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I’ve Opened an Offshore Bank Account. Now What?

photo by Jeff McNeill

Jeff McNeill

Opening an offshore bank account is a relatively simple process for those who plan to work or simply live abroad.  It’s also a great idea even for U.S. residents who wish to diversify their portfolios and reduce their exposure to litigation or political risks.

However, as a U.S. citizen or expat with an offshore bank account, it’s important that you realize the tax and reporting implications of foreign account ownership.  It’s also important to note that many of these requirements aren’t tied to income. Merely having a financial interest in the account is enough to get you on the hook.

Who Is Required to Report?

Well, for starters, foreign financial institutions are required to enter into an agreement with the IRS and report on all their clients who are U.S. persons, or else face a 30% withholding tax on all U.S. transactions.  (Furthermore, if you as their client do not comply with federal reporting requirements, they’re required to impose the same withholding on any payments to you.)

The IRS can then cross-check this information with the individual filings they have (or haven’t) received. So, if you were wondering whether the IRS could or would ever find your piddly little account and actually do anything about your failure to report it, the answer is yes.  And, if that happens, then a 30% withholding tax will be the least of your worries.  More on that later.

Bottom line: If you’re a U.S. resident or citizen (no matter where you currently reside) and you have interest in a foreign financial account (no matter whether it’s generating income) that meets the minimum reporting threshold, then you need to keep reading.  

What Forms Do I Have to File?

This is probably as good a time as any to mention that we are by no means tax or legal advisers.  The United States’ tax and reporting laws are complicated and can change on a whim.  They also vary from one individual to the next, based on your specific situation.

Our best advice?  Use this outline as a guide to help you know where to start. Consult the IRS website for more specific information or, if your situation warrants, a tax or legal professional with experience in foreign account reporting.

To give you a general idea of the requirements at the time of this post, here are the 3 main forms you’ll deal with:

Form 1040 – U.S. Individual Income Tax Return

If you’re a U.S. citizen or green card holder you’re required to file a U.S. tax return, no matter where you live now.  That is, as long as your total income (domestic and foreign) is over $9,350.  That’s because U.S. citizens are taxed on their worldwide income.    

The U.S. has treaties with a number of foreign countries that may allow you to reduce or even eliminate any U.S. tax liability (if you’ve already paid taxes on the income overseas). However, you still have to file in order to take advantage of these credits.  You’ll do this by attaching Forms 2555 and 1116.

Whether or not you’ll need to file a state return depends on where you lived before you moved away, as it varies from state to state.  New Mexico, Virginia, California, and South Carolina are among those that will still require you to file.

Form 8938 – Statement of Foreign Financial Assets

In 2010, the U.S. Congress enacted the Foreign Account Tax Compliance Act (FATCA), a statute designed to help recoup federal tax revenues by making it more difficult for U.S. persons to hide assets in offshore accounts.  As a result, U.S. citizens are now required to report any financial interests they have in foreign financial accounts or foreign financial assets, provided they meet the minimum threshold.    

For those living in the U.S., that’s assets totaling at least $50,000 on the last day of the tax year, or at least $75,000 on any day during that year.  This threshold is raised to $100,000 and $150,000 for married couples filing jointly.

For taxpayers who don’t live in the U.S., those minimum limits are raised to $200,000 on the last day and $300,000 during the year for individuals.  For married couples outside the U.S., it’s $400,000 and $600,000 respectively.

These thresholds are aggregate, so multiple assets that collectively add up to these amounts also put you on the hook.  Amounts are based on fair market value in U.S. dollars as of the end-of-the-year exchange rate.

The Form 8939 is filed with your federal income tax return and is due when your taxes are filed.  In one piece of good news, U.S. citizens living overseas are given an automatic two-month extension (to June 15th) on any filing and payment requirements.  Additional filing extensions can be requested.  However any due payments made after June 15th will be subject to interest and penalties.

Form TD F 90-22.1 – Report of Foreign Bank and Financial Accounts (a.k.a. “FBAR”)

The FBAR is a product of the erroneously-named Bank Secrecy Act, and it’s required of anyone owning (or controlling) foreign financial assets totaling $10,000 or more at any point during the year.  The value is determined by reviewing periodic account statements to determine its maximum value for the year and is reported in U.S. dollars based on the end-of-year exchange rate.

