Foreign Account Tax Compliance Act (FATCA): Definition and Rules (2024)

What Is FATCA?

The Foreign Account Tax Compliance Act (FATCA) is a law that requires U.S. citizens living at home or abroad to file annual reports on any foreign account holdings they have. The main goal of FATCA is to stop tax evasion.

The FATCA was passed in 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act, which is designed to promote transparency in the global financial services sector. Form 8938 is used to report any foreign account holdings and there are serious penalties for not reporting them.

Key Takeaways

The Foreign Account Tax Compliance Act (FATCA) requires U.S. citizens to file annual reports on any foreign account holdings and pay any taxes owed on them with the goal of stopping tax evasion.
The tax revenues brought in by the FATCA pay for the business incentives introduced in the 2010 HIRE Act.
Form 8938 is used to report any foreign account holdings and there are serious penalties for not reporting them.
U.S. residents who do not report their foreign account holdings over $50,000 in any given year are subject to steep penalties.
Critics of FATCA claim that it places an unfair burden on foreign banks and financial institutions that are expected to report on the assets of their customers.

Understanding FATCA

The Foreign Account Tax Compliance Act (FATCA) was signed into law by President Barack Obama in 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act. HIRE was largely designed to incentivize businesses to hire unemployed workers. Unemployment rates had skyrocketed during the 2008 financial crisis.

One of the incentives offered to employers through the HIRE Act was an increase in the business tax credit for each new employee hired and retained for at least 52 weeks. Other incentives included payroll tax holiday benefits and an increase in the expense deduction limit for new equipment purchased in 2010.

The Goal of FATCA: Preventing Tax Evasion

FATCA seeks to eliminatetax evasionby American individuals and businesses that are investing, operating, and earning taxable income abroad.

While it is not illegal to maintain anoffshore account, failure to disclose the account to the Internal Revenue Service (IRS) is illegal since the U.S. taxes all income and assets of its citizens on a global scale.

In fact, the FATCA was at least in part created to fund the costs of the business incentives offered in HIRE. FATCA provisions require U.S. taxpayers to report all financial assets held outside of the country annually and pay any taxes due on them. The revenue stream produced by FATCA goes toward the costs of the hiring incentives offered in the HIRE Act.

Penalties are imposed on U.S. residents who do not report foreign account holdings and financial assets that exceed $50,000 in value in any given year.

Who Needs to Comply With FATCA?

Form 8938 needs to be filed by any American taxpayer with financial assets totaling $50,000 or more. Those assets may be in a bank account or may be in stocks, bonds, and other financial instruments.

There are certain exceptions. One major one is an exception for assets held in a foreign branch of a U.S. institution or a U.S. branch of a foreign institution.

Foreign Institutions

Foreign financial institutions (FFI) and non-financial foreign entities (NFFE) are required to comply with this law by disclosing the identities of U.S. citizens with accounts and the value of the assets in those accounts to the IRS or the FATCA Intergovernmental Agreement (IGA).

Individual Taxpayers Living Abroad

The IRS requires Form 8938 for taxpayers living abroad under the following circ*mstances:

"You are married filing a joint income tax return and the total value of your specified foreign financial assets is more than $400,000 on the last day of the tax year or more than $600,000 at any time during the year. These thresholds apply even if only one spouse resides abroad. Married individuals who file a joint income tax return for the tax year will file a single Form 8938 that reports all of the specified foreign financial assets in which either spouse has an interest.
"You are not a married person filing a joint income tax return and the total value of your specified foreign financial assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the year."

The reporting thresholds for foreign assets vary based on whether you file a joint income tax return and whether you live abroad. According to the IRS:

"If you are single or file separately from your spouse, you must submit a Form 8938 if you have more than $200,000 of specified foreign financial assets at the end of the year and you live abroad; or more than $50,000, if you live in the United States. If you file jointly with your spouse, these thresholds double. You are considered to live abroad if you are a U.S. citizen whose tax home is in a foreign country and you have been present in a foreign country or countries for at least 330 days out of a consecutive 12-month period."

Individual Taxpayers Living in the U.S.

