IRS: Offshore Banks Will Need to Disclose Precious Metals Held by U.S. Clients

IRS: Offshore Banks Will Need to Disclose Precious Metals Held by U.S. Clients

By Mark Nestmann • January 27, 2012

Earlier this week, I participated in to a teleconference sponsored by the Society of Trust and Estate Practitioners and the International Law section of the American Bar Association. The conference addressed the expanded offshore asset disclosure requirements brought into effect by the Foreign Account Tax Compliance Act (FATCA). (For background on FATCA  see here, here, and here.)

FATCA imposes a 30% withholding tax on many types of U.S-source income and gross sales proceeds to what the law calls "foreign financial institutions" (FFIs) and “non-financial foreign entities” (NFFEs). FATCA's withholding provisions will be phased in beginning Jan. 1, 2014 and come fully into effect one year later. To avoid this tax, FFIs and NFFEs must function as unpaid IRS informants. FFIs and NFFEs are defined so broadly that FATCA potentially impacts every foreign financial institution or non-financial entity in the world that receives, directly or indirectly, most types of U.S. source income.

FFIs include not only banks, but virtually all foreign investment vehicles, both publicly and privately traded. Non-U.S. insurance companies, mutual funds, broker-dealers hedge funds, private equity funds, and small family-owned and family-managed funds, are all FFIs. To avoid the 30% withholding tax on U.S. source income or gross sales proceeds, FFIs must certify that they don't accept business from U.S. persons, or alternatively, enter into a one-sided information agreement with the IRS. Among other provisions, such agreements must require FFIs to request waivers from account holders of any applicable foreign secrecy law and to close any account for which holders refuse to provide such waivers.

Alternatively, FFIs may elect to apply the withholding requirements that pertain to U.S. payers of dividends, interest, gross sales proceeds, etc. Under this election, FFIs must provide full Form 1099 reporting for all payments to specified U.S. persons. All U.S. and foreign-source amounts (including gross proceeds) would be reportable.

FFIs must additionally disclose the name, address, and taxpayer identification number (TIN) of each direct or indirect U.S. person with a greater than 10% ownership interest in the FFI, as well as the account balance and the gross receipts and gross withdrawals or payments from the account. Those FFIs engaged in trading or investment must report with respect to a U.S. person holding any level of ownership, no matter how insignificant the percentage or minor the value.

NFFEs are "any foreign entity which is not a financial institution." Thus, NFFEs include offshore corporations, offshore trusts, personal investment companies, and many other types of entities. To avoid 30% withholding, each NFFE must certify that it has no substantial (more than 10%) direct or indirect U.S. ownership. Those NFFEs that meet the 10% threshold must identify all U.S. citizen, resident, or U.S. domiciled owners.

It's no surprise that in anticipation of these severe rules coming into effect, thousands of offshore service providers have "fired" their U.S. clients.  Indeed, the option to ditch U.S. customers to avoid FATCA’s draconian compliance regime is specifically written into the law. FATCA’s intent is not only to discourage U.S. persons from investing offshore, but more fundamentally, to discourage offshore businesses from offering financial services to U.S. citizens or permanent residents. These severe requirements are nothing less than a de facto form of foreign exchange controls.

Self-Disclosure Rules Under FATCA

However, the focus of this week's conference was on the added offshore disclosure obligations that FATCA imposes on individuals, and soon-to-come, what the IRS calls “specified domestic entities.” This latter category includes certain domestic corporations, domestic partnerships and domestic trusts, but not domestic estates.

Joseph Henderson, an attorney with the IRS Office of Associate Chief Counsel (International), answered questions put to him by a panel of tax experts and conference participants. Henderson is a principal drafter of the temporary regulations issued last month for Form 8938, "Statement of Specified Foreign Financial Assets." U.S. taxpayers with interests in such assets that meet applicable filing thresholds must file this form annually with their personal tax return, beginning with 2011 tax returns.

Your obligation to file Form 8938, Mr. Henderson stressed, is entirely separate from your obligation to file Form TD F 90-22.1, the “foreign bank account reporting” form (FBAR), with a deadline of June 30 for reportable accounts held the preceding year. (For more information on the FBAR, click here.) You must report some foreign assets on one form, some on the other form, and some on both.

The major source of this confusion is that the reporting obligations for each form are contained in different code sections of federal law. The FBAR requirements are in Title 31; the FATCA requirements in Title 26. If this causes monumental confusion to law-abiding taxpayers…well, too bad!

In any event, the discussion focused on the following questions:

1. Who needs to file Form 8938? I summarized the requirements here.

2. What's the deadline for filing Form 8938? You submit it with your annual tax return. The deadline is April 17 for 2011 returns. You may obtain an automatic extension until Oct. 15 for filing IRS Form 4868.

