The Tax Implications of Opening a Foreign Bank Account

The Internal Revenue Service (IRS) treats money held in foreign bank accounts differently than money held in domestic accounts. In some cases, the IRS has taken steps to discourage foreign account usage, mostly out of fear of being unable to take revenue from such accounts. For Americans who have assets with foreign institutions – whatever the reason – this is an area of serious concern.

An example from 2014 that illustrates this well was when the IRS mandated all U.S. taxpayers with offshore accounts totaling more than $10,000 had until June 30 to file a new Financial Crimes Enforcement Network (FinCEN) Form 114 or else be subject to a penalty of as much as 50% of their assets.

The fact is most foreign banks do not want deposits from U.S. citizens. This is increasingly the case in traditional destinations, such as Switzerland and the United Kingdom, because of increased aggressiveness from the IRS and the Department of Justice (DOJ). Foreign banks are only willing to devote so much time and energy to courting American clients, and very few have the type of compliance department that can handle complex U.S. regulations and heightened scrutiny.

Americans who want to open foreign bank accounts should consider this hurdle and do what they can to clear up credit concerns or other risk flags. Simply being an American citizen who is subject to IRS taxation can be risky enough to make an overseas bank hesitate, so it is a good idea to seem less risky on an individual level.

Unlike almost every other country in the world, the U.S. government levies taxes on its citizens on income earned anywhere in the world, even if the activity only took place with foreign capital and with foreign trading partners. In fact, the U.S. is the only developed nation that taxes global activity.

What this means is an American expatriate living and working in Germany has to pay income taxes to both the German government and the U.S. federal government. If the American worker deposits his monthly earnings into a German bank, the IRS can grant itself access to that account to collect taxes. There are some relief provisions, including a partial credit for foreign taxes paid on overseas income, but they are often insufficient.

Not all foreign account holders engage in economic activity abroad, which means they do not have to worry about this double taxation. However, concerned workers and investors need to file returns with the IRS.

Since foreign accounts are taxable, the IRS and Treasury Department have a very rigid process for declaring overseas assets. Any American citizen with foreign bank accounts totaling more than $10,000 in aggregate, or at any time during the calendar year, is required to report such accounts to the Treasury. He is also required to report and pay tax on all income from these accounts, except so-called "signature authority accounts."

From the 1970s until June 2013, foreign account holders filed under Treasury Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts, better known as an FBAR. Forms were due annually and processed in the Treasury office in Detroit.

After June 2013, the Treasury announced the paper-based FBAR was no longer acceptable. Instead, foreign account owners needed to electronically fill out the FinCEN Form 114, also titled FBAR. The new FinCEN 114 included more information and had to pass through the Treasury's Bank Secrecy Act E-Filing System. This new FBAR did not replace an income tax filing but was instead a separate document to be submitted individually.

Congress passed the Foreign Account Tax Compliance Act (FATCA) in 2010 without much fanfare. One reason the act was so quiet was its four-year-long ramp up – FATCA did not take effect until 2014. Never before had a single national government attempted, and so far succeeded in, forcing compliance standards on banks across the world.

FATCA requires any non-U.S. bank to report accounts held by American citizens worth over $50,000 or else be subject to 30% withholding penalties and possible exclusion from U.S. markets. By mid-2015, more than 100,000 foreign entities had agreed to share financial information with the IRS. Even Russia and China agreed to the FATCA. The only major global economy to fight the Feds is Canada; however, it was private citizens, not the Canadian government, who filed suit to block FATCA under the International Governmental Agreement clause making it illegal to turn over private bank account information.

Through FATCA, the IRS receives account numbers, balances, names, addresses and identification numbers of account holders. Americans with foreign accounts must also submit Form 8938 to the IRS in addition to the largely redundant FBAR form. Those interested in opening a foreign bank account must be aware of these requirements and possible tax penalties, especially for retirement accounts abroad, which have their own unique treatment.

The popular colloquial notion of offshore tax evasion includes a multi-millionaire U.S. citizen who has a fancy, secret bank account in Geneva. In reality, millions of Americans open offshore bank accounts for a huge number of reasons. The U.S. State Department estimated that 8.7 million Americans lived abroad in 2015 and many millions more had foreign accounts, yet less than 1 million taxpayers filed FBARs to declare these assets.

Obviously, plenty of foreign account holders are not reporting assets. Since 2009, however, the IRS has emphasized compliance, and Americans are more likely than ever to face stiff fines and penalties for nondisclosure. Individuals can be penalized with up to $500,000 and a prison sentence of up to 10 years for failure to file an FBAR.

Even more serious than non-disclosure is a failure to pay taxes on income earned and deposited into a foreign bank account. The federal government can bring civil and criminal charges against those who do not pay Uncle Sam, even by accident. Keep in mind that all foreign accounts need to be reported to the IRS, even if the accounts do not generate any taxable income.