The Foreign Account Tax Compliance Act (FATCA) was enacted as a comprehensive measure to combat offshore tax evasion—a noble enough goal. But FATCA’s comprehensiveness is also a sore point for many in the financial services industry, especially insurance carriers and producers. In comments to regulators, one foreign life insurance trade organization, the Association of International Life Offices (AILO), recently called FATCA’s requirements “onerous and disproportionate to the risk involved.”

Passed as part of H.R. 2847, the Hiring Incentives to Restore Employment Act (HIRE Act) on March 18, 2010, FATCA combats tax evasion by requiring disclosure from foreign institutions about accounts held by individuals, including U.S. citizens, and institutions that may be subject to U.S. tax. Many life insurance and annuity contracts are considered “accounts” under the Act, although FATCA doesn’t generally apply to property, casualty, and term life insurance contracts.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of FATCA in Advisor’s Journal, see IRS Proposed FATCA Guidance Expands Offshore Compliance Initiatives (CC 10-52) & Offshore’s Limited Shelf Life (CC 10-47).

Why is this Topic Important to Wealth Managers? Provides discussion on foreign trust disclosure for April 15th 2011.

Although trusts can be taxpayers, Sections 671 to 679 of the Internal Revenue Code contain the so-called ‘grantor trust rules’, which treat certain trust settlors (and sometimes persons other than the settlor) as the owner of a portion or all of a trust’s income, deductions and credits for US tax purposes. A trust where the settlor (or other person) is treated as the owner of the trust assets for US tax purposes is referred to as a ‘grantor trust’. The grantor trust rules apply to both foreign and domestic trusts, but in different ways.

Under the grantor trust rules, a US person who transfers property to a foreign trust is generally treated for income tax purposes as the owner of that portion of the trust attributable to the transferred property, even if the trust would not have been a grantor trust had it been domestic.

This is the result for any tax year in which any portion of the foreign trust has a US beneficiary. A foreign trust is treated as having a US beneficiary for a tax year unless (i) under the terms of the trust, no part of the trust’s income or corpus may be paid or accumulated during the tax year to or for the benefit of a US person, and (ii) if the trust is terminated at any time during the tax year, no part of the income or corpus could be paid to or for the benefit of a US person. The Internal Revenue Service (IRS) regulations under Section 679 of the Internal Revenue Code generally treat a foreign trust as having a US beneficiary if any current, future or contingent beneficiary of the trust is a US person.

Section 6048 of the Internal Revenue Code imposes reporting obligations on foreign trusts and persons creating, making transfers to or receiving distributions from such trusts. For example, a US person who transfers property to a foreign trust must report the transfer to the IRS, and a US beneficiary who receives a distribution from a foreign trust must report the distribution. Both reports are made on IRS Form 3520 and failure to file the form in a timely manner results in a penalty generally equal to 35% of the gross value of the transfer or distribution.

In addition, if a US person is treated as the owner of any portion of a foreign trust under the grantor trust rules, the US person is responsible for ensuring that the trust files an annual information return on Form 3520-A and provides information to each US person who is treated as the owner of any portion of the trust, or receives (directly or indirectly) any distribution from the trust.

The United States has moved beyond collecting information only where a tax is to be imposed, and now seeks disclosure of a US taxpayer’s interests in foreign trusts, accounts and entities. The HIRE Act [1]creates additional distinctions between the reporting and tax treatment of foreign trusts as compared to their domestic counterparts.

Children and grandchildren of international family clients have previously been counseled that the mere use of a home, yacht, artwork or other property owned by a foreign trust would not cause the beneficiary to have any US reporting obligations or tax consequences. That is clearly no longer the case, and offshore trust structures must be reviewed and their US beneficiaries advised to report where applicable. Even US beneficiaries who are not using foreign trust property and who have not received any cash distributions, but are merely members of a discretionary class of beneficiaries of a foreign trust, should consider consulting US tax counsel.

It should also be noted that, the provisions affecting foreign account compliance and foreign trusts are being used as a revenue offset for the HIRE Act, giving the IRS further incentive to audit taxpayers and enforce these new measures.

Tomorrow’s blogticle discusses additional changes wealth managers can expect in 2011.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] H.R. 2847.

Why is this Topic Important to Wealth Managers? Discusses common reporting requirements in regards to U.S. monetary transactions.  Provides wealth managers with a general overview of the reports clients’ activities may be subject to.

This week’s blogticles discussed compliance reporting generally regarding foreign transactions and activities.  Today, we will continue to explore some of the common reporting requirements that are filed based on domestic and international activity. 

