Should We Have Just Written a Check: The Cost of F.A.T.C.A. and Its Counterparts Abroad

INTRODUCTION

In February of 2009, the Union Bank of Switzerland agreed to pay $780 million to the United States government(1) and turn over names of individuals who sought to evade their U.S. tax filing obligations and obligations to report investments and income required by the Bank Secrecy Act.(2)?

In 2010, Congress passed the Foreign Account Tax Compliance Act (“F.A.T.C.A.”). Among other things, F.A.T.C.A. requires foreign financial institutions (“F.F.I.’s”) to report information regarding foreign accounts held by U.S. taxpayers or foreign entities in which U.S. taxpayers hold a substantial ownership interest.(3)

Various foreign governments demanded reciprocal information sharing, and the Obama administration obliged the demands. Under the final regulations and a victory over the banking industry in Florida,(4) banks in the U.S. were required to report interest payments of $10 or more paid to nonresident alien individuals.(5)?

In February 2012,?the U.S., France, Germany, Italy, Spain and the U.K. entered into a joint understanding regarding the adoption of an intergovernmental approach to improving international tax compliance and implementing F.A.T.C.A.?through intergovernmental agreements (“I.G.A.’s”). This led to a Model I.G.A. published by the Treasury Department in July 2012, the initial I.G.A. with the U.K. in September 2012, more than 110 I.G.A.’s in place, and some in the process of negotiation.??

An I.G.A. is a bilateral agreement that acts as a workaround to local law restrictions on the sharing of personal information held by banks and other financial institutions. Two models exist. The Model 1 I.G.A. requires the F.F.I. to report the information to its respective government, and the information is exchanged with the U.S. The exchange may be reciprocal or nonreciprocal. The Model 2 I.G.A. requires the F.F.I. to report information directly to the I.R.S.(6)

The quest to unveil offshore accounts held by U.S. individuals has placed a burden on domestic banks to report accounts held by nonresident aliens. In April 2013, two banking associations sued the Treasury Department under the Administrative Procedure Act and the Regulatory Flexibility Act, claiming that the new reporting requirements would discourage foreign investment in the United States and would be overly burdensome for some banks.(7) The?suit was unsuccessful, and the reporting obligations imposed on banks ultimately went into effect.(8)

THE REQUIREMENTS

The tax gap provides a rough estimate of the level of overall noncompliance within a particular period. In Tax Years 2008-2010 the revised net compliance rate was 85.8%.(9) Following the UBS scandal in 2009, Switzerland agreed to turn over thousands of American UBS clients to U.S. authorities.(10) Former commissioner Shulman created an amnesty period for U.S. taxpayers to come forward with information regarding their other offshore accounts. More than 15,000 came forward with hidden accounts at various banks.(11) Nonetheless, in Tax Years 2011-2013 the net compliance rate remained the same as it was in the Tax Years 2008-2010.(12)?

Over the course of a decade, the Code and regulations were amended. To that end, Treas. Reg. §1.6049-4(b)(5) now includes a reporting requirement for interest paid to a nonresident alien during the year that aggregates $10 or more.?

COST OF REPORTING REQUIREMENTS

On August 18, 2017, the Sixth Circuit Court of Appeals issued its decision in Crawford v. United States Department of the Treasury. Seven plaintiffs addressed a variety of issues with the reporting requirements and their enforcement. The plaintiffs sought to enjoin the enforcement of F.A.T.C.A., the I.G.A.s, and the F.B.A.R’s. The case was dismissed for lack of standing among the plaintiffs.(13) On April 2, 2018, the United States Supreme Court denied the petition for writ of certiorari.(14)

The issues presented by the plaintiffs in the case were the same or similar as those unsuccessfully presented by the banking associations several years earlier. Plaintiff Crawford discussed how a Copenhagen bank would not accept United States clients because it did not want to assume the burden of reporting.(15) Plaintiff Kuettel renounced his citizenship due to F.A.T.C.A. but may still have to disclose information because his daughter is a citizen of the United States.(16) Plaintiff Zell was an American and Israeli citizen working as an attorney in Israel. Israeli financial institutions required I.R.S. forms even for his non-U.S. clients and required the closing of his accounts and the transfer of funds to other institutions because he was a U.S. citizen.(17)

