Information provided on this site is for general guidance only and is often simplified. Actual IRS procedures are complex, and taxpayers should obtain professional assistance or use IRS sources for complete information.

Overseas Investment Income

The IRS has done quite a thorough job of catching the income or capital gains from just about every kind of offshore or foreign investment that US residents can get involved in. Taxes are either applied as gains are made, or they are applied when an investment is realised, with taxes being calculated back over the period of the investment and compounded forward to the time of payment.

Some of the key tax collection mechanisms over the years have been aimed at Controlled Foreign Corporations, Foreign Personal Holding Companies, Foreign Investment Companies, Passive Foreign Investment Companies, Grantor Trust Provisions and Foreign Trust Reporting Requirements.

Although US citizens may still choose to set up offshore trusts, the rationale will be asset protection rather than tax minimisation. Trusts are caught by the legislation as much as other types of investment structure, and should be considered as tax-neutral at best.

As far as 'passive' income is concerned, international tax planning for US residents is therefore concerned with providing investment structures which are fiscally transparent, so that the gains from higher-yielding international or offshore investments can be taxed in the investor's hands on the same basis as domestic investments. This usually means employing limited partnership or limited liability company structures, which are provided by many offshore jurisdictions, which are usually un-taxed in the offshore jurisdiction, and which are treated as fiscally transparent by the IRS.

Straightforward investments into public offshore investment funds, which may offer superior returns to domestic funds, will be caught by the Passive Foreign Investment Company legislation, and it will often be correct to make a QEF election in order to pay tax year-by-year on the fund's increase in asset value (excluding unrealised capital gains).

Individuals who have significant 'active' business income may be able to make use of offshore corporate tax shelters, although the foreign sales corporation (outlawed by the WTO) has now been abolished.

www.lowtax.net contains details of the corporate and partnership legal structures available in the 35 most prominent offshore jurisdictions, together with descriptions of the most important business sectors in each jurisdiction, local tax regimes, and the international treaties entered into by each jurisdiction.

Foreign Bank Account Reporting (FBAR)

Under the Bank Secrecy Act, each United States person must file a Report of Foreign Bank and Financial Accounts (FBAR), if the person has a financial interest in, or signature authority (or other authority that is comparable to signature authority) over one or more accounts in a foreign country, and the aggregate value of all foreign financial accounts exceeds $10,000 at any time during the calendar year.

FATCA

The Qualified Intermediary program has been a key element of the IRS's regime for overseas investments by US citizens, but proposed changes to the program were put out to consultation by the IRS in October, 2008, requiring QIs to report all account holders that are US persons. In addition, the existence of, and transfers to, offshore accounts will need to be reported on tax returns (as well as foreign account, or 'FBAR' forms) while all US financial intermediaries will be required to report transfers of more than USD10,000 to or from a foreign bank, brokerage or other financial account on behalf of a US person (or an entity in which a US person has more than 50% of the ownership interest).

US source interest, dividends, and other forms of income paid to a non-qualified intermediary would be subject to 30% reporting, although eligible holders would be entitled to refunds. Also, a refundable 20% withholding tax would be imposed on gross proceeds paid to non-qualified intermediaries located in jurisdictions that do not have a comprehensive income tax treaty with satisfactory exchange of information provisions.

These rules were enacted in the Foreign Account Tax Compliance Act (FACTA) on March 18, 2010 within the Hiring Incentives to Restore Employment (HIRE) Act.

In September, the United States Treasury and the Internal Revenue Service (IRS) stated their intent to issue guidance on the reporting requirements imposed on foreign financial institutions (FFIs) by FATCA.

They are requesting public comments on the priority issues they have identified in the preliminary guidance on the application of the FATCA. The legislation makes a number of changes to tax law affecting individuals with foreign bank accounts and assets held abroad.

The FATCA provisions of the HIRE Act add a new chapter 4 to Subtitle A of the Internal Revenue Code. Chapter 4 expands the information reporting requirements imposed on FFIs, as defined in the proposed guidance, with respect to accounts held abroad by US residents.

FFIs are required to deduct and withhold a tax equal to 30% of the amount of any payment to an FFI unless the FFI agrees to disclose the identity of the US residents and report on their bank transactions. The IRS intends to publish a draft FFI Agreement and draft information reporting and certification forms, which will be electronically filed.

The name, address and taxpayer identification number (TIN) is required of each account holder which is a specified US person; and, in the case of any account holder which is a US-owned foreign entity, the name, address, and TIN of each substantial US owner of such entity. The account number is also required to be provided, together with the account balance or value, and the gross receipts and gross withdrawals or payments from the account.

To facilitate this process, the Treasury and the IRS contemplate that the IRS will issue employer identification numbers (EINs) to participating FFIs and that participating FFIs will use these EINs to identify themselves to withholding agents.

Chapter 4 is generally effective for payments made after December 31, 2012, and any US resident who holds more than USD50,000 in a depository or custodial account maintained by an FFI is required to report on any such account under this legislation.

The Treasury and the IRS intend to issue definitive guidance in advance of that effective date to ensure that affected FFIs have time to implement the systems and processes necessary to comply fully with the new withholding, documentation, and reporting obligations imposed.

An FFI is defined as any financial institution which is a foreign entity, and which accepts deposits in the ordinary course of a banking or similar business; holds financial assets for the account of others as a substantial portion of its business; and/or is engaged primarily in the business of investing, reinvesting, or trading in securities, partnership interests or commodities.

However, there are categories of business which have been excluded for having to report or withhold under the FATTCA. These include certain holding companies, start-up FFIs for the first 24 months of their operation, hedging/financial centres of a non-financial group, and the issuers of insurance contracts that have no cash value.