Besides “IRS,” Americans can now add another item to their list of ominous acronyms: FATCA. Like most things related to income taxes, the FATCA issue has a lot of people in a dither. As if US tax law wasn’t already complicated enough, along comes FATCA to gum up the works even more, especially for US citizens living overseas and earning income from a non-US source.
All US citizens or resident aliens living abroad are obligated to pay income taxes to the US Treasury, even if they haven’t lived in the United States for years, have no intention of returning, and even if their income comes solely from foreign sources. The United States of America is the only modern, industrialized nation that taxes the worldwide income of its estimated six million citizens who live abroad, even if their income is generated in a foreign country and they never return to their homeland.
Generally the rules for filing income, estate, and gift tax returns and paying estimated tax are the same whether you are residing in the United States or abroad. Your income, regardless of the source, is subject to US income tax, no matter where you live. But if you reside overseas, or are in the military on duty outside the US, you are allowed an automatic two-month extension, from April 15, to file your return and pay any amount due without requesting an extension. For a calendar year return, this means that taxpayers residing overseas have until June 15 to file a return and pay any taxes due.
But if you, like singer Tina Turner in Switzerland, think renouncing your US citizenship will cure the problem, think again. Even if you give up your citizenship today (which is not a simple process, and must be done officially), you are still subject to any past income tax obligations you may have, and even non-citizens can be subject to future income taxes under certain conditions. Many expats are now nervous about this intensified scrutiny of their possible US tax obligations, especially if they have neglected to file certain forms in the past.
The good news is that there are special tax treaties between the United States and over 50 countries (including Austria, Germany and Switzerland) that protect US citizens from double taxation. But you are still required to file a US tax return in a timely manner in order to receive the Foreign Tax Credit and/or the Foreign Earned Income Exclusion. More about this below.
By the way, if you happen to be one of many US expats who has not properly filed a US income tax return for many years, look into the Offshore Voluntary Disclosure Program (OVDP). Under this program the IRS may forgive penalties in return for your voluntary disclosure and the payment of any back taxes you owe. OVDP may not be available in the future, so it may be wise to take advantage of it now. It is a vital matter that you should discuss with a knowledgeable tax consultant.
What is FATCA?
The Foreign Account Tax Compliance Act (FATCA) is a US law that was passed in 2010. FATCA is part of the 2010 Hiring Incentives to Restore Employment (HIRE) Act that requires individuals to report their financial accounts held outside of the United States, and also requires foreign financial institutions to report to the Internal Revenue Service about their American depositors. FATCA was designed primarily to combat offshore tax evasion and recoup federal tax revenues. Following various complaints, objections, complications and other delays, FATCA’s actual implementation has been pushed back several times. It is now set to take effect for the 2014 tax year.
In any case, FATCA only applies to US citizens with foreign financial assets having a total value above $50,000 at the end of the tax year. If the account value is $50,000 or less, there is no reporting requirement for the year, unless the total value was more than $75,000 at any time during the tax year. For Americans residing overseas the value limits are much higher: $200,000, or $300,000 at any time during the year. For joint filers the limits double to $400K or $600K. (For the details see the Form 8938 link below.) If an American expat has two or more accounts, the total value of those accounts determines whether reporting is required or not. Most of the FATCA reporting burden falls on the foreign banks or financial institutions, rather than the depositor – and therein lies the rub for many critics of the law.
FATCA’s Unintended Consequences
In October 2013 a private Swiss bank announced that it would close its doors rather than comply with the “costly and burdensome rules” imposed on the bank by the US tax authorities. Although it claimed it was financially sound, Bank Frey & Co. AG of Geneva, Switzerland said its shareholders had voted to cease doing business in the face of new US efforts to catch American tax evaders with funds held in Swiss banks. Frey & Co. was one of 14 Swiss financial institutions under investigation by US authorities.
This is an example of how European and other foreign banks may become wary of opening accounts for US clients because of FATCA and regulations that force the banks to disclose information about their US clients’ assets. Foreign banks and financial institutions also face penalties imposed by the US Treasury Department for non-compliance.
But on its “Myth vs. FATCA” webpage (“The Truth About Treasury’s Effort To Combat Offshore Tax Evasion”) Treasury claims that FATCA is getting a bum rap. The US Department of the Treasury counters some of the objections to FATCA that have been raised by critics of the law, emphasizing that FATCA provisions impose no new obligations on US citizens living abroad. Other than the new Form 8938, it is true that FATCA does not add any new tax filing requirements for US expat taxpayers. Even prior to FATCA, overseas taxpayers have been legally required to file certain forms and report their worldwide income to the IRS. (See FBAR below.)
However, FATCA does add new reporting and withholding requirements for foreign financial institutions (FFIs) with US clients or depositors. FFIs must now report information about offshore US accounts, and withhold funds under certain conditions, but Treasury claims that FFIs will not be overburdened. For example, for accounts with less than one million dollars, an FFI is only required to search the account information that is electronically available. There is no reporting required of a foreign financial institution at all for accounts of $50,000 or less.
In response to the claim that US citizens living overseas will become “outcasts in the international financial world,” the Treasury site states: “FATCA withholding applies to the US investments of FFIs whether or not they have US account holders, so turning away known US account holders will not enable an FFI to avoid FATCA. We expect that many, if not most, of the governments implementing FATCA . . . will require their financial institutions to identify and report on all non-resident account holders, not just US account holders.”
