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Happy Halloween.
Trick or Treat?

Happy Halloween.<br>Trick or Treat?

Happy Halloween. The next few days will surely provide a few tricks, and treats, depending on the thickness of your wallet. Here are a few tricks and treats to look for in your candy bag:Happy Halloween. The next few days will surely provide a few tricks, and treats, depending on the thickness of your wallet. Here are a few tricks and treats to look for in your candy bag:

3Q17 CIO Commentary

3Q17 CIO Commentary

In this quarter's CIO commentary, we talk about picking a new Federal Reserve chairperson, the hurricane season, and take a deep dive into the implications of the Republican's tax framework document.

4Q16 CIO Commentary

4Q16 CIO Commentary

In this quarter's CIO commentary, we take a look at the winners and losers coming out of the Trump victory, make a deep dive into the risk-reward tradeoffs offered you US equities at the moment, and name the one US foreign relationship to watch most closely in the Trump era.

F(u)BAR

It’s June. In the US that means graduations, warm evenings, gratitude to fathers and FBAR filings. If either you or your spouse is a US person and held an interest in or signatory authority over foreign financial account(s), including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account, exceeding certain thresholds with an aggregate value of $10,000 or more at any time during 2014, you will want to pay close attention. And even if you don’t have an overseas financial account, you should be concerned about the FBAR. Read on.

FBAR stands for Report of Foreign Bank and Financial Accounts. It’s a mandatory annual declaration of certain foreign financial accounts to the Treasury Department. It came out of the Bank Secrecy Act of 1970 to help the Treasury detect and prevent money laundering has morphed into an important tool in the IRS’s pursuit and punishment of wealthy US tax dodgers using offshore accounts. This IRS effort picked up steam over the last decade with some successful arm-twisting of the Swiss banks, the 2010 passage of the Foreign Account Tax Compliance Act (FATCA) and the offering of numerous voluntary offshore account disclosure (i.e. amnesty) programs. FATCA contains a requirement for individuals to report certain foreign financial assets (Form 8938) that is somewhat overlapping with the FBAR filing requirement. FATCA also requires foreign financial institutions (e.g. local banks, stock brokers, hedge funds, insurance companies, trusts, etc.) to report asset and identity information on certain accounts associated with their clients who are US persons to the IRS.


Cutting off the nose to spite the face

No one likes a tax cheat, but the IRS’s increased efforts to track down offshore tax evasion appear to be doing more harm than good. The IRS is pursuing a few tens of thousands of wealthy and unscrupulous tax dodgers, most of whom live in the US. But in its pursuit, US regulators are triggering massive costs for itself, its citizens and residents, and US and foreign financial institutions. FBAR and FATCA are the epitome of the law of unintended consequences. They are F(u)BAR and they desperately need to be modified or scrapped as soon as possible.


Caught in the crossfire

Over seven million Americans are estimated to be living overseas, approximately the population of the State of Washington. Most are middle class individuals trying to make an honest living. Some work for US companies, some started their own businesses. Some fell in love with and married foreigners. Some were born in the US while their foreign parents were posted on a short US job assignment, and some were born outside of the US but had one parent that was an American citizen. Just like their fellow Americans back in the good ol’ USA, they need bank accounts, insurance policies, and/or investment and retirement savings accounts where they live. But unlike the citizens of all other developed nations, Americans living overseas are taxed by both their country of residence in addition to their country of citizenship (although the US has tax treaties with many countries that reduce, but not eliminate double taxation). FBAR and FATCA, tools created to target a very different demographic (rich, unscrupulous, and usually resident within the US), have made life more difficult and more expensive for the millions of American expats.

FBAR and FATCA combine to create a compliance nightmare for American expats. FBAR and FATCA’s Form 8938 take a long time to complete, are due at different times of the year and to different addresses yet are largely redundant. The IRS figures that Form 8938, due with one’s annual 1040, takes over four and one half hours of work to complete for the typical taxpayer. From personal experience, the FBAR website used to electronically file is extremely user-unfriendly – I wasted over an hour before I was able to get it to work.

FBAR and Form 8938 are complicated forms that, when combined with the numerous other peculiar and unique US and foreign laws and regulations, demand the attention of qualified tax professionals. But this expertise doesn’t come cheap. $10,000+ annual bills from tax professionals are not uncommon for US expats, even for relatively routine tax filings.

