FATCA Explained: Everything You Need to Know About the Foreign Account Tax Compliance Act
If you're a non-U.S. entity or have foreign financial assets, it's time to get familiar with FATCA. The Foreign Account Tax Compliance Act is a critical tool for preventing U.S. citizens from evading taxes through the use of offshore accounts and improving tax compliance with foreign financial institutions (FFIs). With the rise of offshore tax evasion scandals, FATCA was enacted by Congress in 2010 to provide the IRS and U.S. Treasury with a powerful tool in the fight against offshore tax evasion.
Here's a rundown of everything you need to know about FATCA:
Who's Impacted by FATCA?
If you receive most types of U.S. income as a non-U.S. entity, you're likely required to comply with FATCA. The act has a wide reach, and directly impacts FFIs that have U.S. investments or account holders.
What Does FATCA Require?
FATCA has three main parts:
Foreign banks and FFIs must disclose information about financial accounts held by U.S. taxpayers to the IRS. This includes account balances, receipts, and withdrawals. Failure to comply will result in a 30% withholding tax on income from U.S. financial assets held by the bank or financial institution.
U.S. taxpayers with foreign financial assets that exceed certain thresholds must report those assets to the IRS on Form 8938. If an account holder underreports their income in an undisclosed foreign financial asset, they're subject to a 40% penalty.
FATCA closes a tax loophole that allowed investors to avoid paying taxes on dividends by converting them into dividend equivalents.
What Qualifies as a Foreign Financial Institution (FFI)?
An FFI is defined as any financial institution that is a foreign entity, with the exception of those organized under the laws of a U.S. territory. The definition of an FFI is broad and includes foreign banks, brokers, custodians, mutual funds, exchange-traded funds, private equity and venture capital funds, commodity pools, and hedge funds.
What Does FATCA Require of FFIs?
FFIs must withhold a 30% tax on any "Withholdable Payments" unless they:Enter into an FFI Agreement with the IRSMeet the requirements prescribed by the Treasury Department and the IRSAre exempt from FATCA (e.g. a foreign central bank)
What is a With holdable Payment?
A Withholdable Payment is a potential penalty imposed on any U.S. source income in the event the FFI does not comply with FATCA. It includes any payment of interest, dividends, rents, salaries, wages, premiums, annuities, and other fixed or determinable annual or periodical gains, profits, and income (FDAP income). It also includes any gross proceeds from the sale or disposition of any property that can produce interest or dividends from sources within the U.S.
What is an FFI Agreement?
An FFI can become a "Participating FFI" by entering into an agreement (FFI Agreement) with the IRS and avoiding the 30% withholding tax. The agreement requires the FFI to identify U.S. accounts and comply with verification and due diligence procedures.
What Does the FFI Agreement Require?
A participating FFI is required to report certain information on an annual basis to the IRS with respect to each U.S. account and to comply with requests for additional information.