The Foreign Account Tax Compliance Act, otherwise known as FATCA, is a federal law in the United States that requires all American citizens to report to the IRS details of any financial accounts they own that are located outside of the United States. Additionally, FATCA requires that foreign financial institutions report details regarding their American clients’ accounts to the IRS. The Act was created to prevent American citizens from avoiding federal taxes by hiding their funds in offshore accounts. FATCA was designed to increase American citizens’ compliance, rather than to force foreign entities to collect tax revenues.
One of the main reasons FATCA was deemed necessary is that Americans living abroad must still pay US income tax. Even if the income is generated in a foreign country and has no direct connection with the US, income tax must still be paid to the US government. This is unlike most other countries; in fact, the US is the only developed state that currently requires this.
The Foreign Account Tax Compliance Act comprises three main parts. The first part requires foreign institutions to enter an agreement with the IRS. This agreement consists of the foreign institution providing the IRS with information regarding any American clients and their transactions. The second part of FATCA requires American citizens who own foreign accounts to report their assets on tax form 8938. If a US citizen is caught understating their income, they can be fined up to 40% of their actual yearly wages. The third part of FATCA closes a popular tax loophole; many Americans overseas had previously avoided their US tax liability by using swap-contracts to convert their US dividends in to dividend equivalents. After FATCA, however, this is no longer possible.
Like much tax legislation, FATCA has faced major criticism. Although precise statistics are not yet available, many have speculated that the cost of implementing the Act is far more than the additional revenue it will bring in. Moreover, some believe that forcing foreign institutions and governments to spend time and money gathering information regarding American accounts is bad for international relations. It is inconvenient for other countries and thus can be divisive.