FBAR and FATCA compliance can be expensive for an individual, but non-compliance is much more so. Again, these tools were designed to catch and punish wealthy tax dodgers, so their penalties are significant. If the IRS catches you unintentionally failing to make an FBAR filing, the standard penalty is $10,000 for each year, with a cap of 50 percent of the account value. If the IRS determines you willfully failed to file, or willfully filed it incorrectly, the standard penalty is set at 50 percent of the high water amount in the account. However, the IRS has the latitude to decrease or increase penalties depending on your circumstances, including the application of jail time. Less is known about the IRS’s standard penalty for catching you accidently failing to file Form 8938 (a FATCA requirement), but the maximum penalty is $10,000 for each year of non-filing.

Just think of a typical middle-class American living abroad for last five years. He prepares his own local and US tax returns because he feels that he can’t afford tax accountants and/or lawyers in both his local country and in the US. He correctly reports and pays all the local and US taxes due on the interest he’s earned on his local checking and savings accounts over the last five years. Then he gets a letter from the IRS this fall informing him that he failed to declare his local checking and savings accounts with a 2014 FBAR filing. He’s never heard of FBAR and although he never had more than $50,000 combined in these two accounts, he’s now looking at a standard $25,000 FBAR penalty (capped at 50% of the account’s highest value). If he’s lucky, the IRS will let him lightly with a $10,000 penalty, charging him for ‘only’ a single year of missed FBAR filings. Fortunately he didn’t have to file a Form 8938 because the size of his accounts came below the thresholds for citizens living outside of the US.


Carrot Stick and stick

You might wonder how the IRS would discover an unreported local banking account. As of July 1, 2014, FATCA began requiring global financial institutions to report to the IRS annually most names and account details of its US person clients. Although FATCA is a US law and the costs for global financial institutions to implement it are steep (Congress did not conduct a cost benefit analysis before passing FATCA, but various estimates have put the initial implementation costs at between $200 billion and $1.2 trillion) financial institutions are ‘highly incentivized’ to comply. US payors are required to withhold a 30% tax on payments made to financial institutions that do not comply with FATCA – one big stick. Those not going along with the US on FATCA are effectively shut out of the US financial market. No surprise that most global financial institutions are falling into line with FATCA.

Foreign financial institutions have understandably grown wary of crossing the US on FATCA. Many have chosen to lower their risk of accidental violations, along with costs of compliance, by ceasing to do business with US persons, particularly smaller, less profitable ones. But it’s not just foreign financial institutions that are cutting loose of US persons, so too are US financial institutions. Major US custodians such as Merrill Lynch, Morgan Stanley, PNC Bank, Scottrade, Sharebuilder, Etrade, TD Ameritrade, Vanguard and Fidelity have been reported to refuse to maintain accounts for US citizens who admit to residing and/or working overseas. Mutual fund companies have also begun to bar overseas Americans from buying their funds, most notably Putnam and Fidelity. So now our typical middle-class American expat, who was just fined tens of thousands of dollars by the IRS for forgetting to file an FBAR, also had his local bank accounts and his US-based brokerage accounts recently closed. F(u)BAR.


Tunnel Vision

I imagine US regulators are pleased with their recent efforts to reign in overseas tax evasion by its taxpayers. US regulators successfully pierced the system of secret Swiss bank accounts and extracted over $3 billion in bank secrecy related fines from its two largest players, Credit Suisse and UBS. US voluntary offshore account disclosure programs have brought in more than $6.5 billion in back taxes, interest and penalties from more than 45,000 submissions. FATCA is estimated to generate an additional $8.7 billion in tax revenues between 2010 and 2020. Add it all up and give it some some generous rounding, the IRS and other US regulators will have delivered $20 billion to the American taxpayer through 2020.

$20 billion may sound like a lot. But to put this in perspective, US regulators’ decade of effort to nab tax cheats using overseas accounts will collect less than two days of federal government expenditures (based on FY15’s budget of $3.9 trillion). Hardly impressive but even this viewpoint is a grossly inaccurate way to measure the true success of the US regulators’ effort. In business-speak, this $20 billion is merely the revenue of the operation. Profit of the operation is what is relevant and this is what is left over after all costs of the operation are subtracted. Looking only at revenue, while ignoring costs, is an extreme case of tunnel vision. One could perhaps excuse the IRS for having such tunnel vision, after all the IRS bares few of these costs, but I can’t excuse the US lawmakers who enacted FATCA for such narrow mindedness.

