Regulations are prompting some financial advisers to urge their clients to bring money back to the U.S.
Owning a portfolio of offshore holdings is about to get much riskier, thanks to new U.S. tax-reporting rules, financial advisers say. As a result, some advisers are urging clients to shift money back to the U.S.
The Foreign Account Tax Compliance Act, known as Fatca, will require both U.S. citizens and foreigners living in the U.S. to make extensive disclosures about overseas holdings on their tax returns or risk harsh penalties. Foreign financial institutions also will be required to report more detailed information on income earned by their U.S. account holders, or face possible U.S. tax penalties.
The rules start to take effect this year, with additional requirements set to be phased in over the next several years.
Proceed With Caution
The implementation of Fatca is one of the latest turns in a three-year campaign by Washington to combat offshore tax evasion. In a 2009 settlement, Swiss bank UBS AG agreed to turn over to the U.S. the names of more than 4,000 U.S. taxpayers with secret accounts.
Financial advisers who want to keep clients out of trouble with the Internal Revenue Service are now taking a closer look at Swiss bank accounts and funds based in tax havens such as the Cayman Islands. These accounts, already red flags for audits, likely will come under even more scrutiny.
"If you have any client with a hint of a foreign connection, proceed with great caution," says Leigh-Alexandra Basha, chairwoman of international private wealth services at law firm Holland & Knight LLP in Northern Virginia. The new U.S. regulations and a host of changes by other countries have created an "obstacle course" that is difficult to navigate, she says.
The penalties for those who don't follow the new reporting rules will be severe, totaling as much as $10,000 for each account if the IRS determines the account holder simply made an error, and up to 50% of the account balance if the IRS determines the account holder was purposely trying to hide the assets.
Advisers have dreaded the tax changes in large part because they mean more, and sometimes duplicative, reporting. A taxpayer with more than $10,000 in an offshore account, for example, already must file a Report of Foreign Bank and Financial Accounts with the IRS. Now, anyone with at least $50,000 in a foreign account will have to file a separate tax-compliance form, along with his or her annual return.
Charles K. Kolstad, an attorney in the Los Angeles law firm of Venable LLP, recently advised two sisters whose father left them a fortune in Swiss accounts to move that money to the U.S. The women are seriously thinking about doing so, he says.
"Five years ago, we would have said to leave it where it was," says Mr. Kolstad. An alternative to a Swiss account, he says, may be a trust set up in Delaware, Alaska and South Dakota, states where the law favors trustees.
The new reporting requirements also apply to certain foreign financial assets, including stock of foreign companies and business partnerships, which didn't have to be reported before. Some of these investments may become too troublesome to be worthwhile, advisers say.
Foreign mutual funds and some kinds of foreign life insurance, for example, will have to be reported annually under the new rules, instead of just when bought or sold. To avoid a tax problem, an adviser may suggest a client with a lot of these investments replace them with U.S. mutual funds that invest in foreign securities.
Real estate held overseas also may become a headache. Taxpayers will have to report to the IRS any stake in property worth more than $50,000 if the property is owned by a partnership, which many families set up for such purposes.
That means that a client with, say, a piece of a family-owned villa in Tuscany will have to get more frequent appraisals, a process that can be costly.
Advisers say Fatca may raise delicate issues, challenging them to balance the need to let the U.S. government know where its taxpayers are keeping their money and earning income, without compromising the confidentiality of clients' estate plans. Mr. Kolstad, the attorney, used the example of a grandfather with $100 million. Say the man doesn't want all of his family members to know exactly how much money he has, or what they stand to inherit.
All of a sudden, says Mr. Kolstad, "you're asking the grantor or trustee to open the kimono and reveal information they might regard as private and confidential." While the grandfather's reports to the IRS would be confidential, each beneficiary would have to report, too, Mr. Kolstad says. So the man would have to reveal information about his estate to each person who stood to inherit, he says.
One French client who lives in the U.S. is so exasperated with all of the new reporting that he wants to give up his green card and return to France, Holland & Knight's Ms. Basha says. The client holds foreign life insurance, foreign mutual funds and shares in foreign companies.
But a move overseas can mean paying hefty U.S. exit tax, creating something of a Catch-22, she says.
Ms. Dale is a special writer for Dow Jones Newswires in New York. She can be reached at firstname.lastname@example.org.