Foreign Account Tax Compliance Act (FATCA)

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Foreign Account Tax Compliance Act (FATCA): Overview and Key Compliance Rules

What is FATCA?

The Foreign Account Tax Compliance Act (FATCA) is a U.S. law designed to combat offshore tax evasion. It requires U.S. persons to report specified foreign financial assets and obliges foreign financial institutions (FFIs) to identify and report accounts held by U.S. persons. Noncompliance can trigger steep penalties and withholding on U.S.-source payments.

Why FATCA was enacted

FATCA increases transparency over offshore assets and income so the IRS can detect unreported taxable income. It also shifts reporting responsibility onto foreign financial institutions through information-sharing or withholding requirements.

Who must report

  • U.S. persons: U.S. citizens, U.S. residents, domestic corporations and partnerships, certain trusts and estates, and other entities treated as U.S. persons for tax purposes.
  • Foreign financial institutions (FFIs) and certain nonfinancial foreign entities (NFFEs): must identify U.S. account holders and either report information to the IRS (directly or via an intergovernmental agreement) or face withholding.

Defining U.S. person and the substantial presence test

  • U.S. person includes U.S. citizens, residents, domestic entities, and certain trusts/estates.
  • The substantial presence test (to determine residency) counts days in the U.S.: all days in the current year + 1/3 of days in the prior year + 1/6 of days in the year before that. Meeting 31 days in the current year and a total of 183 days by this formula makes you a U.S. resident for tax purposes.
  • Certain visa holders are temporarily exempt: e.g., most F and J students (up to five years) and many J teachers/researchers (up to two years).

Individual reporting: Form 8938

U.S. taxpayers with specified foreign financial assets may need to file IRS Form 8938. Filing thresholds depend on filing status and residency:

  • Taxpayers living in the United States:
  • Unmarried: more than $50,000 on the last day of the year or more than $75,000 at any time during the year.
  • Married filing jointly: more than $100,000 on the last day or more than $150,000 at any time.

  • Married filing separately: more than $50,000 on the last day or more than $75,000 at any time.

  • Taxpayers living abroad (tax home in a foreign country and present abroad 330+ days in a 12‑month period):

  • Unmarried: more than $200,000 on the last day of the year or more than $300,000 at any time during the year.
  • Married filing jointly: more than $400,000 on the last day or more than $600,000 at any time.

Specified foreign financial assets include foreign bank accounts, foreign stocks and securities, partnership interests, and interests in foreign hedge funds and private equity funds. Some exceptions apply (for example, certain accounts held at U.S. branches).

FFI and NFFE obligations

FFIs and many NFFEs must either:
– Register and report annually (name, address, taxpayer ID, account number, account balance and certain transactional information) for U.S. accounts; or
– Face a 30% withholding on withholdable U.S.-source payments (interest, dividends, and certain other income).

Consequences of noncompliance

  • Individuals: civil penalties can include a $10,000 penalty for failure to file Form 8938 (with additional penalties up to $50,000 for continued failure) and significant tax adjustments; understatement of tax related to undisclosed foreign assets can incur penalties as high as 40%.
  • FFIs: failure to comply can lead to exclusion from U.S. markets and a 30% withholding on applicable U.S. payments.
  • Statute of limitations: failure to report specified foreign financial assets can extend the statute of limitations for assessment in certain cases (e.g., longer periods for substantial unreported income).

Costs and criticisms

FATCA imposes substantial compliance costs on financial institutions for account screening, due diligence, and reporting systems. Critics argue these costs can burden foreign banks, deter investment, and create privacy and sovereignty concerns. Expat groups contend that FATCA places disproportionate reporting burdens on Americans living abroad and may hinder their ability to maintain local banking relationships.

FATCA vs. FBAR

  • FBAR (Report of Foreign Bank and Financial Accounts) is filed separately (FinCEN Form 114) and focuses on foreign bank and financial accounts with a combined maximum value over $10,000 at any time during the year.
  • FATCA (Form 8938) has broader asset coverage (including foreign securities, partnership interests, and certain funds) and different filing thresholds.
  • Some accounts must be reported on one form but not the other; in many cases both forms are required.

Can FATCA be avoided?

There is no lawful way for a U.S. taxpayer with reportable foreign assets to avoid FATCA reporting if thresholds are met. Attempting to evade reporting risks heavy penalties.

Practical takeaways

  • Determine if you are a U.S. person for tax purposes (citizenship, green card, or residency via substantial presence).
  • Inventory foreign financial assets and compare to Form 8938 thresholds based on filing status and residency.
  • Ensure foreign banks holding your assets have appropriate FATCA status and understand their reporting obligations.
  • File required forms (Form 8938 and, if applicable, FBAR/FinCEN Form 114) and consult a tax professional experienced with international reporting.

Conclusion

FATCA significantly expands U.S. tax reporting and international information sharing to deter offshore tax evasion. U.S. persons with foreign assets and foreign institutions that serve them must understand and comply with reporting obligations to avoid substantial penalties and withholding.