enter into contracts with hundreds – if not thousands – of FFI's, the Treasury recently announced that the Treasury will enter into agreements directly with foreign governments. Under these agreements, each FFI will turn over the required data to their own central bank, and the central bank will turn the data over to the Treasury. But for the U.S. taxpayer, the effect is the same.

Additional FATCA Reporting

FATCA brought with it yet another required reporting form. Form 8938 ("Statement of Specified Foreign Financial Assets") must be filed annually by all U.S. taxpayers (citizens and resident aliens) who own foreign assets. Although most of the same information about foreign bank accounts, brokerage funds, etc that must be reported on FBAR is also reported on Form 8938, the new form in no way replaces or obviates the requirement to file FBAR. There are some foreign assets that are required to be disclosed on Form 8938 that are not required to be disclosed on FBAR, such as foreign securities not held in a financial account, foreign partnership interests and foreign hedge funds and private equity funds. But for most taxpayers, the Form 8938 disclosure will replicate the disclosure on FBAR. There are other minor differences: Form 8938 is filed with the taxpayer's Form 1040, and is due on the due date of the Form 1040, including extensions. FBAR is filed independently, is due by June 30 of the following year, and no extensions are permitted. FBAR is due if the taxpayer had $10,000 in foreign accounts at any time during the year. The threshold for Form 8938 is $50,000, measured on the last day of the year.

The Overseas Voluntary Disclosure Initiative ("OVDI")

If you own a foreign bank account and have earned income on the account which you have not reported, the bad news is that, unless the bank is located in the Falkland Islands, it is highly likely that, as a result of FATCA, the bank will report the account to the Treasury. Once that happens, you are open to penalties that are so steep that they could exceed the value of account itself, even if the earnings on the account have been minimal. That's because the penalties are based on the value of the account, not on the untaxed income. The IRS may – and has – brought criminal prosecution where the tax loss to the IRS has been substantial.

But there is no need to panic. The OVDI is the IRS' amnesty program. It's complicated, but here's how it works in a nutshell. If you come forward and file all the FBAR forms you didn't file for the past eight years, pay a penalty equal to 27.5% of the highest amount in the foreign account for the past eight years, and pay the tax you owe and the interest thereon, that's all you will have to pay, and you will have the assurance that there will be no criminal prosecution. But in order to qualify for the amnesty, you have to beat the IRS to the punch. If the foreign bank turns you in and the IRS opens an investigation, you will not qualify for the amnesty, even if the IRS has not gotten around to notifying you.

If you haven't filed the required FBAR forms but you do not have any unreported income, the news is even brighter. The account may have been a checking account that earned no interest, or you may have been a co-owner of an account with a foreign relative who received all of the income. In such a case, you are technically out of compliance. But all you need to do is to file the FBAR forms for the past eight years, and you are home free.

The worst thing you can do is put your head in the sand and hope that everything will turn out OK. FATCA changed all that. Your friendly foreign bank isn't your friend any more.


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Robert F. KluegerJD, LLM 
Mr. Klueger is one of the very few private attorneys in America who has argued a tax case before the United States Supreme Court, [United States v. Brockamp, 519 US 347 (1997)], which resulted in a change in the tax law regarding tax refund claims filed by disabled taxpayers....

Jacob Stein, JD, LLM
Mr. Stein is one of California’s best known attorneys and AV rated by Martindale-Hubbell (highest possible rating). He lectures dozens of legal seminars each year on the subjects of asset protection and advanced tax planning....
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