Senator Rand Paul acted as a plaintiff in the Crawford case. He challenged the constitutionality of the I.G.A.’s because he was denied the ability to vote against the I.G.A.’s, which is his Constitutional right and duty in connection with treaties of the U.S.?However, an I.G.A. is not a treaty, but only an administrative agreement. Judge Boggs(18) addressed Senator Paul’s argument stating that he “has a remedy in the legislature, which is to seek repeal or amendment of F.A.T.C.A. itself, under the aegis of which the Treasury is executing the I.G.A.s.”(19) No legislation has been passed to alter F.A.T.C.A. or challenge the Department’s agreements.

F.A.T.C.A.’s enactment created a burden on F.F.I.s when accepting U.S. clients, which has led to the loss of financial opportunities for U.S. taxpayers. Sanat Vallikappen, of the Washington Post lamented as follows:

Go away, American millionaires. That’s what some of the world’s largest wealth-management are saying ahead of Washington’s implementation of [F.A.T.C.A.] * * * * HSBC, Deutsche Bank, Bank of Singapore and DBS Group all say they have turned away business.(20)

Being turned away from banks is not the only problem for taxpayers.

The reporting obligations terminated a period of salutary neglect by Americans abroad regarding tax return filing obligations. The once valuable U.S. passport became viewed as more of a burden than a blessing. Americans abroad began renouncing U.S. citizenship more than in previous years. The number of individuals renouncing their U.S. citizenship in 2011 amounted to 1,780, eight times more than in 2008.(21)

I.G.A.’s placed a reciprocal burden on banks when a client from a partnering nation opened an account at a U.S. financial institution. For instance, the Model 1 agreement with Thailand states that a Thai Reportable Account is an account maintained by a reporting U.S. financial institution if it meets certain requirements.?(22)

Domestically, regulations were updated to ensure domestic banks included accounts held by nonresident alien individuals when reporting.(23) Internationally, partner nations prepared for F.A.T.C.A. compliance. The agreement with Thailand was signed on March 4, 2016. By 2017, Thailand’s Revenue Department began testing an online system that would allow Thai financial institutions to submit information pertaining to U.S. reportable accounts.(24)

Since the initial responses to F.A.T.C.A. and the I.G.A’.s, nations have begun seeing value in reporting requirements and information exchange. As of April 25, 2019, 105 jurisdictions were parties to the O.E.C.D.’s Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information.?It calls upon participating jurisdictions to exchange financial account information automatically with other participating jurisdictions.(25) Switzerland, known for bank secrecy, is a participating jurisdiction.(26) The financial privacy afforded to taxpayers in the past is quickly fading.

Enforcing F.A.T.C.A. compliance has led to renunciations of citizenship, international agreements, implementation of international reporting systems, a reduction in financial privacy, and other costs. However, the financial burden may have been the heaviest to bear. It was estimated that each large multinational financial institution would incur approximately $100 million in costs to comply with F.A.T.C.A.(27) Kyle Pomerleu of the Tax Foundation wrote:

The biggest issue with FATCA is that it is exceedingly complex and creates compliance costs that exceed its revenue projections. Not only will U.S. citizens living abroad need to file more paperwork, financial institutions will need to do so too. The total cost of this new compliance burden is estimated to be about $8 billion a year. This compliance cost is estimated to be 10 times greater than the expected revenue gain of $800 million a year. This casts large doubts on whether this law is worth it at all. (28)

James Broderick, the former head of JP Morgan’s European, Middle Eastern and African management business, suggested, “It would be easier to just write a check to the I.R.S.”(29) Taxpayers and foreign financial institutions can only hope that all these costs were worth it.