While the FBAR is filed with the IRS, it’s done completely separate from your tax return.  Due on June 30th (meaning actually received, not just postmarked), it should be submitted electronically through the Financial Crime Enforcement Network (FinCEN) e-filing system.

photo by Image Money

Image Money

What Happens If I Fail to File the Required Forms?

Well, that depends.  Penalties vary based on whether you failed to file one or multiple forms, whether your omission was committed in conjunction with any other illegal activity, and whether or not your failure to file is determined to have been a willful one.

Since the above forms are filed independently of each other, they’re also penalized as such.  

Let’s start with the Form 8938.  Failure to report any foreign financial assets when you file your tax return can earn you an initial fine of up to $10,000, plus an additional $10,000 for each month thereafter, up to a total of up to $60,000.  Depending on the circumstances, criminal penalties may also apply.

With the FBAR, the punishment is even steeper.  Even a non-willful violation can be earn you a $10,000 fine.  However the penalty for a willful violation starts at the greater of $100,000 or 50% of the total balance of the applicable accounts. This offense can also be criminally prosecuted with additional fines up to $100,000 and/or up to five years in prison.

The limit on that penalty increases to $500,000 and/or ten years in prison (per offense) if you’ve also violated another law (e.g. the Internal Revenue Code) or been involved in criminal activity involving more than $100,000. In other words, there’s a special place in penal hell for those who use offshore accounts to hide their involvement in illegal activity.  Don’t do it.  

The IRS claims that their goal in enforcing these penalties is compliance with the law, not revenue.  We’ll take their word for it on that one, but the bottom line is that everyday unsuspecting citizens can and are being charged these fines for simply failing to do their due diligence on what’s required.

What Determines Whether a Violation is Willful?

An act is considered to be willful when it’s done with the knowledge that it violates the law. Ignorance of the law is a defense.  However, it’s a difficult one to prove.  

Obviously, if you’re the one who opened the account, you’ve got a weak case.  You’re similarly screwed if you intentionally responded incorrectly to question 7a on your Schedule B, Interest and Ordinary Dividends, which asks if you had “financial interest in or signature authority over a financial account (such as a bank account, securities account, or brokerage account) located in a foreign country.”

Oh @$#%! I’m in Big Trouble!

There’s good news for those who’ve either newly become aware of their delinquency or who’ve decided to come clean about their intentional evasion.  Under the Offshore Voluntary Disclosure Initiative (OVDI), U.S. persons are given one last opportunity to comply with the law.

In exchange for their honesty, their maximum penalty is reduced to only 27.5% of the highest value of their accounts during the period of which they failed to report.  In addition to paying the fines, they must also amend their federal income tax returns for the previous 8 years.

Note, the OVDI program is a voluntary one and is not an option for taxpayers who have already been contacted or are being investigated by the IRS.  The process should only be attempted with the assistance of experienced legal counsel and should begin with a phone call to make sure no investigation is underway.

While this amnesty program could be a bit of a relief for some individuals, it’s no substitute for forthright and timely compliance with U.S. tax laws.  Owning an offshore account can be of tremendous benefit to expats and investors.  But it carries with it some hefty responsibilities.

Don’t find yourself on the wrong end of an IRS investigation. If you choose to take advantage of the opportunities associated with banking and investing overseas, make sure you dot your i’s and cross your t’s.

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2 thoughts on “I’ve Opened an Offshore Bank Account. Now What?

  1. 1

    I believe there are still some countries who have not agreed to become FFI’s – one of them is Belize. Can you confirm what Central American countries haven’t yet, as FACTA supposedly goes into effect in July (its been delayed many times already). Thanks!

    • 2

      Sharon,In fact most Belize banks are trying to find ways to work with FACTA reporting. Full implementation takes effect 2014; however, Belizean bankers are calling on the Government of Belize to look into an alternative procedure whereby banks would not directly sign agreements with the IRS, but whereby they could provide the requested information under an intergovernmental agreement. Hope this helps!

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