What is FATCA?

Kerie Kerstetter
The Foreign Account Tax Compliance Act (FATCA), passed by Congress in 2010 as part of the HIRE Act, is a way of stemming tax evasion through the use of Foreign Financial Institutions (FFIs). Different to FBAR, its aim is to impose a withholding on certain assets held on foreign soil by citizens and companies based in the United States.   As part of a two-tiered approach to tax reporting, the Internal Revenue Service (IRS) requires individuals and corporations to report qualifying funds each year. FATCA is a one-size-fits-all approach to preventing tax evasion – with a few exceptions, even U.S. citizens who don’t spend any time Stateside are subject to FATCA.   In an increasingly connected world, it is unreasonable to expect larger organizations not to have any overseas holdings at all. Therefore, it’s important to understand FATCA reporting, what is involved in the process and what constitutes being exempt from FATCA reporting.
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What is FATCA reporting?

FATCA reporting covers any asset with a taxable event, including royalties, rent, real estate, insurance policies and ownership stakes. It applies to assets held by U.S. citizens through FFIs, regardless of whether they are held inside or outside of the United States itself.  FFIs are required to report all information about financial accounts and foreign entities in which U.S. taxpayers hold a substantial interest directly to the IRS. In this capacity, FATCA imposes on all affected organizations extensive obligations to screen and identify, perform due diligence on and process transactions.   Despite changes in administration, the U.S. federal government continues to be concerned about “profit-shifting” activity, eager to seek it out, prosecute the organizations and individuals that engage in it, and collect what it is owed. FFIs that are found to have been evading FATCA may be subject to a punitive tax of up to 30% on all U.S. investment flows, the individual or corporate status of the assets notwithstanding. 

FATCA reporting requirements checklist

If you are beginning the process of filing for FATCA, it’s vital to understand the regulatory requirements to ensure the IRS is provided with all essential information. Whether you are a qualifying U.S. taxpayer, a business entity with overseas holdings or a foreign financial institution, you need to know how to report U.S. earnings correctly and efficiently.   The below FATCA reporting requirements checklist outlines everything to consider and include. 

1. Determine your FATCA status

Firstly, determine whether you need to file FATCA reports at all. For individuals and business entities (non-FIFA), determine whether you are required to file a U.S. federal income tax return, then continue on to the next step. If not, then you do not have to report to FATCA.  

2. Do you own any Specified Foreign Assets?

Specified Foreign Assets is a term used to describe all the different ways one can earn money in a foreign market. These possibilities include the following: 
  • Any foreign financial account. This might be bank accounts, brokerage accounts, financial accounts, mutual funds or hedge funds. 
  • Foreign stock or security issued by a foreign person not held in a foreign account; for example, if you had an ownership interest in a foreign entity. 
  •  Any interest in a foreign entity not held in a FIFA account. 
  •  Any foreign life insurance policy with a cash value not held in a FIFA account. 
  •  Any foreign instrument or contract held for investment that lists a foreign person as a counterparty. 

3. Clarify whether any of your Specified Financial Assets are used in, or held for the use in, the conduct of your organization’s business dealings.

If so, then you need not include your business assets in the aggregate value of your Specified Foreign Financial Assets. 

The importance of filing FATCA forms

Should you determine that you need to file FATCA reports, then you will need to complete a Form 8938, filed when you file your federal tax return.  This is essential: the reason FATCA is so successful at revealing the underpayment of foreign earnings is that, in addition to relying on your organization being compliant, FATCA also requires the foreign financial institutions that handle this money to report all deposits made by U.S. taxpayers. While there are some exemptions for publicly traded corporations and other business entities, the wisest option is always going to be to comply with legal obligations.  Penalties for not following FACTA rules and choosing a path of non-compliance are severe, ranging as high as forfeiture of 100% of unreported funds plus subjecting your organization to a multi-year audit process. 

FATCA reporting exemptions?

Certain payees are exempt from FATCA reporting and can select a FATCA code; a reporting code to identify the specific reason they are exempt. FACTA reporting thresholds vary with two factors: your tax filing status and where you reside.   The reporting thresholds will change depending on whether the annual income tax filing is being filed jointly or according to a different status that is not joint. The bar for reporting is higher for joint filings, as two individuals filing jointly should have to earn more money to be subject to the same financial withholdings as one individual. Once the bar for reporting is exceeded, reporting is mandatory. Individuals filing with any status other than a married, joint filing have a reporting threshold of $50,000 if they reside in the United States and a reporting threshold of $200,000 if residing outside of the U.S. If filing jointly when married, the thresholds double, meaning $100,000 in specified foreign assets for U.S. citizens residing in the United States and $400,000 for those residing outside of the U.S. It sounds straightforward, yet there is subtext to these statements. 

