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FATCA Lawyer Boulder CO | Three Main Parts of FATCA

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Now FATCA, when it came out in 2010, was a revolutionary piece of legislation. It completely changed not only US Tax Compliance but the entire landscape of International Tax Compliance. After FATCA, we have OECD countries developing a Common Reporting Standard, the CRS to which the US did not join for very interesting reasons; that could be a topic of a CLE in of itself.

But, FATCA affects pretty much everyone who is doing business internationally. Why is that? Well, there are the three parts of FATCA that I would like to discuss today. There are some different provisions of FATCA which do not quite fall within those three parts; but they’re not important for today’s discussion, or at least not directly important.

The first part of FATCA is the requirement by Foreign Financial Institutions to report assets owned by US Persons to the IRS directly or indirectly; it depends on the FATCA enforcement treaty. So in essence, all the Foreign Financial Institutions are now forced to become agents of the IRS, reporting agents. In essence it’s that third party verification of US Tax Compliance that has been completely absent from US Tax Law; it just never existed before. For example FBARs, they don’t have any third party verification. That’s why as an information return, FBARs actually have very limited utility.

Now why would Foreign Financial Institutions comply with it? There’s a second part of FATCA: a 30% withholding tax on the gross amount of transactions. Can you imagine that a 30% withholding tax on the entire value of the transaction, not on the gain, loss it doesn’t matter just on the gross value? So this means that if say Institution A which is FATCA compliant and there’s an Institution B which is not FATCA compliant and then your client comes to Institution A and says, ‘Here, I’m sending $100,000 to Institution B, Institution A is going to withhold 30% tax from that $100,000 and send the rest of it to Institution B and obviously when the clients, the other party comes in to collect, they will see that instead of $100,000 there is about $70,000; that’s a pretty big difference. It could be the entire profit margin.

And because every institution is linked to another institution (so basically we have a system where all FATCA compliant institutions are forcing all of the FATCA noncompliant banks to become FATCA compliant); otherwise there’s not going to be any dealing between them.

So under the first part of FATCA, the Foreign Financial Institutions provide this information so they’re a third party verification. But verification of what?

And then there’s a third part of FATCA which really came into the tax landscape without as much fanfare as the first part. The first part, people have heard about: there have been protests, letters to congressmen, organizations, lobbying against it: what have you. But the third part of FATCA, and this is form 8938, it came in sort of in a very quiet way, in gradually but very early on already in 2011.

Indianapolis Form 8938 Lawyer | The Compliance Burden of Form 8938

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Form 8938, even though it does not share the same amount of penalties (and we will talk about penalties in a little bit later), still it’s importance is much more significant than that of FBAR.

The reason being is that not only are the US Persons required to report their Foreign Financial Accounts, which is very similar to FBAR, but they’re also required to disclose pretty much every type of a financial instrument.

In your handout you see here ‘Specified Foreign Financial Assets‘ under the column, under line I it should say: ‘Specified Foreign Financial Assets‘; this is a huge paragraph of assets. All of these assets must be disclosed on the form 8938.

So, we have Foreign Financial Accounts, we have Assets Held for Investment and not held in a financial institution, so we are talking about stocks and securities issued by a non US Person, any interest in a foreign entity, any interest in a foreign partnership, any financial instrument or contract including interest rate swaps, currency swaps, basis swaps, interest rate caps, bonds, notes, debentures, options, derivatives; I mean we’re talking about a whole range of financial assets that have to be now disclosed on form 8938 and they were never required to be disclosed in the same format at least before.

It’s a huge compliance burden obviously.

Form 8938 Penalties & Statute of Limitations | FATCA Tax Law Firm New York

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In order to force ‘Specified Persons‘ to report all of this; there’s a set of penalties. ‘Failure to File’: $10,000 per form. If the IRS sends out a notice and within 90 days the person still does not file the form the penalty accumulates at about $10,000 per month capped at $50,000.

Accuracy-related penalty: if underpayment of tax is related to a transaction involved any of these ‘Specified Foreign Financial Assets‘ the accuracy-related penalties go automatically to 40%.

The civil fraud penalty is actually similar to a regular civil fraud penalty, it’s 75%. Criminal Penalties are possible as well. Usually they’re combined with something – a very substantial income tax noncompliance. We have not really seen yet at least yet because remember this is a fairly new form; we have not really seen form 8938 criminal penalties being imposed. It’s probably coming down the road but not yet.

And then there are significant implications for the ‘Statute of Limitations’. With respect to the examinations, the Statute of Limitations basically the ability of the IRS to go back and open up a tax return until you file a form 8938, the Statute of Limitations never starts to run. Basically, the return is open forever. So the IRS can go back today and impose the penalties for the form 8938 that was not filed with the 2011 tax return.