Suspicious Activity Reports

Congress has enacted legislation to the affect that the Secretary of the Treasury requires financial institutions to report any suspicious transaction relevant to “a possible violation of law or regulation.” [1] The Financial Crimes Enforcement Network (FinCEN) maintains theses “reports in a central database and makes the information available electronically to state and federal law enforcement and regulatory agencies to assist in combating financial crime.” [2]

Currency Transaction Reports

Under Federal Statute the Department of the Treasury requires “banks, securities broker-dealers, money services businesses, casinos, and other financial institutions”, to file a “report for each transaction involving the payment, receipt, or transfer of U.S. coins or currency (or other monetary instruments as Treasury may prescribe)” in excess of $10,000. [3]

Report of International Transportation of Currency or Monetary Instruments

There is no Federal law that limits the “total amount of cash or other monetary instruments that a person may bring in or take out of the United States”, nor is there an imposition of “any taxes or customs duties on the import or export of currency or other mediums of exchange.” [4]

Nevertheless, the law “requires persons physically transporting, mailing or shipping cash or other monetary instruments exceeding $10,000 at one time, either into or out of the U.S., to file a report with U.S. Customs and Border Protection declaring the amount being transported.” [5]

The report is currently made on FinCEN Form 105, “Report of International Transportation of Currency or Monetary Instruments”.

Report of Foreign Bank and Financial Accounts (FBAR)

There is also no specific Federal law that prohibits an individual from owning any interest in a financial account in foreign jurisdictions.  “However, because offshore financial accounts can be used to hide criminal proceeds or evade taxes, federal law does require disclosure of such accounts.” [6] The new Hire Act was passed to address this problem.  In addition, FBAR is also used in this regard.  See our blogticles earlier this week for more on the new reporting and FBAR.

Report of Cash Received in a Trade or Business

The Internal Revenue Service/FinCEN Form 8300 “must be filed by any person in a trade or business (other than a financial institution) who receives more than $10,000 cash in a single transaction or in related transactions.” [7]

This includes, wealth managers, “[a]ttorneys, travel agents, jewelry dealers, pawnbrokers, real estate brokers, automobile dealers, and all other non-financial trades or businesses”. [8]

Form 8300 is similar to a currency transaction report for non-financial institutions, but “is required only with respect to receipt of cash, whereas the currency transaction report applies both to receipt and disbursement of cash”. [9]

Next week’s blogticles will discuss bankruptcy.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] Title 31 U.S.C. § 5318(g).

[2] Steven Mark Levy .  Federal Money Laundering Regulation: Banking, Corporate and Securities Compliance (FMNYL) § 7.01. Citing, 65 Fed. Reg. 13683, 13685 (March 14, 2000).

[3] Title 31 U.S.C. § 5313(a); 31 C.F.R. § 103.22.

[4] FMNYL § 9.01.

[5] Id.

[6] FMNYL § 10.02.

[7] 31 U.S.C. § 5331. 

[8] Id.

[9] FMNYL § 8.02.

Why is this Topic Important to Wealth Managers? Presents wealth managers with relevant law and analysis related to the HIRE Act and foreign trusts.  Also, discusses important reporting requirements regarding foreign trusts owned by U.S. persons. 

Use of Foreign Trust Property and Deemed Distributions

The new FATCA law expands 26 U.S.C. § 643(i) to provide that any use of trust property by a U.S. grantor or U.S. beneficiary, or any U.S. person related to a U.S. grantor or U.S. beneficiary, is treated as a distribution equal to the fair market value of the use of the property. [1] 

“Thus, the rent free use of real estate, yacht, art work or other personal property (wherever located including the United States) or an interest-free or below-market loan of cash or uncompensated use of marketable securities will trigger a distribution equal to the FMV for the use of such property to the extent of distributable net income”. [2]

However, if the trust is paid the fair market value, within a reasonable period of time, for the use of property or the market rate of interest on a loan by the trust, the new law does not create a deemed distribution. [3]

This provision is effective after March 18, 2010. 

When does a foreign trust have a U.S. beneficiary?

The new also law creates a rebuttable presumption that the trust has a U.S. beneficiary when a U.S. person directly or indirectly transfers property to a foreign trust. [4]

This presumption can be overcome by submitting information (as the Treasury may require) and by demonstrating to the satisfaction of the IRS that (i) under the terms of the trust no part of the income or corpus of the trust may be paid or accumulated during the tax year to or for the benefit of a U.S. person, and (ii) if the trust were terminated during the tax year, no part of the income or corpus could be paid to or for the benefit of a U.S. person. [5]

The presumption becomes effective after March 18, 2010.