1. Residency Requirement

What is it to be a United States citizen living abroad? The IRS states that, “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.” Thus, if you spend the vast majority of your time abroad and skip going home to visit family for the holidays, you might have a significant difference in your reporting threshold, unlikely as that may seem.   There is a further subtext: the IRS states that, as a condition for the reporting, you are defined as living abroad only if, first, your tax home is in a foreign country. Your tax home is the city or country in which you do most of your work, defined as “the place where you are permanently or indefinitely engaged to work as an employee or self-employed individual.” Essentially, there are many nuances of FATCA withholding, and it is best to contact a tax professional to ascertain where your exemption status lies. 

2. FATCA Threshold

The next important consideration is whether your assets are applicable to the FATCA threshold; the assets that will contribute are designated as specified foreign financial assets.   A specified foreign financial asset is, primarily, any financial account managed by a foreign financial institution. This does not include, however, the foreign branches of U.S.-based financial institutions, or the U.S. branch of foreign financial institutions. Specified foreign financial assets will also include stocks or securities issued by persons not based in the United States, any financial interest in a foreign entity, and any financial instrument or contract that is issued by a non-U.S. person or involves a non-U.S. counterparty  Specified foreign financial assets also do not include beneficial interests in a foreign trust or estate if the individual does not have knowledge of the interest, and interest in a social security or similar program administered by a foreign government. 

3. Timing 

Finally, timing determines whether your assets are subject to FATCA withholding. Despite the rules of $50,000 and $100,000 for individuals and couples living in the United States and $200,000 and $400,000 for individuals and couples living abroad, there is a key clause in FATCA where these thresholds only apply so long as your specified foreign assets did not exceed a greater threshold at any point during the year. The thresholds are then $75,000 for non-jointly filing U.S. residents, $150,000 for married jointly filing U.S. residents, $300,000 for non-jointly filing U.S. citizens living abroad and $600,000 for married jointly filing U.S. citizens living abroad.   The rationale for this is clear: the IRS aims to prevent people from evading tax payments by moving one-third or greater of their specified foreign financial assets before the last day of the tax year to avoid being subject to FATCA reporting. 

4. Financial Institution Reporting 

FATCA also requires foreign financial institutions to report certain information about their U.S. account holders to the IRS. This is the other side of the coin; it makes reporting complicated for institutions that may have those from a multiplicity of nationalities as account holders.   In addition to reporting requirements, the institutions must withhold and pay 30% of any U.S. source income and gross proceeds of securities sales that generate U.S. source income. Generating, tracking and managing these reports becomes a time-consuming, tricky financial business. Leveraging technology is often the best way to begin managing complicated concerns such as FATCA withholdings. 

