What Is FATCA and What Does It Mean for Investors?
If you invest or live outside the U.S., you have to report any income or dividends to the IRS. Here's why.
If you're an American and decide to move abroad, you need to know about FATCA. FATCA is short for the Foreign Account Tax Compliance Act. FATCA requires Americans who keep money abroad to report those foreign assets for tax purposes. In simpler words, FATCA prevents Americans from dodging taxes through financial accounts located outside the United States.
If you are a U.S. citizen and plan to live, save money, or invest outside of the United States, FATCA may apply to you. Keep reading to learn more about FATCA reporting and how it affects Americans in the United States and abroad.
What Is FATCA?
FATCA is short for the Foreign Account Tax Compliance Act. The bill was passed in 2010 in response to a major scandal involving Swiss bank accounts. A specific 2009 scandal inspired this legislation, but it has a worldwide impact on Americans who keep money abroad.
Since the passing of FATCA, hiding money in Swiss bank accounts happens only in the movies. Now it is much more difficult for Americans to hide money in foreign accounts for tax evasion and other illegal purposes, as the penalties for noncompliance are very high. Under FATCA, foreign bankers and Americans with foreign accounts have a strong incentive to stay on the right side of the law.
How Does FATCA Affect Americans Abroad?
FATCA created new regulations for reporting foreign assets and increased the penalties for failing to comply. Because of FATCA, U.S. citizens must self-report foreign assets and income to the IRS and the U.S. Department of the Treasury. But foreign financial institutions are also required to report American-owned assets to the U.S. government.
In general, most people had to report these types of accounts even before FATCA. But since FATCA's passing, higher penalties and new reporting requirements for foreign banks make it harder to evade taxes with foreign accounts.
While some wealthy people may still find ways around tax reporting with foreign accounts, the penalties are so harsh it isn't worth the risk to most people. Law-abiding citizens shouldn't be too worried, as they were already reporting foreign accounts as required by U.S. tax code.
What Are the FATCA Reporting Requirements?
FATCA reporting requirements are broken down into two main requirements.
- First, foreign financial institutions (FFIs), which include banks and investment companies, are required to share details with the IRS on accounts held by U.S. taxpayers. If an FFI fails to comply, they will have to pay a penalty of 30% withholding tax on income from U.S. assets. That's a huge cost, so foreign banks have a strong incentive to play by the U.S. rules.
- Second, taxpayers with foreign assets above certain dollar amounts are required to report foreign assets to the IRS on Form 8938. Skipping this results in an even bigger penalty than banks have to deal with: $10,000 to $50,000 plus 40% of the highest account total for each year of nondisclosure.
Who Must Report Under FATCA?
Under FATCA, both banks and taxpayers must report foreign holdings to the U.S. Internal Revenue Service. The IRS checks to make sure your tax return matches what the foreign banks report. If there's a mismatch, you'll have to work with the bank and the IRS to sort out the difference.
As mentioned above, foreign banks are fined 30% of all U.S.-derived profits, while taxpayers could be fined up to $10,000. And if they don't report after being notified by the IRS, the fine can be increased up to $50,000. Besides, there is a 40% penalty for each year of failing to report foreign holdings.
If you hold money in a foreign bank account and the amount in it is $10,000 or more at any time during the year, you will still need to report it to the U.S. Treasury under FABER.
What Is FATCA Reporting and When Do You Need to Report?
As a U.S. taxpayer, your FATCA reporting is included with your annual tax filing. Filing IRS Form 8938 fulfills your FATCA reporting requirements.
The threshold for Form 8938 is $50,000 in combined foreign assets if you live in the United States. If you live outside the United States, the threshold is $200,000. These limits apply to the total of all foreign assets on the last day of the calendar year. Higher limits apply for the rest of the year.
Most taxpayers will want to complete this form with their tax return by the annual tax due date in April for U.S. residents. If you live outside the United States, the due date to file your U.S. income tax forms is usually June 15, including in 2023.
FATCA Penalties for Noncompliance
Penalties for non-compliance with FATCA can be quite costly.
|Who didn't comply||Penalty|
|U.S. Taxpayer||40% penalty on each understatement of income, plus $10,000 to $50,000 in fines|
|Foreign Financial Institution (FFI)||30% of U.S. profits|
Practical Implications of FATCA for Americans Abroad
For most U.S. investors who keep their finances with banks and financial companies located in the United States, the reporting requirements are minimal. Unless you have holdings of foreign assets, you may not have to report anything at all.
If you open bank and investment accounts with an FFI, however, you should certainly take note of FATCA requirements. Each year when you file taxes, which are still required even if you don't live in the United States, simply disclose your foreign assets with your tax filing.
Steps All Americans Abroad Should Take
If you don't like FATCA or think it's an overreach, you have to take that up with your elected representatives. Outside of an action by the U.S. legislature, FATCA isn't going anywhere any time soon.
Keeping good records year-round makes it easier to stay on the right side of the law and complete your taxes with ease. If you feel overwhelmed by FATCA, consider hiring a tax professional to help you navigate how it impacts your own tax situation.
Always track your personal financial details in any case. If you're an American abroad, you have a higher bar to report foreign bank accounts, investment accounts, and other assets when you file your taxes.
If You Own Foreign Assets, Make Sure You Know if You Need to Report It to the IRS
FATCA is an important law for U.S. investors living both in the United States and abroad. The increase in enforcement makes it much harder to cheat on your taxes with foreign accounts. But for law-abiding citizens, it shouldn't be too much of a burden. Just make sure always to follow reporting requirements to stay on the right side of the law to avoid financial penalties.