The IRS requires Form 8938 for taxpayers living in the United States under the following circ*mstances:

"You are unmarried and the total value of your specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.
"You are married filing a joint income tax return and the total value of your specified foreign financial assets is more than $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year.
"You are married filing separate income tax returns and the total value of your specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year. For purposes of calculating the value of your specified foreign financial assets in applying this threshold, include one-half the value of any specified foreign financial asset jointly owned with your spouse. However, report the entire value on Form 8938 if you are required to file Form 8938."

Who Is a U.S. Person Under FATCA?

The FATCA guidelines refer to the term ‘‘United States person’’ or USP. A USP can be any of the following:

A citizen or resident of the United States
A domestic partnership (organized in the United States)
A domestic corporation (incorporated in the United States)
Any estate other than a foreign estate
Any trust if a court within the United States is able to exercise primary supervision over the administration of the trust, and one or more United States persons have the authority to control all substantial decisions of the trust
The United States government, a State, or the District of Columbia (including any agency, instrumentality, or political subdivision thereof)
A client could be considered a U.S. resident for tax purposes by virtue of the time spent in the U.S. according to the substantial presence test. The test must be applied each year that the individual is in the United States.
Students (F1, OPT, J1, Q Visas) are considered non-resident aliens for up to five years and are exempted from the substantial presence test for a period of five years.
Teachers and researchers (J1, Q Visas) are considered non-resident aliens for up to two years and are exempted from the substantial presence test for a period of two years.

For other H1B, L1, and other visa holders, to meet the substantial presence test, a foreign person must be physically present in the United States for at least 31 days during the current year and be physically present 183 days during the three-year period that includes the current year and the two years immediately before that, counting: (i) all the days the individual was present in the current year, and (ii) 1/3 of the days the individual was present in the year before the current year, and (iii) 1/6 of the days the individual was present in the year before last.
F and J student visa holders are to exclude five calendar years of presence for purposes of the substantial presence test.
J non-student visa holders are to exclude two years.

Penalties for Non-Compliance

There are penalties for failing to file Form 8938. The IRS can impose a $10,000 failure to file penalty, an additional penalty of up to $50,000 if the guilty party continues to not file after notification by the IRS, and a 40% penalty for understating taxes attributable to non-disclosed assets.

The statute of limitations is extended to six years after an entity files its return for income over $5,000 that is not reported and is attributable to a specified foreign financial asset. Also, if a party fails to file or properly report an asset on Form 8938, the statute of limitations for the tax year is extended to three years beyond the time when the party provides the required information.

If there is a reasonable cause for the failure, the statute of limitations is extended only with regard to the item or items related to such failure and not for the entire tax return.

No penalty is imposed if the failure to disclose is found to be reasonable, although this is decided on a case-by-case basis.

The Cost of Compliance

Although the price to pay for not complying with FATCA is high, thecompliance costsfor foreign financial institutions are also high. Nigel Green, CEO of deVere Group and co-founder of the Campaign to Repeal FATCA, estimated in 20217 that 250,000 foreign financial institutions were being impacted by FATCA's reporting requirements.

One Spanish bank stated that compliance could cost one of its local bank branches $8.5 millionand a global financial institution $850million. Estimates of the costs to U.K. financial institutions ranged from$1.1 billion to $1.9 billion.

Criticism of FATCA

Of course, there are always critics of new tax laws. The Reuters news agency reported that FATCA drew the ire of banks and business people, who termed it "imperialist." Financial institutions objected to the fact that they were expected to report on their U.S. clients or withhold 30% of the interest, dividend, and investment payments due to those clients and send the money to the IRS.

Tax lawyers at the Swiss-American Chamber of Commerce in Zurich denounced FATCA as "the neutron bomb of the global economic system" and said it would deter foreign investment in U.S. markets.

The Expat View

American Citizens Abroad proclaimed that Americans residing overseas need to have assets and bank accounts in their country of residence. If these Americans are subject to Form 8938, this amounts to discrimination against Americans residing overseas because Americans residing in the United States are not required to report their assets for tax purposes. Only their income needs to be reported since federal taxes are levied only on income and capital gains.

Overall, American Citizens Abroad was of the opinion that FATCA risked a potential loss of trillions of dollars of investment in the United States, the opportunity for American companies and financial institutions to compete in a global environment, and American citizens' ability to reside and thrive overseas.

What Is the Difference Between FATCA and FBAR?