And by opening up the tax return they can find other things and other penalties may accumulate; but there’s another aspect of it. The Statute of Limitations on the assessment of tax. So we are talking about this situation where it doesn’t matter; (and this is a trick for you) it doesn’t matter that the form 8938 was even required to be filed as long as the Specified Foreign Financial Assets are involved and the failure to report was of more than $5,000 of income from those Specified Foreign Financial Assets, the Statute of Limitations automatically goes up from 3 years to 6 years. Again, even if form 8938 filing threshold was not met.

These are very significant penalties. And now we can appreciate and understand then that when IRS adds a new category of filers to form 8938, this means a significant burden for those, to those filers and we can appreciate that we need to understand exactly who needs to file that form and when they need to file it and how this determination is being made.

Specified Domestic Entity Definition | Boston Form 8938 Lawyer

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In my handout you see that here the general definition of under the ‘Specified Domestic Entity’ table we see the general definition here directly from the Treasury Regulations 1.6038D-6(a) and it says: ‘A specified domestic entity is a domestic corporation, a domestic partnership or a trust described in IRC Section 7701(a)(30)(E), if such a corporation, partnership, or trust is formed or availed of for the purpose of holding, directly or indirectly, ‘Specified Foreign Financial Assets‘.

Wow, what a sentence, huh?! Let’s read it again. ‘A Specified Domestic Entity’ is a domestic corporation, domestic partnership and a trust described in IRC Section 7701(a)(30)(E), if such a corporation, partnership or trust is formed or availed of for the purposes of holding directly or indirectly ‘Specified Foreign Financial Assets‘.

You know, one of the reasons why I love international tax law is because every clause requires further interpretation. Let’s see, pretty much everything here is subject to further analysis. Let’s take this sentence apart. So we see here ‘Specified Foreign Financial Assets‘; we already talked about them; we have a full description of them or I shouldn’t say full description of them; it’s as comprehensive as I can make them. At this point obviously there are assets with equivalent to the assets that you have listed in your handout and that would be required to be reported on form 8938.

A domestic corporation is pretty easy to understand. It’s a corporation formed under the laws of any of the States of the United States. Partnership: for the purpose of not getting into any complexities sketches; let’s assume it’s the same thing – any partnership formed under the laws of the States of the United States.

In actuality, there are certain rules which can make an entity that is formed in the United States a foreign partnership. We’re not going to touch those today.

And then a trust described in IRC Section 7701(a)(L)(1)(830)E, basically they’re talking about ‘Domestic Trust’. There’s a Section 7701(a)(30)(E); it describes two tests: the control test and the court test that must be met in order for the trust to be designated as a domestic trust.

Okay, now we’re going to get to the most interesting part: ‘Formed or Availed of‘ for purposes of holding ‘Specified Foreign Financial Assets’. Now you know if you just read the sentence, you would think the IRS is talking about an entity formed with the intention of holding ‘Specified Foreign Financial Assets‘. That there’s going to be a discussion of intent, that something we have to dig into the evidence, dig into the facts: what was the purpose of establishing the entity? Nothing like that. It has, the intent here has no role whatsoever.

‘Formed or Availed of‘ for purposes of holding ‘Specified Foreign Financial Assets‘ – it actually means slightly different things for foreign corporations and partnerships vs. trusts, but it actually means compliant with specific requirements.

Now what are these ‘specific requirements’? Let’s start with the corporations of partnerships because it’s a more complex analysis. Here on the second box, I have a description, a general description that a corporation of a partnership have to pass a closely-held test and a passive test.

Who is Required to File Form 8938? | International Tax Lawyer New York

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Who is required to file Form 8938? ‘Specified Persons’. Okay, we are getting real close to our discussion of ‘Specified Domestic Entity’.

Specified Persons until 2016, or if you want to be more technical, until all the tax years that start after December 31, 2015, if you want to take the direct line and use that exact language.

Specified Persons included US Citizens, US Tax Residents and that of course includes all the US Green-Card Holders and all of the persons who satisfied the Substantial Presence Test, all of the non-resident aliens who chose to declare themselves tax residents for the purpose of filing a joint tax return and residents of Puerto Rico and Possessions, US Possessions. So we’re talking about Guam, American Samoa and the North Mariana Islands.

Does anyone see here a common thread throughout this category of pre 2016 categories of filers? Does anyone want to take a guess? We’re talking about citizens, tax residents… (inaudible) exactly! All of them are individuals. So what happened this year is that now it’s no longer just individuals; businesses are required to file form 8938; businesses that satisfy the requirement of ‘Specified Domestic Entity’.