BRIDGING THE TAX GAP

The gross tax gap is the difference between the total tax liability and the amount paid on time.(30) In 2019, the I.R.S. released research that showed the average annual gross tax gap for the 2011-2013 tax years. The gross tax gap for that period was $441 billion, which is roughly 16% of the total tax liability.(31)

It is noteworthy that the gross tax gap is partially speculative. While audits can detect unintentional errors made by taxpayers, they cannot detect all forms of deliberate cheating.(32) In 2010, Andrew Johns and Joel Slemrod explained the following:

Perhaps the most striking aspect of the aggregate tax gap estimates is the huge variation in the rate of misreporting as a percentage of true income by type of income (or offset). Only 1 percent of wages and salaries and 4 percent of taxable interest and dividends are misreported, all of which must be reported to the IRS by those who pay them; in addition, wages and salaries are subject to employer withholding. In sharp contrast, self-employment business income, which is not subject to information reports, has a sharply higher estimated net misreporting percentage (NMP): an estimated 57 percent of nonfarm proprietor income is not reported, a total of $68 billion, which by itself accounts for more than a third of the total estimated underreporting for the individual income tax. Over half is attributable to the underreporting of business income, of which nonfarm proprietor income is the largest component.(33)

Where withholding and reporting are required, tax compliance is higher.

The reporting requirements and increased global compliance should assist the I.R.S. and other countries’ tax authorities in closing the tax gap. However, the I.R.S. has not yet provided numbers to support the implementation of these reporting requirements. It is likely that the impact of F.A.T.C.A. and the I.G.A.s will be reported by the I.R.S. in the near future, possibly even this year.?

CONCLUSION

In order to determine the true impact of F.A.T.C.A. and the I.G.A.s, taxpayers need to see information supporting a shrinkage in the tax gap beginning in the year 2014. Until then, financial institutions and taxpayers across the globe are left wondering if the cost of implementation was worth the governmental benefit. It is likely that increased reporting will decrease the tax gap.

The buzzword among governments is that transparency yields higher collections. The Corporate Transparency Act, F.A.T.C.A, CbC reporting, and beneficial owner registers in Europe and elsewhere are examples of developments in transparency as to wealth and profits. Taxpayers rightfully want to know whether they just should have written a check to governments or if F.A.T.C.A. has benefitted the U.S. Treasury and its counterparts abroad. The jury is still out at this time.?