FATCA reporting template 

FATCA rules and compliance are constantly evolving, as are reporting regimes around the world. That’s why it is even more critical to stay up to date with FATCA and create a reporting template that ensures ongoing compliance.  Creating a FATCA reporting template can help simplify and streamline your FATCA reporting. It’s essential that your company, its entities and its suppliers are — and remain — in compliance.  Neglecting FATCA compliance can result in heavy fines and penalties, in addition to reputational damage. It’s much easier to implement FATCA compliance and remain compliant than to suffer through audits, penalties and fines.  Here are seven items that should be included in a FATCA reporting template:  Tax documentation: Mechanisms must be created whereby your organization collects tax documentation for both U.S. and foreign subsidiaries and suppliers. In addition to Form W-9, forms in the W-8 series may apply. Collecting tax documentation upfront is easier than trying to obtain it in the middle of tax reporting season. In addition, requiring suppliers and entities to ensure that all of their documentation is up to date on an ongoing basis is critical.  FATCA classification: All entities must be classified into one of three categories: U.S. entities, foreign financial institutions and non-financial foreign entities. There are sub-categories of non-financial foreign entities, which include active, passive or corporations that are publicly traded (and their affiliates). Non-financial foreign entities must provide appropriate, valid documentation about U.S. owners with substantial interest, unless an exemption applies. Many organizations are unaware that their employee benefit plans meet the definition of foreign financial institutions, although they may qualify for an exemption. You must also consider whether treasury centers, holding companies, captive finance companies, special-purpose entities, bank-like subsidiaries and non-U.S. insurance companies are appropriately classified, as they may meet FATCA’s test as foreign financial institutions.  Withholding: The United States imposes a 30 percent withholding tax on some U.S. source income that is paid to entities that don’t participate in FATCA or that lack the appropriate documentation. Tracking tax documentation and following up and withholding the appropriate amounts is a necessity in order to comply with FATCA. FATCA compliance must be integrated with accounts payable and treasury to ensure that appropriate withholding can occur as necessary.  Reporting on certain U.S. source income paid to non-U.S. persons: From the compliance standpoint, FATCA reporting is critical. Tax documentation and withholding must be done correctly so that accurate and timely reporting can occur. In entities with multiple subsidiaries, especially those with foreign subsidiaries, customers and suppliers, FATCA compliance must occur year-round to ensure that reporting is correct.  Common Reporting Standard (CRS): The common reporting standard, or CRS, is an Organization of Economic Cooperation and Development (OECD) that requires financial institutions to collect and review information and documentation from financial account holders and then report back to local tax authorities. CRS is a global reporting standard that allows the common exchange of information about financial holdings between financial institutions, governments and companies.  Multinational compliance: FATCA and CRS overlap, providing multinational corporations and their subsidiaries with the opportunity to optimize tax reporting compliance. It’s vital to ensure that your FATCA and CRS compliance is uniform across subsidiaries and jurisdictions.  Creating an audit trail: To ensure that you are fully compliant with FATCA, creating an audit trail of compliance efforts is critical. You want to be sure to document compliance across subsidiaries, divisions and countries, so that you can proactively deal with any potential IRS compliance reviews or audits. 

How to ensure FATCA reporting compliance

Establishing compliance guidelines with FATCA can be divided into three major stages: 
  1. Creating an initial management framework
Organizations begin this stage of the process by classifying all of their entities and assets according to the requirements of FATCA. The goal is to establish a permanent database for the storage of this information, which can be easily managed from multiple locations. 
  1. Ongoing, automated surveys
Once the basic data repository and methods of management are in place, organizations can turn toward ongoing compliance by implementing surveys that can be run periodically over all of the different entities that compose a multinational, multi-level organization. These surveys can be adjusted to the specific requirements of FACTA reporting as it is interpreted by the IRS on an ongoing basis, and what’s more, they can be automated for efficiency and eliminating human error from the equation. 
  1. Workflow management
Automated workflow management directly supports companies dealing with the implementation of FATCA requirements. A software platform that incorporates FATCA management not only keeps track of all relevant data, but also can alert responsible employees and authorities to upcoming filings, ensuring that all required operations are performed correctly and on time. It also logs and preserves these processes through the data repository, ensuring that everything is in place when audit time rolls around. 

Stay FACTA compliant with the right technology 

Trying to stay up to date with the ever-changing nature of FATCA reporting, along with the evolution of your organization, is a tall order. This is exactly why many companies leverage technology to ensure proper entity management and compliance.  Diligent Entities contains a FATCA Management module that directly answers the needs discussed above and many more. It establishes a strong framework for compliance with FATCA, whichever: 
  •     Categorizes entities by appropriate FATCA classification. 
  •     Automates review of FATCA exposure. 
  •     Constructs a permanent audit trail. 
  •     Tracks foreign financial assets, offshore accounts and thresholds. 
  •     Records all reviews and updates. 
  •     Provides a complete, accurate and historical record of all FATCA decisions. 
  •     Creates a single source of clean data for ongoing, reliable FATCA compliance. 
  •     Ensures regular updates as organizational change occurs. 
Diligent Entities’ FATCA solution provides an efficient and cost-effective FATCA compliance tool that removes the burden of manual processes for your legal and compliance staff. It eases the FATCA compliance burden through a simple step-by-step Wizard for each account, while creating a recorded audit trail for each step of the process.  If you have questions about FATCA filing or want to discuss ways that Diligent Entities’ FATCA solution might benefit your organization, learn more and or schedule a product demonstration.