Reporting requirement by U.S. owners of foreign trusts.

The new FATCA law also requires U.S. persons, “when treated as an owner of any portion of a foreign trust under the grantor trust rules, to provide information as may be required with respect to the trust, in addition to ensuring that the trust complies with its [traditional] reporting obligations.” [6]

“In other words, if a U.S. person is treated as the owner of a foreign trust under the grantor trust provisions, the U.S. person is responsible for ensuring that the trust files an information return for the year and that the trust provides other information to the IRS as the Treasury may require to each U.S. person who is treated as the owner of any portion of the trust or receives any distribution from the trust.” [7]

The provision is effective for tax years beginning in year 2011.

General reporting rules

If a U.S. person creates or transfers property to a foreign trust, the U.S. person generally must report this event and certain other information by the due date for the U.S. person’s tax return, including extensions, for the tax year in which the creation of the trust or the transfer occurs. [8]

If a U.S. person directly or indirectly receives a distribution from a foreign trust, the U.S. person generally must report the distribution by the due date for the U.S. person’s tax return, including extensions, for the tax year during which the distribution is received. [9]

If a U.S. person is the owner of any portion of a foreign grantor trust at any time during the year, the person is responsible for causing an information return to be filed for the trust, which must, among other things, give the name of a U.S. agent for the trust. [10]

Penalties

The new law increases penalties if the reporting requirements with respect to certain foreign trusts are not met. [11]

“Under the new law, an initial minimum penalty of $10,000 or 35 percent of the gross reportable amount may be imposed for failing to report where the Treasury has insufficient information to determine the gross reportable amount of the property transferred to a foreign trust under [26 U.S.C. § 6048].” [12]

This provision is effective to notices and returns required to be filed after December 31, 2009.

Tomorrow’s blogticle will conclude this week’s discussion of international tax compliance. 

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] Section 531. HIRE Act. H.R. 2847. 2010.; See generally, TAXES – The Tax Magazine, FATCA: The Global Financial System Must Now Implement a New U.S. Reporting and Withholding System for Foreign Account Tax Compliance, Which Will Create Significant New Exposures—Managing This Risk (Part III). CCH. Sept. 1, 2010. ; See also Dean Marsan. FATCA: An Analysis.  21 JITAX 24, 63-64. 2010. 

[2] TAXES – The Tax Magazine. FATCA. Sept. 1, 2010.

[3] Id.       

[4] Section 532. H.R. 2847;TAXES – The Tax Magazine. FATCA. Sept. 1, 2010.; 21 JITAX 24, 63-64. 2010. 

[5] Id.

[6] 21 JITAX 24, 63.; See also, Section 534. H.R. 2847.

[7] TAXES – The Tax Magazine. FATCA. Sept. 1, 2010.; See also, Section 534. H.R. 2847.

[8] TAXES – The Tax Magazine. FATCA. Sept. 1, 2010. Citing, 26. U.S.C.§ 6048(a).

[9] Id. Citing, 26. U.S.C.§ 6048(c).

[10] Id. Citing, 26. U.S.C.§ 6048(b).

[11] Section 535. H.R. 2847.

[12] TAXES – The Tax Magazine. FATCA. Sept. 1, 2010.; See generally, Section 535. H.R. 2847.

Why is this Topic Important to Wealth Managers? Continues the discussion on what FATCA is and how it will affect clients including a number of topics of current interest with regards to this new legislation.

The Federal Government has estimated that the “United States loses an estimated $345 billion in tax revenues each year as a result of offshore tax abuses primarily from the use of concealed and undeclared accounts held by U.S. taxpayers or their controlled foreign entities.” [1]

In consideration of the goal of eliminating this gap, “it is not surprising that the government recently ratcheted up its pressure on taxpayers who structured their activities, in many cases, with the active help and assistance of promoters and facilitators to avoid reporting their taxable income on their tax returns or hide these offshore accounts from the government.” [2] This increased “pressure” came in the form of the HIRE Act passed in the first quarter of 2010. [3]

As was discussed earlier this week,[4] the new law provides for reporting requirements by foreign financial institutions with U.S. accountholders about the status, specifically identity and balance, of their account. [5]

“The touchstone of the new law is to impose upon a foreign financial institution a 30-percent withholding tax if it fails to provide the information required under the so-called ‘Code Sec. 1471(b)’ agreement.” [6] The agreement is between a foreign financial institution and the IRS which states the financial institution will comply with reporting requirements generally regarding U.S. taxpayers and the IRS will not enforce a 30% withholding tax on payments by U.S. persons to the financial institution. [7]

