The tax man cometh: Are you ready for FATCA?

Published November 21, 2013 by Kay Gotshall

The Foreign Account Tax Compliance Act (FATCA) may not be on the radar of many individuals and businesses in Virginia, but the new regulations, which will take effect in 2014, will have significant tax and reporting implications.

U.S. persons are subject to U.S. taxes on their worldwide income.  This includes any income earned by foreign bank accounts or foreign financial assets.  Do you, your trusts/estates or your company have any direct or indirect access to foreign bank accounts? A great many people and businesses can answer “yes” to that question and should already be reporting those accounts under the Foreign Bank and Financial Account Reporting (FBAR) rules.

It’s important to note that the Internal Revenue Service considers trusts and companies to be “persons” as well as individuals, so the FBAR reporting requirements have an extensive reach. According to the FBAR rules, U.S. persons (including trusts/estates and companies) with financial interests in, or signature authority over, financial accounts maintained in a foreign country are required to report details about the accounts to the Department of Treasury. Reporting is mandated if the aggregate amount maintained in all the foreign accounts during a calendar year exceeds $10,000.  Substantial penalties may be imposed for failure to report.

In addition to the FBAR reporting of financial accounts, the 2010 Tax Act imposed additional reporting requirements, namely the Foreign Account Tax Compliance Act.  Simply put, FATCA was imposed to allow the IRS to further enforce foreign account compliance.  To do this, FATCA mandates that foreign financial institutions report to the IRS accounts at their institutions that are owned by U.S. persons. Of course, reporting the proper details about these accounts will be critical because any discrepancies may result in potential IRS investigation.  Foreign financial institutions need to have registered in 2013 to participate in the FACTA agreement to report information to the IRS. Otherwise they will be subject to a withholding tax on payments covered under FATCA made to them by U.S. companies.

Foreign financial institutions may include certain holding companies if “formed in connection with or availed by a collective investment vehicle, mutual fund, exchange traded fund, private equity fund, hedge fund, venture capital fund, leveraged buyout fund or any similar investment vehicle established with an investment strategy of investing, reinvesting, or trading in financial assets.”  Reg. Section 1.1471-5(e)(1)(v)(B). Thus, a foreign financial institution broadly encompasses many financial businesses.

Beginning July 1, 2014, if a foreign financial institution is not complying with FACTA, payments to these institutions from the U.S. are subject to a 30 percent withholding.  Virginia businesses making payments to foreign companies or foreign financial institutions will need to confirm they are not subject to withholding.

In addition to the foreign financial institution registration and filing requirements, there is an individual filing requirement under FATCA beginning as early as 2011to report all foreign financial assets if valued over $100,000 for married filing joint taxpayers or $50,000 for single taxpayers for U.S. residents. 

FATCA, which was passed as part of the 2010 Hiring Incentives to Restore Employment (HIRE) Act, has come under increased scrutiny as a result of its complicated set of rules and new reporting requirements. The IRS has offered a bit of a reprieve by recently announcing that the enforcement of the withholding under FATCA will begin on July 1, 2014 rather than Jan. 1, 2014. These additional six months provide some breathing room for individuals and businesses, but they must begin acting now to prepare for the FATCA regulations.

Another reason that businesses, individuals, and financial institutions must begin preparing is that the government is using that six month extension to sign more intergovernmental agreements with other countries. These agreements make it easier for foreign financial institutions to report information on their account holders directly with the IRS. According to the Treasury Department, agreements have been reached with nine countries and negotiations are underway with more than 75 other jurisdictions around the globe.    

Despite the potential steep penalties, many businesses and individuals remain unaware of FATCA’s looming presence. A number of recent surveys have shown that the majority of respondents — including banks, companies and individuals — have not begun preparing for FATCA compliance. Delaying FATCA compliance is a risky proposition and one that should not be taken lightly. Although the IRS is still issuing some FATCA guidelines and rules, basic preparation should be well underway. To its credit, the IRS has been providing more details on FATCA enforcement and in September released a set of frequently asked questions related to FATCA registration.  

In summary, if a Virginia business makes payments to foreign entities or foreign financial institutions, they need to determine if a 30 percent withholding applies.  Furthermore, individuals need to make sure they are compliant for reporting foreign accounts and financial assets under the FBAR rules as well as the FATCA laws.

Kay Gotshall is a senior tax manager with Keiter, one of the largest accounting and consulting firms in Virginia. She can be contacted at [email protected]