The IRS' Secret Control to Curb Your Offshore Investment...
by Vernon Jacobs, Guest Editor, The Oxford Club
A Investment U White Paper Report
Editor's Note: The IRS is cracking down on offshore holdings. They want us to keep on believing it's illegal. We tracked down one of the world's foremost experts, Vernon Jacobs, to shed some light on U.S. regulations and offshore accounts. Vernon is a CPA with a focus on international tax law. He's the author of half a dozen books on international taxes, including the comprehensive Guide to Reporting Foreign Financial Accounts. And the timing couldn't be more perfect for this topic.
De facto is Latin for "in fact."
It's often used to describe the exercise of power that hasn't been legally or officially established. It also describes any other established practice that isn't an "official" law or policy. Such is the case with currency controls in this country.
Since the announcement of the near $1 trillion package of programs to stimulate the economy (and bail out the "too big to fail" institutions), fears of inflation have motivated many investors to anticipate that currency controls will soon follow.
Those fears are unfounded. Why? Because we already have currency controls.
They aren't a law that restricts the movement of dollars outside the United States. What we have is a more devious method of deterring U.S. investors from moving dollars and assets offshore, without actually passing a law that explicitly says anything about currency controls.
"De Facto" Currency Controls
The United States has adopted reporting and disclosure laws that function as a strong deterrent for those who are looking for currency diversification. One of them is the Report of Foreign Bank and Financial Accounts (known as FBAR). This requirement has been in existence since 1970. But only recently has the IRS used it to encourage taxpayers to report any income they receive from a foreign account.
The other is a new report that's part of the 2010 Hiring Incentives to Restore Employment (HIRE) Act, which requires U.S. persons to file an annual report with their tax return to identify offshore assets with a combined value of more than $50,000.
The FBAR form isn't new. It was created by the 1970 Bank Secrecy Act to encourage money launderers to disclose their foreign holdings. Of course it didn't work. But it did provide a strong incentive for law-abiding taxpayers to divulge their foreign accounts to the Treasury Department each year.
While currency controls are not yet present in a traditional form, there's a disclosure system in place that the government could easily use. If an executive order were signed requiring the repatriation of any offshore financial accounts, it would be a simple matter to contact everyone in that database.
The FBAR form requires the disclosure of financial accounts held offshore. That clearly includes:
- Bank accounts.
- Time deposits with a financial institution.
- Investment accounts.
- It also includes foreign mutual funds.
But it's not clear if it includes:
- Private equity funds or hedge funds.
- Until recently it also wasn't clear if it included a foreign annuity.
- A life-insurance policy.
- Precious metals stored offshore.
- Or anything else that could easily be converted to dollars or other currencies.
The FBAR form doesn't require the disclosure of directly held (minority) shares of stock in foreign companies, debt obligations of foreign organizations, foreign real estate, or even various collectibles held in storage outside the United States. Nor does it include a variety of non-financial assets that are used in an active trade or business outside the United States.
Higher and HIRE
To ensure that any other assets located offshore would also be disclosed, a new condition was included in the Foreign Account Tax Compliance Act of 2009 and as part of the HIRE Act.
One of the provisions of that act is a requirement that taxpayers must now report "certain specified foreign financial assets" with their income tax return, if the aggregate value of those assets exceeds $50,000. The law explicitly includes any securities issued by a foreign person and any interest in a foreign entity. This new law is applicable for taxable years beginning after March 18, 2010. The specific rules are to be set forth in regulations to be issued by the IRS. You can safely expect that the IRS will cast a wide net in its regulations.
We still have to disclose all foreign financial accounts to the government if the value exceeds $10,000 at any time during the calendar year. But now we're also required to disclose "specified foreign financial assets" with an aggregate value over $50,000, based on whatever the IRS chooses to define as a financial asset.
But there's more...
The High Cost of Doing Business
The United States now requires foreign financial institutions to provide information to the IRS about any income received for the account of any U.S. person. Foreign banks and other financial institutions that don't want to incur the very substantial cost of compliance - or whose laws make such disclosures illegal - will become subject to 30% withholding rate on all U.S. source income.
It seems likely that many foreign financial institutions will tell the U.S. government there's "no way" they'll comply. They'll then withdraw their assets from the United States and will most likely tell any U.S. account holders to take their assets elsewhere. These banks will also refuse to do business with anyone else from the United States.
The net effect of this law will be to prevent all but the most determined U.S. persons from moving any assets offshore and out of the dollar.
Some smaller foreign banks will continue to accept business from U.S. investors or businesses and will comply with the IRS reporting requirements. And for the time being, it's still legal to own foreign currencies, gold and other precious metals, and foreign businesses.
For now, the United States only has a de facto form of currency controls. Owning foreign currencies or other assets is not yet prohibited as a matter of law.