A foreign financial institution means a foreign entity that (i) accepts deposits in the ordinary course of a banking or similar business; (ii) holds financial assets for the account of others as a substantial portion of its business; or (iii) is engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities interests in partnerships, commodities or any interest (including a futures or forward contract or option) in such securities, partnership interests or commodities. [8] This broad definition includes not only traditional banks, but could also include but is not necessarily limited to, insurance companies, investment trusts, mutual funds, hedge funds and pension plans. [9]

“The idea behind the new regime is to coerce foreign financial institutions to report information about their U.S. customers and account holders to the IRS.” [10] To avoid the withholding tax by the U.S. withholding agent on payments made to foreign financial institutions, “a foreign financial institution can elect to comply with ‘Form 1099’ reporting after applying the assumption that each account holder who is a specified U.S. person or a U.S.-owned foreign entity is a U.S. citizen.” [11]

Interestingly, because information disclosure and compliance is sought from international financial entities that themselves may not be subject to U.S. law or tax, “the information reporting cannot be mandated in a rule of law but must be incentivized”, and hence the 30% withholding, which occurs for non complying foreign financial institutions at the U.S. source by the withholding agent (who are subject to U.S. law and tax). [12]

Moreover, the new law provides that “a withholding agent will be required to withhold 30 percent” from most payments made to “a nonfinancial foreign entity that fails to obtain from the beneficial owner or the payee a certification that the beneficial owner does not have any substantial U.S. owners, or otherwise satisfies the information reporting requirements”. [13] This obligation of the new law, like that to foreign financial institutions, “is intended to require a nonfinancial foreign entity receiving U.S.-source income to report information about its beneficial owners to the IRS.” [14]

Commentators are now suggesting that the above described, incentivized, “‘foreign tax piggy-back legislation’ can be just as invasive as the U.S. model.” [15] In other words, since the U.S. is now asking to know the identities and account balances of Americans that own U.S. accounts, a foreign financial institution will have to know whether or not its accounts are owned by U.S. persons, or if the intended beneficiaries are U.S. persons.  “To that end, [foreign entities] will be asking global account owners to certify or provide documentation acceptable to the Treasury whether they are specified U.S. persons.” [16]

Tomorrow’s blogticle will continue the discussion of international tax compliance.

We invite your questions and comments by posting them below, or by calling the Panel of Experts

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[1] CCH. Taxes—The Tax Magazine. July 2010. At 28. Citing, Update on Reducing the Federal Tax Gap and Improving Voluntary Compliance, U.S. Department of the Treasury, July 8, 2009; U.S. Senate, Permanent Subcommittee on Investigations, Committee on Homeland Security and Governmental Affairs, Tax Haven Banks and U.S. Tax Compliance, Staff Report (July 17, 2008).

[2] CCH. Taxes—The Tax Magazine. July 2010. At 28

[3] Hiring Incentives to Restore Employment Act. H.R. 2847. 2010. (available: http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:h2847enr.txt.pdf)

[4] AdvisorFYI: How Foreign Account Tax Compliance Act May Impact Your Business and Clients

[5] See generally Section 1471. HIRE Act. H.R. 2847. 2010.

[6] CCH. Taxes. At 40.

[7] See generally Section 1471. HIRE Act.

[8] Section 1471(d)(5). HIRE Act.

[9] Deloitte Touche Tohmatsu. Aisa Pacific Dbref- U.S. FATCA Requirements.  October 2010.

[10] CCH. Taxes. At 40.

[11] Id.

[12] Id. at 41.Citing, New York State Bar Association Tax Section comments dated January 10, 2010, entitled, Comments on the Foreign Account Tax Compliance Legislation (hereinafter “NYSBA Tax Section Comments”).

[13] CCH. Taxes. At 41.

[14] Id.

[15] Id.

[16] Id.

Why is this Topic Important to Wealth Managers? Discusses legislation passed earlier this year that affects wealth managers whose clients have offshore accounts.  This discussion is presented so that wealth managers have more than enough time to discuss alternative solutions to meet long-term planning objectives.