CITATIONS

1. Manisha Arora, UBS Agrees to Pay $780 Million, Forbes (Feb. 18, 2009, 7:00 PM), https://www.forbes.com/2009/02/18/ubs-fraud-offshore-personal-finance_ubs.html?sh=10d6d5af71da.
2. 31 USC 5311 et seq.
3. Foreign Account Tax Compliance Act, U.S. Department of the Treasury (last visited Mar. 4, 2022, 5:38 PM), https://home.treasury.gov/policy-issues/tax-policy/foreign-account-tax-compliance-act.
4. Kevin Drawbaugh, Dena Aubin, and Patrick Temple-West, Bankers’ Lawsuit Jeopardizes U.S. Tax Dodger Crackdown, Reuters (Nov. 12, 2013, 5:47 PM), https://www.reuters.com/article/us-usa-bank-fatca-idUSBRE9AB18K20131112?edition-redirect=ca.
5. 77 F.R. 3391
6. Dr. Anthony P. Polito, U.S. International Withholding and Reporting Requirements and FATCA, Bloomberg Tax Practice Series 7170.07D (last visited March 24, 2021, 1:01 PM).
7. Kevin Drawbaugh, et al., Bankers’ Lawsuit Jeopardizes U.S. Tax Dodger Crackdown, Reuters (Nov. 12, 2013, 5:47 PM), https://www.reuters.com/article/us-usa-bank-fatca-idUSBRE9AB18K20131112?edition-redirect=ca.
8. Fla. Bankers Ass’n v. United States Dep’t of Treasury, 19 F. Supp. 3d 111, 114 (DC Dist. 2014).
9. Publication 1415.
10. Jason Rhodes and Kim Dixon, Swiss to Reveal UBS Accounts to Settle U.S. Tax Battle, Reuters (Aug. 19, 2009, 5:20 AM), https://www.reuters.com/article/us-ubs/swiss-to-reveal-ubs-accounts-to-settle-u-s-tax-battle-idUSLJ59987220090819.
11. Lynnley Browning, U.S. Ends Inquiry of UBS Over Offshore Tax Evasion, The New York Times (Nov. 16, 2010), https://www.nytimes.com/2010/11/17/business/17tax.html.
12. Publication 1415
13. Crawford v. U.S. Dep’t of the Treasury, 868 F.3d 438 (2017).?
14. Crawford v. U.S. Dep’t of the Treasury, 138 S. Ct. 1441 (2018).
15. Crawford, 868 F.3d at 443-444.
16. Id. at 444.?
17. Id. at 445.
18. Judge Danny J. Boggs is known for administering a general knowledge test to those he considered for his clerkship. The New Yorker even did a profile on him entitled “The Honorable Answer Man.” Jonathan Kay, The Honorable Answer Man, The New Yorker (May 6, 2001), https://www.newyorker.com/magazine/2001/05/14/the-honorable-answer-man.?
19. Crawford, 868 F.3d at 460.
20. Sanat Vallikappen, Foreign Banks Freezing Out U.S. Millionaires, The Washington Post (May 12, 2012), https://www.washingtonpost.com/business/foreign-banks-freezing-out-us-millionaires/2012/05/11/gIQABfXRLU_story.html.?
21. Brian Knowlton, Many Americans Abroad Surprised by Tax Code’s Nasty Bite, The New York Times (May 10, 2012), https://www.nytimes.com/2012/05/11/us/11iht-expats11.html?auth=linked-google.
22. Agreement between the Government of the United States of America and the Government of the Kingdom of Thailand to Improve International Tax Compliance and to Implement FATCA, Thai-US, art. I §bb, Jun. 30, 2014.
23. ?Treas. Reg. 1.6049-4(b)(5).
24. Rachanee Prasongprasit & Piphob Veraphong, New Tax Legislation to Comply with Fatca, Bangkok Post (May 16, 2017), https://www.bangkokpost.com/business/1250374/new-tax-legislation-to-comply-with-fatca.
25. Multilateral Competent Authority Agreement, OECD (last visited Apr. 1, 2021, 12:58 PM), https://www.oecd.org/tax/exchange-of-tax-information/multilateral-competent-authority-agreement.htm.?
26. William McBride, FATCA, Automatic Information Exchange, and the End of Financial Privacy, Tax Foundation (Nov. 20, 2014), https://taxfoundation.org/fatca-automatic-information-exchange-and-end-financial-privacy/.?
27. Robert W. Wood, FATCA Carries Fat Price Tag, Forbes (Apr. 1, 2021, 3:48 PM), https://www.forbes.com/sites/robertwood/2011/11/30/fatca-carries-fat-price-tag/?sh=32dae0054ae9.?
28. Kyle Pomerleau, Foreign Account Tax Compliance Act (FATCA) Goes Into Force Today, Tax Foundation (July 1, 2014) https://taxfoundation.org/foreign-account-tax-compliance-act-fatca-goes-force-today;.
29. Robert W. Wood, FATCA Carries Fat Price Tag, Forbes (Nov. 30, 2011, 6:12 AM), https://www.forbes.com/sites/robertwood/2011/11/30/fatca-carries-fat-price-tag/?sh=32dae0054ae9.
30. IRS The Tax Gap, IRS (last visited Apr. 7, 2021, 10:04 AM), https://www.irs.gov/statistics/irs-the-tax-gap.
31. What Is the Tax Gap, Tax Policy Center (updated May 2020), https://www.taxpolicycenter.org/briefing-book/what-taxgap#:~:text=Individual%20Taxes-,What%20is%20the%20tax%20gap%3F,percent%20of%20total%20tax%20liability.
32. Brian Erard and Jonathan Feinstein, The Individual Income Reporting Gap: What We See and What We Don’t, IRS Research Bulletin: Proceedings of the 2011 IRS/TPC Research Conference, 129-142. Publication 1500 (rev 4-2012).
33. Andrew Johns and Joel Slemrod, The Distribution of Income Tax Noncompliance, National Tax Journal Sept. 2010, at 397, 403.