Planners should pay close attention to a new U.S. tax statute that will take effect in the 2012 tax year that experts say could make it difficult for their clients to keep their American citizenship and their foreign-based assets at the same time.
Starting in 2013, “Americans living abroad are going to find it very hard to maintain assets abroad,” said H. David Rosenbloom, director of the International Tax Program at the New York University School of Law. “There are a lot of repercussions for planners.”
At issue is a tax reform statute that passed in Congress to little public notice in March 2010 as part of a jobs bill. The so-called Foreign Account Tax Compliance Act seeks to retrieve billions of dollars in tax revenues that the U.S. government claims it loses annually to wealthy tax scofflaws who hide assets abroad.
However, critics say, any gains would be dwarfed by the cost to implement it across all affected institutions and individuals. The new law requires all financial institutions abroad to report to the IRS their American clients with investment accounts of $50,0000 or more. If they fail to do so, these institutions – inclusive of banks, brokerage houses, hedge funds and other entities – will be levied a 30% tax on all of their income derived from U.S.-based investments, from stakes in real estate and mutual funds to treasury bills. The legislation also extends to all foreign companies in which Americans have beneficial ownership.
It further requires all foreign financial institution to collect a 30% tax on any “pass-through” transactions made with banks that are not in compliance with the new rules.
“It’s their responsibility to withhold that money and send it to the U.S.,” said Denise Hintzke, global leader for compliance with the new tax law at Deloitte.
In response, some foreign banks have said they will close all their American clients’ investment accounts rather than incur the expense of complying. That move could prompt even fully tax-compliant Americans who reside abroad to renounce their citizenship rather than face this prospect.
“There are all kinds of legitimate reasons why people have foreign bank accounts,” said Troy Thompson, a financial planner and the founder of Thompson Advisory in Portland, Oregon. In his previous career, Thompson practiced tax law and handled international tax cases. “One of the problems with this legislation is that it contains the seed of an assumption that there is no legitimate reason for you to have foreign bank accounts. And if you do, we’re going to make it very difficult for you to maintain them.”
One advocacy group, American Citizens Abroad, claims that the new tax law will have “a devastating impact” on American citizens everywhere. It has launched a campaign to have the legislation repealed.
In essence, the U.S. government is trying to get foreign financial institutions to do our tax enforcement work for us, said Rosenbloom, who also practices international tax law at Caplin & Drysdale in Washington D. C.
“This may be the widest expansion of jurisdiction by U.S. authority in American history,” Rosenbloom said. “I can’t think of any other instance in which the U.S. has passed a statute where we’ve tried to be so expansive in our reach.” Rosenbloom used to work for the U.S. Treasury, as director of the Office of International Tax Affairs. His firm represents roughly 700 clients who are looking to come into compliance with the IRS on their foreign holdings at a “reasonable cost.”
In both Rosenbloom and Thompson’s view, the IRS is simply unprepared to become the tax agency for every single corporate entity in the world with American ties.
“Fatca imposes an unsustainable burden on our tax administration,” Rosenbloom said. Even without the new act, the agency is vastly underfunded, he said.
However, Hintzke disagrees. Conscripting foreign companies into the effort of gathering U.S. taxes is “evil genius” on the part of the IRS, she said.
“It’s really a minor impact on the government in general,” she said. “The only thing (the IRS) has to do is enter into the agreement (with foreign entities). Then it becomes a self –policing situation. Once a financial institution has entered into this contractual agreement, it will probably be their responsibility to hire an external auditor to do the review and report back to treasury.”
Politicians who sponsored the act describe it as a necessary step to keeping smaller taxpayers from continuing to carry the overall tax burden that many of the wealthiest citizens have avoided for years.
“The bottom line is that each of us has a legal and civil obligation to pay taxes, and most Americans fulfill that obligation,” said one of the act’s supporters Carl Levin, a democrat and U.S. senator from Michigan, in a speech before the Congress in July on a Fatca-related matter. “It is time to force the tax scofflaws, the tax dodgers, and the tax cheats to do the same …”
If some foreign financial institutions decide not to participate in the Facts system, that’s their business, Levin said.
“But if U.S. taxpayers start using those same foreign financial institutions to hide assets and evade U.S. taxes … that’s our business,” he added. “The United States has a right to enforce our tax laws and to expect that financial institutions will not assist U.S. tax cheats.”
One of the largest problems the IRS may face in implementing the legislation is simply a lack of awareness on the part of both individual taxpayers and, especially, smaller corporations. Hintzke said it remains to be seen how the IRS succeeds in with its global ambitions.
Obviously, the government has decided it’s worth the risk.
“As a diplomatic proposition, (Fatca) is fairly aggressive,” Thompson said. “Treasury recognizes that. They think there is a lot of money escaping taxation and they are tired of it.
Ann Marsh writes for Financial Planning.