During the first quarter of 2010, President Obama signed into law H.R. 2847, the Hiring Incentives to Restore Employment Act. “The act provides incentives for job creation, but in order to pay for the incentives, the act also contains significant changes that will affect foreign financial institutions that choose to do business with U.S. persons.” [1] Half of the “U.S. Congressional Record that contains the act” is “dedicated to foreign account tax compliance.” [2]

Therefore, “although the act is commonly referred to as the HIRE Act for its focus on job creation, one of its main purposes is to target tax dodgers’ use of foreign accounts.” [3] The act is basically a model of the 2009 Foreign Account Tax Compliance Act (FATCA) which was introduced by the Senate.   “The act incorporates substantially all of FATCA, with one important exception: FATCA would have imposed reporting requirements on material advisors, including attorneys, accountants, and other professionals, who advise on acquisitions or formations of foreign entities.” [4]

One professional journal states “[a]lthough this provision did not make it into the act, practitioners should take note that the U.S. Congress and the U.S. Treasury tried to bring attorneys, accountants, and other professionals into their information gathering police force.” [5]

“The focus of the foreign account compliance provisions of the act is to increase transparency in the international banking world.” [6] “[T]ax dodgers conceal billions of dollars in assets within secrecy-shrouded foreign banks, dodging taxes and penalizing those of us who pay the taxes we owe.”[7]

The Act specifically creates a new 30 percent withholding tax on “withholdable payments” on foreign financial institutions with U.S. account holders. [8]

Foreign financial institutions may avoid the 30 percent withholding tax, as it relates to “witholdable payments”, by either 1) entering into a reporting agreement with the IRS, or 2) be deemed to have met the reporting requirements. [9] The new withholding tax comes into effect on January 1, 2013. [10]

To avoid the withholding, a foreign financial institution will be required to report with respect to “each U.S. account maintained by such institution: 1) The name, address, and TIN of each account holder; 2) account number; 3) account balance; and 4) gross receipts and gross withdrawals from the account.” [11]

A similar provision in the Act creates a similar withholding tax and reporting, albeit a somewhat less intensive, scheme for nonfinancial foreign entities. [12]

In addition, the Act creates new reporting requirements for individuals and domestic entities. The new law states that “[a]ny individual who holds an interest in a ‘specified foreign financial asset’ must attach to his or her tax return certain information if the aggregate value of all such assets exceeds $50,000.” [13] A specified foreign financial asset generally means a financial account held in a foreign financial institution or any stock or security or interest in a foreign entity. [14]

The IRS has increased the statute of limitations to six years instead of the normal three, along with the “normal 20 percent underpayment penalty to 40 percent for any portion of an underpayment that is attributable to any undisclosed foreign financial asset.” [15]

“The act will increase transparency in the international financial world, but at increased compliance costs by foreign financial institutions.” [16] It is no surprise given the experience of domestic financial institutions’ efforts to comply with financial reporting measures, that foreign institutions will “likely need to spend significant sums of money to create operating systems to comply with the act.” [17] The Federal government has created an ultimatum for foreign financial institutions; “[t]his bill offers foreign banks a simple choice — if you wish to access our capital markets, you have to report on U.S. account holders.” [18]

Experience has already shown that “[s]ome foreign financial institutions may determine that the cost of compliance will outweigh the benefits of managing U.S. account holders” and therefore the “banks no longer want to manage U.S. accounts and have forced the clients out of their institution, notwithstanding the clients’ significant account balances.” [19]

“In addition, in order to avoid complications, some foreign financial institutions will likely avoid investing in U.S. stocks and bonds altogether. Thus, an unintended result of the act may be to drive capital away from the United States to more user-friendly jurisdictions.” [20]

“In summary, the act creates significant legislation that will affect almost every foreign financial institution. The act is also a significant step toward a more transparent international financial world.” [21]

The new individual reporting requirements are in addition to the required FBAR report, which is the topic of tomorrow’s blogticle.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] Abrahm W. Smith.  Florida Bar Journal.  84-AUG Fla. B.J. 52

[2] Congressional Record — Senate, February 11, 2010 (Tax Analyst Doc. 2010-3117).

[3] 84-AUG Fla. B.J. 52

[4] Id.

[5] 84-AUG Fla. B.J. 53

[6] Id.

[7] Id. Citing, Statement by Senator Carl Levin, D-Mich, made on March 17, 2010, with respect to the act.

[8] 26 U.S.C. §1471.

[9] 26 U.S.C. §1471.

[10] Id.

[11] Id.

[12] 26 U.S.C. §1472.

[13] Id.

[14] 26 U.S.C. § 6038D.

[15] 84-AUG Fla. B.J. 53-54.

[16] 84-AUG Fla. B.J. 55.

[17] Id at 56.

[18] Id. Citing, Statement by the Global Financial Integrity in response to the act, dated March 19, 2010.

[19] 84-AUG Fla. B.J. 56. Citing, Senator Rangel. (United States Congress News Release, dated October 27, 2009).

[20] 84-AUG Fla. B.J. 56.

[21] Id.