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Foreign Account Tax Compliance Act – Traps for the Unwary

For anyone who has clients or family members that live and work abroad, the new Foreign Account Tax Compliance Act (FATCA) is a real problem. Although this Act is supposed to punish Americans who hide assets abroad to avoid their tax liabilities, the Act doesn’t differentiate between those deliberately hide assets and those who don’t realize that they are required to report their assets to the IRS.

Under the FATCA, there’s an up-to-$50,000 penalty for failing to file with your return the new 6038D statement disclosing specified foreign financial assets with an aggregate value >$50k ($10,000 for not filing, plus up to an additional $40,000 if you don’t file within 90 days after the Secretary notifies you that you’ve failed to disclose). Then, if you don’t include the income from such foreign assets, you get hit with a new 40-percent penalty on an understatement attributable to an undisclosed foreign financial asset. And to top it all off, the IRS gets 6 years to assess you for the underreporting and penalty.

But wait, there’s more. There’s a new open-ended unlimited extension of the assessment statute for failing to provide timely information returns required with respect to PFICs and the new 6038D self-reporting of foreign financial assets. Until you file the 6038D disclosure form there’s no SOL on assessment (making it akin to the current situation for fraud). That’s true even if the IRS knows you’ve got the asset(s) because they notified you about failing to file the 6038D and then socked you with $40,000 in penalties for not filing the attachment. And the killer is that the unlimited extension is “not limited to adjustments to income related to the information required to be reported.” I read that to mean the entire return has no SOL on assessment until you file a 6038D for “every” foreign financial asset once the aggregate of your foreign financial assets is >$50k.

For U.S. citizens living abroad the FATCA would require reporting the purchase of a residence with a fair market value of >$50k, even though such an asset is not currently taxable and any gain on the sale of the asset may not be taxable. The same would be true of tax-exempt assets.

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