FATCA – What it is and how it affects US citizens

by Lance Morris
Jul 24, 2022
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What is FATCA? What impact does it have for US citizens living overseas, or living in the US with foreign financial assets?

FATCA is USA based legislation (Foreign Account Taxation Compliance Act) leveraged by agreements between the USA and other countries including UK, EU countries, Australia and NZ that is reasonably well known but generally not well understood.

Introduced under the leadership of Barack Obama, FATCA was intended to complete the puzzle of the US tax system.

Since inception of the US tax system has based its compliance on the principle of tax residency tied to citizenship, not based on where the individual resides. The US is one of only three countries worldwide which adopts this system.

This means a US citizen living overseas (expat) is treated no differently by the IRS to a US citizen who resides in the US, meaning that all foreign sourced income must be reported on their US tax return annually, just as if it had been earned in any one of the 50 states.

Historically, the ability of the IRS to pursue a US citizen living overseas was extremely limited, and usually required the IRS to prosecute a case in a local court, to claim unpaid tax with respect to an individual residing outside the US. This was a very inefficient and ineffective process.

As a result, whilst the US had a system of taxing based on citizenship, enforcement was largely ineffective and the vast majority of US citizens living overseas did not report their non-US income to the IRS on an annual basis (or report at all), believing the IRS was unable to pursue them effectively outside the US.

The introduction of FATCA dramatically enhanced the US tax system and the US government’s ability to enforce obligations on all US citizens.

FATCA was designed to ensure that a digital system existed, whereby the onus to collect tax and identify, locate and value overseas US citizens was no longer on the IRS alone, but instead involved foreign tax departments, and foreign banks and financial institutions.

From the beginning of 2012, the United States began to reach agreements with most western countries, and then eventually almost all countries around the world to introduce the FATCA laws into the foreign jurisdictions.

The laws consisted of two main attributes:

1.   Data-sharing.

Laws introduced around the world now required foreign tax departments to provide information with respect to US citizens, their income, and any other information held by the foreign tax department, to the IRS. Whilst this system was intended to be reciprocal, to date, the IRS is only sharing information with the UK. However all other countries who have signed FATCA, have been supplying tax information on US citizen residing in their countries to the IRS.

2. Compliance

Through the banks and financial institutions. Any foreign bank or financial institution that intended to do business with/in the US, which includes use of the US dollar, was now required to comply with FATCA legislation with regards to the US citizen clients.

Through FATCA, foreign banks and financial institutions were now required to proactively identify all of their clients who are or may be US citizens and report their personal and financial information to the US Financial Crimes Centre.

Once the bank account is identified as being owned by a US citizen, personal and account information is then reported annually to the IRS / Financial Crime Centre, supplementing information being provided by the foreign tax department.

In the case that the IRS wished to pursue an overseas based US citizen. For example, when placing a lien on a foreign bank account, the IRS was no longer required to prosecute a case in a local court.

Instead under FATCA, foreign banks can place a freeze, or even levies on the bank account of a US citizen, despite being a foreign bank in a foreign country.

These changes completely changed the tax landscape for US citizens overseas. Gone were the days when it was possible to wilfully ignore (believing they were untouchable) the US based tax system of tax residency being tied to citizenship. Instead, the IRS now had a similar amount of power when dealing with a US citizen overseas, as they do with taxpayers on US soil.

For any US citizen residing overseas, or living in the US but with foreign bank accounts or foreign income, FATCA should be taken very seriously. It is crucially important to remain tax compliant in the eyes of the IRS, no matter where you live in the world, as only a very small handful of countries have so far not signed up to the FATCA legislation. The reach of the US IRS is now almost unlimited.

All US citizens with foreign financial accounts (the sum of the highest balances in each account being greater than US$10,000) must file a Fincen114 return annually. This is effectively the same information as the banks provide. Creating two directly comparable data files.

The penalties for willful non-compliance with FATCA for an individual can be sever, including heavy penalties and criminal prosecution.

Through FATCA:

 ·      The US Government has knowledge of the location, contact information and value of all citizens outside the US.

 ·      US citizens living abroad must comply with the requirements of FATCA

 ·      The penalties for non-compliance are severe

 ·      Foreign governments have committed to assisting the US IRS and FINCEN in pursuing non- compliant US citizens.

 US Global Tax assists clients around the world, ensuring tax compliance with the IRS and the FATCA regulations whilst also prioritising tax efficiency, and preventing double taxation through the use of tax treaties wherever possible.