Foreign Bank Account Opening: Avoiding Tax Filing Triggers

Foreign Bank Account Opening: Avoiding Tax Filing Triggers
Updated on April 25, 2024

Whether you live abroad, have a foreign-based business, or both, opening a foreign bank account has numerous benefits. First, it can help you function financially in your country of choice. But, there are other benefits as well, such as obtaining access to investment opportunities not available in the US, fewer fees, less fuss about currency fluctuations, increased privacy, and extra financial stability if US markets begin to struggle. However, these benefits do not come without potential pitfalls. Knowing these tips for opening offshore bank accounts in advance can help you strategize and avoid traps.

FATCA Makes Opening Offshore Bank Accounts Tricky

The primary reason opening an offshore bank bank account can be difficult is due to increased US compliance requirements by banks, businesses, and individuals, due to the Foreign Account Tax Compliance Act (FATCA). For individual taxpayers, FATCA introduces filing requirements only; no taxes are assessed on foreign bank accounts simply because they are foreign. You should keep in mind, however, that if interest is earned, that could be taxable (though, possibly offset using the Foreign Tax Credit). FATCA requires a FinCEN Form 114 (FBAR, or Foreign Bank Account Report) to be filed if there is $10,000 or more in aggregate in foreign bank accounts. To determine if you have a filing requirement, check the amount of money in your foreign bank accounts on the days when the sums were highest, and if they all add up to $10,000 or more, you’ll be required to complete an FBAR filing. Even if they are at $10,000 for only a single moment out of the whole year, a filing requirement is still triggered.

What Counts as a Foreign Account

What are foreign accounts, you may ask? The IRS defines foreign financial accounts as any financial accounts located abroad. This can include bank accounts, securities accounts, foreign retirement and pension accounts, and even prepaid debit cards! There are exceptions, so speaking with an expert before opening an offshore bank account is helpful if you’re in need of clarifications or have a unique situation. Knowing what is considered a foreign account is important, as unfiled FBARs can be subjected to $10,000 per violation. If the IRS believes you avoided filing purposefully, the fine can be $100,000 or 50% of the balance of the account at the time of the violation – whichever is greater.

A Word About Foreign Brokerage Accounts

Many investments in foreign securities are considered PFICs (passive foreign investment companies) by the IRS and subjected to additional tax and reporting requirements.

A foreign corporation is considered a PFIC if it meets either an income or an asset test.

  • Income Test – If at least 75% of the corporation’s annual gross income is categorized as investment-type income (interest, dividends, capital gains, royalties, etc.).
  • Asset Test – If at least 50% of the average percentage of its assets produce or are held to produce passive income.

Generally, foreign mutual funds (or other pooled investments) held by foreign brokerages or financial service providers will be considered PFICs.

If you are a direct or indirect shareholder of a PFIC, you must file Form 8621 with your US expatriate taxes each year that you:

  • Have a gain on a direct or indirect disposition of PFIC stock, or
  • Receive certain direct or indirect distributions from a PFIC, or
  • Make an election reportable on Form 8621

This can result in additional tax due, and it can greatly complicate your tax filings. Offshore investment accounts tend to hold a much more aggressive tax treatment than US accounts, which most US citizens may not realize until they’ve already made an investment. US mutual funds (which invest in foreign stocks) would have a long-term capital gains tax of 15%; however, a similar fund in the UK or anywhere outside the US for that matter would produce “ordinary income” in the eyes of the IRS, meaning you would be taxed at your top individual rate of 37%. Additionally, PFICs don’t have the same advantages when it comes to capital losses, which can’t be carried forward or used to lower other capital gains.

Some Offshore Bank Accounts Require Even More Reporting, Like Forms 3520 and 3520-A

Some accounts, particularly foreign retirement accounts, can trigger Form 3520 or Form 3520-A reporting, as the IRS may view these as foreign grantor trusts.

Let’s examine an example of Jane Q. Taxpayer, a US citizen who lives in Spain and opens a private pension plan. Jane makes all contributions to the plan, and it is managed by a trustee who takes title to the property to conserve the funds for her, the beneficiary. The trust is protected from creditors. Upon analysis, the trust is deemed to qualify as a foreign grantor trust.

Since Jane is a US person who satisfies the ownership rules of a foreign trust and has also transferred money to the foreign trust, she has a requirement to file Form 3520, which is an “Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts.” Additionally, as the US owner of a foreign grantor trust, Form 3520-A, which is an “Annual Information Return of Foreign Trust with a US Owner,” must also be filed.

Non-Compliance Penalties and Taxes When Opening a Foreign Bank Account

Penalties for non-compliance can be large. Failure to file a timely Form 3520-A, failure to file all information, or filing includes incorrect information: The initial penalty is the greater of $10,000 or 5% of the gross value of the portion of the trust’s assets treated as owned by the US person at the close of the tax year.

Failure to file a timely Form 3520 (Part II), failure to furnish all information required, furnishes incorrect information: This additional separate penalty is the greater of $10,000 or 5% of the gross value of the portion of the trust’s assets treated as owned by the US person at the close of that tax year.

Failure to report the creation or transfer to a foreign trust: 35% of the gross value of any property transferred to a foreign trust.

Failure to report distributions received from a foreign trust by a US person: 35% of the gross value of the distributions.

In some situations, one account—for example, a foreign investment account that is treated as a foreign grantor trust—could trigger requirements for all of the forms discussed: FBAR, Forms 3520/3520-A, and Form 8621!

While all of these are considerations when opening foreign accounts, they should not dissuade you from opening foreign accounts. The key is understanding the ramifications when opening a foreign bank account so you can plan for your financial future.

Have Questions About Opening Offshore Bank Accounts?

Greenback can help. Our dedicated CPAs and IRS Enrolled Agents can assist you with your US expatriate taxes every step of the way, including opening a foreign bank account. Get started with Greenback today.

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