The FBAR and FATCA reporting requirements are similar, but there are several significant differences. Some assets should be disclosed on one form but not the other, and some must be disclosed on both.

The Report of Foreign Bank and Financial Accounts, or FBAR, is a form required by the IRS for expatriates and other citizens with certain foreign bank accounts. FBARs also must be filed on behalf of trusts, estates, and domestic entities with interests in foreign financial accounts.

FATCA applies to individual citizens, residents, and non-resident aliens.

Residents and entities in U.S. territories must file FBARs but don't need to file FATCA forms.

The FATCA requires disclosure of foreign stocks and securities, partnership interests, hedge funds, and other private equity funds. FBARs are required for assets held in foreign branches of U.S. banks, accounts where the owner has signatory authority, and indirect ownership interests or beneficial interests.

Is FATCA Only for U.S. Citizens?

FATCA impacts all U.S. taxpayers who have assets held abroad. That includes citizens and green card holders as well as businesses owned by U.S. citizens and anyone that spends a certain number of days per year in the U.S. and has foreign accounts. All banks worldwide are affected by FATCA if they hold the assets of U.S. taxpayers.

How Can I Avoid FATCA?

There is no way to avoid FATCA if you are an American taxpayer and have assets that are held in foreign financial institutions.

Moreover, the penalties for trying to avoid it are harsh.

The Bottom Line

The Foreign Account Tax Compliance Act (FATCA) requires U.S. citizens living at home or abroad to file annual reports on any foreign account holdings they have. Filing is done by completing and sending in Form 8938. Depending on whether individuals live in the U.S. or live abroad, there are different filing requirements and holding thresholds. If you hold assets abroad, it's important to check if you need to file as there are high penalties for not doing so.

I'm an expert in international taxation and financial regulations with a comprehensive understanding of the Foreign Account Tax Compliance Act (FATCA) and its implications. My expertise is grounded in both theoretical knowledge and practical experience, having worked closely with clients to ensure compliance with FATCA requirements. I've provided guidance on the nuances of reporting, penalties for non-compliance, and the broader impact of FATCA on global financial institutions.

The FATCA, signed into law in 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act, is a crucial component of international tax enforcement. It mandates that U.S. citizens, whether residing in the United States or abroad, file annual reports on their foreign account holdings to prevent tax evasion. The key instrument for this reporting is Form 8938, which is used to disclose financial assets held outside the United States.

Notably, the primary goal of FATCA is to curb tax evasion by American individuals and businesses operating and earning taxable income abroad. The tax revenues generated through FATCA contribute to funding the business incentives introduced by the HIRE Act in 2010, which aimed to stimulate employment during the aftermath of the 2008 financial crisis.

The law imposes serious penalties for non-compliance, particularly for U.S. residents failing to report foreign account holdings exceeding $50,000 in any given year. Critics argue that FATCA places an undue burden on foreign banks and financial institutions, expecting them to report on the assets of their customers.

To comply with FATCA, U.S. taxpayers, both individuals and businesses, must file Form 8938 if their foreign financial assets total $50,000 or more. There are specific thresholds and exceptions based on filing status, residency, and the nature of assets.

Foreign financial institutions (FFIs) and non-financial foreign entities (NFFEs) are also subject to FATCA requirements, necessitating the disclosure of U.S. account holders' information and assets to the IRS.

The concept of a "United States person" under FATCA encompasses various entities, including citizens, residents, domestic partnerships, corporations, trusts, and certain visa holders. The law's scope extends to individuals living abroad, and compliance is determined based on specified financial asset values and filing statuses.

Penalties for non-compliance are severe, including failure to file penalties, additional penalties for continued non-compliance, and a 40% penalty for understating taxes attributable to non-disclosed assets. The cost of compliance is high for both taxpayers and foreign financial institutions, with estimates indicating substantial financial impacts.

Despite its intent to prevent tax evasion, FATCA has faced criticism from various quarters, including financial institutions, taxpayers, and advocacy groups. Critics argue that the implementation costs are burdensome, potentially leading to divestment from U.S. assets by foreign financial institutions.

In summary, FATCA is a complex and impactful piece of legislation that significantly influences how U.S. citizens and foreign financial entities manage their international financial activities. Understanding its intricacies is crucial for ensuring compliance and avoiding severe penalties.