Banks and certain other financial institutions located outside the United States that have U.S. account holders are scrambling to meet a looming IRS deadline. These institutions — known as foreign financial institutions, or FFIs — must achieve full compliance with the U.S.'s Foreign Account Tax Compliance Act (FATCA) by 1 January 2020. As a result, U.S. taxpayers with assets in foreign accounts may see those accounts closed or frozen in the new year.
In this post, we'll discuss the reason FFIs are stepping up their FATCA-related compliance efforts. We'll also provide a short history of FATCA and tell you about another critical reporting requirement for U.S. citizens that have foreign financial assets.
A short history of FATCA
FATCA is a U.S. federal law that went into effect in 2010 and aims to prevent U.S. corporations and individuals from sheltering assets in non-U.S. accounts for the purposes of avoiding or evading paying U.S. taxes. Specifically, FATCA requires U.S. citizens with foreign financial assets to report those assets to the Internal Revenue Service and/or U.S. Treasury each year. It also requires FFIs to report identifying information about their U.S. account holders to the IRS. Failure to comply can result in hefty penalties, account freezes and, in extreme cases, criminal prosecution.
Under FATCA, FFIs have been asked to collect the following information about their U.S. account holders and report it to the IRS:
- The name, address and Taxpayer Identification Number (TIN) of each account holder and, in the case of any account holder which is a United States owned foreign entity, the name, address and TIN of each entity owner
- The account number
- The account balance
- Gross dividends, interest and other income paid or credited to the account
A FATCA grace period that's coming to an end
Due to the difficulty of collecting the information above — in particular account holders' TINs — in 2014, the IRS granted FFIs a three-year grace period to achieve full compliance. During the grace period (which is still in effect), FFIs have been required to provide their U.S. clients' TINs only if the FFI already had record of them. FFIs were also required to ask each U.S. client for their TIN every year, and to make electronic searches for those that were missing.
The grace period comes to an end on 31 December 2019. Beginning in January 2020, FFIs will be required to provide TINs for all their U.S. clients. Failure to do so may result in an FFI incurring a 30 percent withholding tax on all income streams from their U.S. investments. This is a severe penalty that, according to the European Banking Federation, "may lead to serious financial difficulties, including bankruptcy" for financial institutions around the world.
FFIs are now understandably intensifying their efforts to obtain the missing TINs of their U.S. account holders. A U.S. citizen or corporation that fails to comply with an FFI's request for their TIN must provide a reasonable explanation to the FFI or risk having their accounts frozen.
Below is a brief summary of U.S. TIN types.
Tax Identification Numbers
According to the IRS, a Tax Identification Number (TIN) is a nine-digit number used for the administration of U.S. tax laws. Of the five different types of TINs, the three most common are:
- Social Security Number (SSN): The Social Security number, or SSN, is the most common tax identification number. It is also the only TIN issued by the Social Security Administration (SSA) instead of the IRS. SSNs are issued to U.S. citizens, permanent residents and certain temporary residents.
- Employer Identification Number (EIN): Also known as a federal tax identification number, an EIN is used to identify a business entity that must pay taxes to the U.S. government.
- Individual Taxpayer Identification Number (ITIN): ITIN's are issued to certain non-resident and resident aliens, their spouses and dependents who cannot get a Social Security number.
Information on how to apply for and obtain a TIN is available on the IRS website.
To comply with an FFI's request for a U.S. TIN, an individual typically must provide his or her U.S. Social Security number (SSN). For most U.S. citizens this is a straightforward process. Unfortunately, there is a substantial number of so-called "accidental Americans" who may be baffled by an FFI's request for a U.S. TIN. These accidental Americans hold U.S. citizenship because they were born in the U.S. and left at an early age, or because one of or more of their parents was a U.S. citizen. Many of them aren't even aware of their U.S.-citizenship status, let alone of their obligation to file U.S. tax returns and comply with FATCA.
In one case, a 74-year-old woman in the UK was sent a series of letters from her bank demanding her U.S. TIN, even though she left the States in 1947, when she was 18 months old. Understandably but mistakenly, she had assumed her U.S. citizenship had lapsed. When she discovered her true citizenship status and FATCA obligation, she paid both an accountant and a lawyer to help her obtain an SSN, paid five years' worth of back taxes, declared all her assets and renounced her U.S. citizenship. The entire process took several months and cost her more than 11,000 pounds.
While the IRS has offered some relief for accidental Americans, the European Parliament estimates that there are nearly 300,000 of them in the EU, all of whom are likely subject to FATCA. These individuals should research their respective situations as soon as possible, and if necessary consider obtaining a U.S. TIN and/or taking other action as recommended by tax and legal advisors.
Other Reporting Requirements
Providing a U.S. TIN and other information to your FFI may not be the only reporting requirement for U.S. citizens and corporations that hold assets outside the U.S. U.S. taxpayers holding foreign financial assets with an aggregate value above a certain threshold must report those assets on Form 8938, Statement of Specified Foreign Financial Assets, which must be filed annually with the IRS as part of their annual tax return.
It's important to note that Form 8938 is separate from the reporting requirement regulated by the Financial Crimes Enforcement Network (FinCEN). U.S. citizens and corporations that hold assets outside the U.S. with an aggregate value above a certain threshold must report those assets on form 114a, Report of Foreign Bank and Financial Accounts (FBAR). An individual may have to file both forms and could be subject to separate penalties for failure to file either of them.
To learn more about U.S. foreign assets disclosure read, If you're a U.S. taxpayer with a foreign bank account, you need to know about FBAR.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.