January 11, 2012
(Editor’s note: With January comes the start of tax season. Throughout the month, we’ll be looking at current and possible future developments in tax law.)
Click here for the first post on U.S. v. Home Concrete and Supply.
Thanks to legislation signed into law in 2010, tax reporting requirements will be vastly different for some individuals.
Despite its representing probably the most significant changes to the tax system in over a decade, the law was passed to little fanfare and with fewer objections.
That legislation is the Foreign Account Tax Compliance Act (FATCA).
Passed as part of the Hiring Incentives to Restore Employment (HIRE) Act on March 18, 2010, FACTA purports to remedy the problem of tax evasion through the use of foreign bank accounts.
It does this primarily through two reporting requirements.
First, FACTA imposes a 30% tax on the U.S. investments of foreign financial institutions if they refuse to disclose information about offshore accounts owned by U.S. citizens or by foreign entities in which U.S. taxpayers hold a substantial ownership interest.
This “information” includes a given account’s balances, receipts, and withdrawals, and “foreign financial institution” is broadly defined as “any financial institution which is a foreign entity” (a definition that includes far more institutions than simply banks).
Though this provision – which is scheduled to phase in over the next two to three years – may be very effective, it has had and will have some unintended consequences.
For example, U.S. citizens living abroad are already having difficulty opening accounts with foreign financial institutions because they just don’t want to deal with the increased risks and requirements associated with the accounts of U.S. citizens.
The second reporting requirement applies to U.S. taxpayers with foreign financial assets exceeding $50,000 in value.
These taxpayers must now report information about those assets on a new form (Form 8938) to be attached to the annual tax return, or face a 30% penalty on the account (assuming the IRS later discovers its existence).
In addition to these reporting requirements, FACTA closes the tax loophole of “dividend equivalent strategies.”
Before FACTA takes effect, dividends paid by U.S. companies to foreign shareholders are taxed at 30%.
However, it has been common practice for banks to use derivatives that allow clients to turn dividends into “dividend equivalents,” which, although they operate exactly like a dividend, are labeled as derivatives and aren’t taxable.
According to a Government Accountability Office report, this loophole cost billions in lost revenue.
In light of IRS estimates of $70 billion in lost annual revenue from unreported foreign accounts, it’s easy to understand the fiscal benefits of FACTA, especially at a time when the topic of the federal deficit has been so prominent.
Given these revenue benefits, repeal is unlikely.
Making that possibility even more remote is the absence of any major economic power in opposition.
Considering FACTA’s arduous reporting requirements, it’s tempting to think that the law was opposed by financial institutions.
However, domestic financial institutions, which comprise the vast majority of affiliated lobbying efforts, only stand to gain from FACTA, since it will inevitably lead to U.S. citizens shifting their accounts domestically.
So, it looks like FACTA is here to stay, which makes the real question whether it will actually produce the revenue benefits it contends that it will.