3. What's the reporting threshold? The threshold for reporting starts at $50,000. It doubles to $100,000 for married couples filing jointly and increases further for U.S. citizens or green card holders living overseas. Click here for more information.

4. What assets need to be reported? I summarized financial assets that need to be reported on Form 8938 here. Henderson confirmed that foreign real estate owned by a U.S. individual isn't reportable. By extension, precious metals, art, or other personal possessions you maintain in a foreign residence aren't reportable, either. But, when asked about the reportability of precious metals held by an individual in offshore safe deposit boxes or private vaults. Henderson briefly consulted with one of his colleagues and replied, “That will be covered in forthcoming regulations under Chapter 4.”

Henderson was referring to Chapter 4 of FATCA, the subject heading of which is “Taxes to Enforce Reporting on Certain Foreign Accounts.” This is the notorious section that imposes the 30% withholding tax on most U.S. payments to FFIs and NFFEs.

To avoid withholding, FATCA requires FFIs (but not NFFEs) to:

"…Comply with requests by the Secretary for additional information with respect to any United States account maintained by such institution."

In the context of offshore precious metals holdings, it would be simple for an FFI holding a custodial account on behalf of a U.S. person to provide this information to the IRS. However, Henderson was specifically asked about the reportability of precious metals held in a safety deposit box or private vault.

The only way the FFI would be able to obtain the requested information for a safety deposit box would be to obtain an inventory from the owner, or break open the safety deposit box and take its own inventory. If it failed to do so, the FFI would presumably be subject to the 30% withholding regime. I hope this draconian interpretation is incorrect, but the answer will apparently be found in the future regulations for Chapter 4.

However, an offshore private vault is arguably not an FFI. FACTA defines a FFI as any non-U.S. entity that:

"… (i) accepts deposits in the ordinary course of a banking or similar business, (ii) holds financial assets for the account of others as a substantial portion of its business, or (iii) is engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities, partnership interests, or commodities."

An offshore private vault that isn't engaged or holding itself out to be engaged such activities would seem to be a NFFE, not a FFI. As such, the private vault shouldn't be subject to FATCA's withholding regime so long as it can prove that it doesn't have 10% or greater U.S. ownership. Nor should the vault be required to disclose the names or the investments maintained by U.S. customers.

Henderson's response also implies that offshore precious metals held by an individual in a safety deposit box or private vault aren’t reportable for Form 8938 purposes, at least not for 2011. The case for not reporting the holding on either disclosure form is strongest if you have exclusive access to the box, because in that event you arguably need not report it on either Form 8938 or the FBAR. For the reasons why I don't think it's reportable on the FBAR, read this post.

5.  What's the status of the pending expansion of Form 8938 requirements to domestic entities? Certain “specified domestic entities” will eventually need to file Form 8938.

6. How should reportable assets be valued? A published or online statement reflecting the highest value or end-of-year value for each reportable asset is preferred. If you are unable to obtain a valuation of a reportable asset, you can indicate that you plan to file an amended return when the valuation becomes available.

7. Are foreign pensions reportable? Yes, in some cases. For instance, the beneficiary of a self-directed IRA that invests in specified foreign financial assets must report those investments on Form 8932 if they meet the reporting threshold. Generally, foreign social security pensions aren't reportable; foreign private pensions are. If the pension provides an annual valuation statement, you can use that to indicate the pension's value. If you don't, you apply IRS distribution rules to obtain an approximate value.

8. How strictly will the IRS interpret the reporting rules? Henderson assured the participants that persons who make a good-faith effort to comply with the reporting rules won’t be penalized. That’s reassuring in light of the heavy penalties that apply for failure to comply with these rules. He recommended including a statement to accompany Form 8938 to explain any ambiguities and/or assumptions made in preparing the return.  If you discover a mistake, you can file an amended tax return with the corrected Form 8938. Henderson also agreed with one participant’s suggestion that if anyone close the reporting threshold should make a “protective” Form 8938 filing.

There’s much more to come, of course, in the complex web of reporting obligations Congress and the IRS have created to discourage Americans from investing overseas. I’m especially interested, and more than a little concerned, about what the IRS has in mind for offshore precious metals holdings outside of an offshore private residence.

Despite Henderson's reassurances, there's no question that FACTA in general, and Form 8938 in particular, mark a dramatic escalation of the incredibly complex disclosure requirements that apply to all U.S. citizens or permanent residents with assets, income, or business interests outside the United States. It's no wonder that the IRS itself concluded that thousands of Americans have chosen to give up U.S. citizenship or long-term residence and expatriate, rather than attempt to comply with these obligations.

(Click here for the most recent IRS updates on Form 8938.)

Copyright © 2012 by Mark Nestmann

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About The Author

Since 1990, Mark Nestmann has helped thousands of clients seeking wealth preservation and international tax planning solutions. He is the author of highly acclaimed Lifeboat Strategy and other books & reports dealing with these subjects.

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