As discussed earlier, direct costs for the global financial industry to implement FATCA through 2020 have been estimated to run somewhere between $80 billion and over $200 billion (giving FATCA a global loss of between $60 billion and over $180 billion). Most of the cost to implement FATCA is being borne by foreign financial institutions, but I would venture to guess at least 10% of this cost, $8-20 billion using the range estimates, will be incurred by US financial institutions. But even if US financial institutions didn’t bear a single dime in FATCA implementation costs, I find US lawmakers to be arrogant and rude to think it permissible to force foreign financial institutions to spend between $80 billion and over $200 billion so that the US Treasury can add a mere $20 billion to its coffers. The rest of the world definitely finds it so. This value destruction damages the global economy and directly punishes investors in foreign financial institutions, many of whom are American citizens.

As detailed earlier in this discussion, American expats are bearing significant tax preparation costs and potential fines due to FBAR and FATCA. The companies that need their expertise, including US multinationals, are also negatively affected by FBAR and FATCA by making an American expat more expensive and risky to employ. This is particularly true for certain high level management positions and American entrepreneurs working with foreign partners, roles that may require the individual to have signature authority over financial accounts of certain non-financial companies or the establishment of foreign entities in the business which are held in nominee status by a corporate officer.

American companies are also incurring meaningful costs because of FATCA. As discussed above, many US financial companies bear FATCA implementation costs and many US brokerage houses and mutual fund companies are now foregoing business from US expats and foreigners that had once been profitable to them. FBAR and FATCA also disadvantages US companies trying to attract global talent to fill US-based positions.

Cause and effect are hard to prove, but it would appear that FATCA is driving many Americans to renounce their citizenship. Over the last five years (Congress passed FATCA five years ago) we’ve seen a more than a quadrupling in Americans giving up their US passport.

 Source: Zero Hedge

Source: Zero Hedge

While departures are still modest at 3,749 over the last 12 months through March 2015, I fear that this trend will continue to increase for many years to come. In order to renounce one’s citizenship, one first needs to have another citizenship in place. Given the long lead-time for individuals to gain an additional citizenship (5-10 years is typical), the spike in US citizenship renouncements may be just getting started. Obtaining a ‘fallback’ passport usually requires youth, health, higher education or wealth, so many of the renouncers are the very people that the US can least afford to lose.

An objective cost benefit analysis would show that FATCA doesn’t make sense, either from a global perspective or from a selfish, US-centric perspective. However, I’m afraid that logic is unlikely to prevail in the near term, so US expats need to adapt to FATCA.


Taxation without representation

It may not be too surprising that US lawmakers ignore what foreign countries think, but it’s frustrating to me that the voices of more than seven million US expats, a block large enough to be the 14th largest state, go virtually unheard by US lawmakers. But this too is not surprising when one understands that US expats vote in the district where they last voted before moving overseas, thereby making them a small minority constituency in their district. In the simple math of a Congressperson, the risk of being labeled ‘soft on rich tax dodgers’ far outweighs the upside to be gained advocating for only 2.5%, on average, of the voters in their district. Attempting to fix FATCA is political suicide in today’s political climate.


The clock is ticking

So getting back to why this discussion started. If either you or your spouse is a US person with ownership or signature authority over financial accounts abroad, you should immediately find out if the IRS requires you to report them. You may be required to make multiple types of annual disclosures, but the deadline for the FBAR filing is the most pressing to research given its approaching June 30 deadline. If you missed required filings in the past, I recommend that you seek professional advice to better help you understand your options. Using one of the IRS’s voluntary disclosure programs, such as the Delinquent FBAR Submission Procedures or the Streamlined Filing Compliance Procedure (see links below) may allow you to get you back into compliance without financial penalties.

The FBAR and FATCA may be F(u)BAR, but ignoring them is not a sound strategy. By now I hope you understand that penalties for non-filers are stiff and the likelihood of the IRS discovering you has increased now most financial institutions are now required to report on US persons accounts to the IRS.

As for the Americans without foreign financial accounts, I hope you are concerned about the unintended consequences of FBAR and FATCA which are negative for the country. These consequences include the significant costs triggered for over seven million Americans and for US and foreign companies in which your international mutual funds are likely invested, the contempt for the US that has been created overseas and the surge in Americans renouncing their US citizenship.

Below are a few links that may be helpful to US persons who are associated with financial accounts overseas:


NOTES & DISCLOSURES

The above discussion is not intended as legal or tax advice, and cannot be relied upon for any purpose without the services of a qualified professional. The views expressed in this commentary are exclusively those of the author, and are not meant as investment advice and are subject to change without notice. The commentary does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive it. You should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. There is no guarantee that any investment program or account will be profitable or will not incur loss. You should note that security values may fluctuate and that each security's price or value may rise or fall. Past performance is not necessarily a guide to future performance. Individual client accounts may vary.

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