As to the claim that Americans living abroad will give up their US citizenship because of FATCA, the Treasury Department points out that the new law imposes no new obligations on US citizens living abroad. Instead, FATCA’s withholding obligations fall on institutions making payments to FFIs, and the due diligence and reporting requirements fall on the FFIs themselves. Renouncing one’s US citizenship “would not relieve these individuals of prior US tax obligations, and might well create additional US tax obligations for certain citizens and long-term residents who give up citizenship or residency.”
ACA’s anti-FATCA Campaign
One of FATCA’s biggest critics is American Citizens Abroad (ACA), a nonprofit organization based in Geneva, Switzerland (and soon also in the United States). In an open letter to the Treasury Department and its director, Robert Stack, the ACA responded to Stack’s online “Myth vs. FATCA” posting. In her rebuttal letter, ACA’s executive director, Marylouise Serrato, points out that, despite Stack’s claims to the contrary, American expats are already having difficulties with bank account closures and the denial of financial services in some foreign locations.
The letter continues: “ACA acknowledges that there is a large tax-gap for overseas filers. However, this is due in great part to Americans overseas being unaware of their filing obligations since they are already paying taxes to a foreign jurisdiction and believe they have fulfilled their personal tax obligation as a resident in a foreign country; they are essentially confusing the worldwide standard of residency-based taxation with the US system of citizenship-based taxation.” ACA has long been pushing for a fundamental change in US tax law, from the current citizenship-based taxation to a system based on residency. The expat organization also disputes Treasury’s claim that FFIs do not face any unusual increase in costs due to FATCA’s reporting requirements.
According to Treasury, US taxpayers living abroad who have used offshore accounts to evade tax obligations “may rightly fear that FATCA will identify their illicit activities.” After all, Treasury says, the intent of the law is to recover tax revenue that would otherwise be lost because of illegal tax evasion. In turn, ACA and other critics point out that the law seems to treat most American expats as if they were all tax cheats. They argue that American expats who live and work in a foreign country should not be lumped together with large corporations trying to evade US taxes, or with US residents who have offshore bank accounts designed to hide income.
Before FATCA there was FBAR and Form TD F 90-22.1
With all the hubbub over FATCA, many American expats have come to discover that they may in fact be tax dodgers, or at least may have unintentionally failed to comply with long-standing US tax-reporting requirements. One of these existing tax regulations concerns yet another F-word: FBAR.
What is FBAR?
The Foreign Bank Account Report (FBAR), filed on Form TD F 90-22.1, is due annually on or before June 30. Any “United States person” who has a foreign bank account or bank accounts with an aggregate balance of over $10,000 at any point in the year must file a report with the US Treasury Department listing all foreign accounts. For example, if your German bank or Sparkasse account had a balance of €9,000 ($11,700) at any time in 2013, you are required to file an FBAR. The same is true if you have two separate German accounts, say, with balances of €1800 and €7,200 each. The combined total of the two accounts (€9,000/$11,700) exceeds the $10,000 FBAR limit, requiring you to file a Form TD F 90-22.1.
Speaking of forms, ACA has also objected to the duplication of reporting that FATCA imposes. In addition to the existing FBAR reporting mentioned above, FATCA now requires US expats to file yet another document: Form 8938.
Besides FBAR, there have long been other income tax forms and tax regulations related to US citizens living overseas. Remember the taxation treaties we mentioned earlier? The Avoidance of Double Taxation treaty with Germany was first signed in 1990. Similar tax protocols with Austria and Switzerland came about six years later. The US now has dual taxation agreements with over 50 nations. These treaties help US taxpayers avoid having their worldwide income taxed twice. However, in order to take advantage of these protocols, US taxpayers living overseas must file certain forms and meet certain requirements. They have to file a US income tax return, and are thus subject to dual taxation – which is then offset by foreign tax credits.
The only reason this problem exists at all is the citizenship-based tax system used by the United States. The US would not need to have tax treaties with over 50 foreign nations if it simply did what every one of those countries already does: tax income based on where a person lives, rather than a person’s passport.
That simple change in the tax laws would make FATCA and all its complications unnecessary. But when was the last time the US Congress was sensible enough to do what was logical and simple?
Related Web Links
- American Citizens Abroad: FATCA
- IRS: Foreign Account Tax Compliance Act (FATCA)
- IRS: U.S. Citizens and Resident Aliens Abroad – IRS instructions, information
- IRS: Frequently Asked Questions (FAQs) About International Individual Tax Matters
- IRS: Do I Need to File Form 8938?
1. The African nation of Eritrea (pop. six million) is the only other country besides the US that taxes its citizens’ worldwide income.
2. Turner, who lives near Zurich, Switzerland with her German husband, recently became a Swiss citizen and gave up her US citizenship, a practice that has increased since the introduction of FATCA, but may not actually help avoid US taxes.
3. The IRS definition of the term “United States person” is: (1) a citizen or resident of the United States, (2) a domestic partnership, (3) a domestic corporation, or (4) a domestic estate or trust.
NOTE: None of the information on this page is intended as financial or legal advice. Always consult a professional tax advisor who has experience with expat taxation matters.