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FATCA, the Foreign Account Tax Compliance Act, directs U.S. citizens, whether living in the nation or abroad, to declare and document their foreign account ownership. The primary purpose is to prevent tax evasion. Under the HIRE Act, FATCA aims to enhance transparency in the global economic services sector.
Non-resident Indians (NRIs), pay income tax* in India based on the income they generate in the country. As per the Indian taxation* system, any income generated in the country is taxable. Therefore, if you are an NRI, you must know the NRI income tax rules to understand the applicable taxes.
The Foreign Account Tax Compliance Act (FATCA) demands U.S. citizens to report their foreign account ownership, whether residing in the country or abroad. The main objective of FATCA is to prevent tax evasion.
The FATCA rule was passed under the Hiring Incentives to Restore Employment (HIRE) Act. It aims to improve transparency in the economic services sector globally. The FATCA tax utilises Form 8938 to report foreign account holdings and severe penalties exist for non-compliance.
Understanding FATCA
FATCA tax reporting became law in 2010 when President Obama signed it as part of the HIRE Act. The primary goal of the HIRE Act was to encourage businesses and organisations to hire unemployed individuals due to increased unemployment rates resulting from the 2008 financial emergency.
As part of the HIRE Act, employers were incentivised through an enhanced credit of business tax for each new employee they employed and retained for a minimum of 12 months.
Additional impressive incentives included payroll tax holidays and an extended limit on deducting expenses for newly obtained equipment in 2010.
What is the Objective of FATCA?
FATCA, meaning the Foreign Account Tax Compliance Act, aims to prevent tax evasion. It seeks to stop tax evasion by businesses and U.S. individuals earning, operating, and investing taxable income abroad.
Though maintaining an offshore account is not illegal in the U.S., not revealing the account details to the Internal Revenue Service (IRS) is against the law, as the U.S. taxes all assets and income of its citizens worldwide. Primarily, the establishment of FATCA was to finance the expenses associated with the business incentives offered by HIRE.
FATCA directs U.S. taxpayers to annually report their foreign financial assets, contributing to HIRE Act incentives revenue. Penalties apply for non-disclosure of foreign accounts and assets exceeding USD 50,000 annually.
Who Is a U.S. Person Under FATCA?
The reference "United States Person" or USP, as per FATCA guidelines, includes the following:
- A United States resident.
- A domestic corporation incorporated in the United States.
- Researchers and teachers on J1 and Q visas are classified as non-resident aliens for two years and are exempt from the substantial presence test during these two years.
- Any estate other than a foreign estate.
- A domestic partnership organised in the United States.
- A trust falls under the category of a USP if a U.S. court can largely supervise its administration. In addition, one or more U.S. individuals can control its significant decisions.
- The District of Columbia, the United States Government, or a state.
- Students holding F1, OPT, J1, and Q visas are categorised as non-resident aliens for a maximum of five years. They are excluded from the substantial presence test for these five years.
- F and J student visa holders can exclude five calendar years of presence when applying for the substantial presence test. For J non-student visa holders, the exclusion period is two years.
- A client may be considered a U.S. resident for tax purposes based on their time in the U.S. under the substantial presence test, which should be applied annually.
- To ensure that taxpayers meet the substantial presence test for visa categories such as H1B, L1, and others, individuals must be physically present in the United States for a minimum of 31 days in the present year and a total of 183 days over the current year and the two preceding years.
This count involves all days present in the current year, 1/3rd of the days before the current year, and 1/6th of the days in the year before that.
Who Must Comply with FATCA?
U.S. taxpayers must file Form 8938 if their financial assets total USD 50,000 or more, whether in a bank account or various financial investments. Exceptions include assets held in a U.S. branch of a foreign organisation or a foreign branch of a U.S. organisation.
Foreign Institutions
Foreign Financial Institutions (FFI) and Non-Financial Foreign (NFFE) entities must comply with FATCA, revealing the details of U.S. citizens holding accounts and the connected asset values to the IRS or the FATCA Intergovernmental Agreement (IGA).
FFIs that fail to comply with the IRS regulations face exclusion from the U.S. market and a tax penalty of 30% of any withheld payment. These withheld payments include income generated from banks' U.S. financial assets, such as dividends, interest, and frequent profits.
FFIs and NFFEs featuring FATCA compliance are required to report annually. They must disclose each account holder's name, address, and Tax Identification Number (TIN), fulfilling U.S. citizen criteria. Additionally, they need to provide the account number, account balance, and details of any deposits and withdrawals for the year.
Individual Taxpayers Living Abroad
If you live abroad and are married, filing jointly, you must file Form 8938 if your specified foreign financial assets exceed USD 400,000 on the last day of the taxation year or USD 600,000 at any time during the year.
This applies even if only one of you resides abroad. For unmarried individuals, file if the total value of your specified foreign financial assets is more than USD 200,000 on the last day of the taxation year or more than USD 300,000 at any time throughout the year.
Individual Taxpayers Living in the United States
If you live in the U.S., you need to fill out Form 8938 if:
You are single, and your foreign monetary assets exceed USD 50,000 at the end of the taxation year or USD 75,000 any time throughout the year.
You are married and filing jointly, and your foreign monetary assets are over USD 100,000 at the end of the tax year or USD 150,000 at any time.
You are married, filing separate tax returns, and your foreign monetary assets are more than USD 50,000 at the end of the tax year or USD 75,000 at any time. If you jointly own assets with your spouse, include half the value. Report the full value if filing Form 8938 is needed.
Penalties for Non-Compliance
If you fail to fill out the Form 8938, you will be liable to the following penalties enforced by the IRS:
- Initial Penalty: A base penalty of $10,000 for not filing the form.
- Continued Non-Compliance: If the taxpayer continues to not file even after receiving notification from the IRS, an additional penalty of up to USD 50,000 may be imposed.
- Understating Taxes Penalty: If taxes are understated related to undisclosed foreign financial assets, a 40% penalty on the understated tax may be applied.
In cases related to specific foreign financial assets, the limitations can extend under certain circumstances:
- Income Over USD 5,000: If there is income over USD 5,000 from a specified foreign financial asset that is not reported, the statute of limitations is extended to six years after the entity files its return.
- Failure to File or Report Properly: If a taxpayer fails to file or properly report an asset on Form 8938, the statute of limitations for the tax year is extended. In such cases, the extension lasts three years beyond when the taxpayer provides the required details.
Suppose there is a reasonable reason for the failure. In that case, the regulation of limitations extension applies only to the specific item or items related to such failure and not to the entire tax return.
In cases where the failure to disclose is considered reasonable, no penalty is imposed. However, determining how reasonable the situation is may vary from case to case.
Wrapping up
FATCA makes it mandatory for U.S. citizens living abroad or at home to file annual reports on any foreign account holdings that they possess. The FATCA income tax filing for NRI involves completing and submitting Form 8938.
Different filing requirements and holding entries exist based on whether individuals reside in the U.S. or abroad. Ensuring FATCA compliance is important when holding assets abroad, as significant penalties apply for non-compliance.
