It’s rather evident the Department of Treasury is working hard towards
forcing getting more and more U.S. residents to (voluntarily) disclose their overseas financial accounts and assets. After all, the U.S. income tax is a worldwide system; income tax is imposed on income of U.S. residents from all sources, regardless where it is earned.
As applied to some U.S. residents, however, this system seems overly broad. The Internal Revenue Code imposes income tax not only on U.S. residents but also its citizens on worldwide income. Consider the dilemma of this law-abiding expatriate. This is not a unique situation; many U.S. born citizens move abroad without changing their citizenship, also easily subjecting themselves to, among other things, FBAR requirements. As much as you and I may feel for these individuals, the bottom line is they are subject to the Internal Revenue Code and the Bank Secrecy Act, and there are no signs that the Treasury will change this result.
In fact, the signs point in the opposite direction. As part of the Hiring Incentives to Restore Employment (HIRE) Act, the Foreign Account Tax Compliance (FATC) Act was passed in March 2010, establishing a entirely new and distinct foreign asset disclosure regime.
That’s right. This is separate from and in addition to the FBAR rules. Let’s look at the key components.
The relevant provision, IRC section 6038D, essentially says that an individual holding an interest in a “specified foreign financial asset” during the tax year must attach to his or her tax return certain information for each such asset if the total value of all such assets exceeds $50,000. It’s unclear whether the 50k threshold: (a) is similar to the FBAR 10k rule, (b) is evaluated at the end of the tax year, or (c) need be met only at some point during the tax year.
All of the following are considered “specified foreign financial assets”:
- a depository, custodial, or other financial account maintained by a foreign financial institution;
- a stock or security issued by a person other than a U.S. person;
- a financial instrument or contract held for investment that has an issues or counterparty other than a U.S. person; and
- an interest in an entity that is not a U.S. person.
Clearly, the scope of assets is significantly broader than those covered by the FBAR. Interests held in offshore hedge funds, for example, are specified foreign financial assets, but are not reportable accounts for FBAR purposes.
It’s worth re-pointing out that if subject to 6038D, the taxpayer must attach the disclosed assets to his/her tax return. This is unlike the FBAR, which is filed with the Treasury office in Detroit, MI. In other words, the IRS will clearly see the foreign assets owned. Don’t be surprised if taxpayers subject to 6038D have a high audit rate.
The FATC is effective for tax years beginning after March 18, 2010. In other words, most individual taxpayers are subject to the rules beginning with their 2011 tax year.
What about penalties? Are they as absurd as the FBAR penalties? Yeah, pretty much.
The baseline penalty is $10,000 for failing to disclose. If the IRS mails to the taxpayer a notice of failure to disclose, and failure continues for 90 days thereafter, the taxpayer is subject to additional penalties of $10,000 for each 30-day period of noncompliance after the 90 day period, up to $50,000. Ugh.
But that’s not all. If the IRS determines additional tax due from the undisclosed assets, a 40% accuracy-related penalty may be imposed on the understatement of tax.
The one possible form of relief is that penalties will not be imposed if the failure to disclose is due to “reasonable cause.” While that at least provides an out, don’t be the first person to test the standard. I’d play it safe and disclose away, until hearing otherwise.
ADDENDUM: Moments before I published this post, international tax attorney Philip Hodgen published a very interesting letter written by a tax practitioner, who serves expatriates, to the Treasury about foreign financial asset disclosure. View it here.