In 2010, the U.S. Congress enacted the Foreign Account Tax Compliance Act (FATCA) to prevent U.S. taxpayers from using hidden offshore bank accounts to commit tax evasion. But a massive loophole and poor enforcement by the Internal Revenue Service has enabled wealthy taxpayers to continue hiding billions of dollars offshore, according to a recent report from the U.S. Senate Finance Committee.
The Senate Finance Committee became aware of these issues due to an IRS investigation into alleged tax evasion by billionaire software businessman Robert Brockman. According to the government, Brockman allegedly used offshore bank accounts, foreign trusts, and a series of shell companies to hide about $2.7 billion in income from the IRS. Brockman, who passed away in August, allegedly used a loophole that allowed him to turn offshore shell companies into “shell banks” approved by the IRS. His case is unique because it is the largest tax evasion case brought against an individual, according to the Senate Finance Committee’s report, entitled The Shell Bank Loophole. But lawmakers are concerned that Brockman’s case could create a troubling precedent, since the U.S. tax system relies on voluntary compliance.
Twelve years after FATCA was enacted, the government continues to struggle with taxpayer compliance with offshore accounts. This is the case even though the IRS has spent nearly $600 million on enforcement. However, enforcement may become stronger now that the IRS will receive an extra $80 billion in funding from the Inflation Reduction Act.
What is FATCA
The U.S. government created FATCA to ensure transparency of U.S. taxpayers’ offshore financial accounts and combat tax evasion. Under the law, taxpayers with a certain threshold of foreign financial assets must file Form 8938, Statement of Specified Foreign Financial Assets. The thresholds, which start at $50,000 and top out at $600,000, depend on the taxpayer’s marital status and whether they live in the U.S. or abroad. Under FATCA, foreign financial institutions holding U.S. taxpayer assets are required to share account information with the IRS. Institutions that fail to do so are subject to a 30 percent withholding rate on their U.S. source payments.
The Global Intermediary Identification Number Loophole
Through FATCA, the U.S. has entered into intergovernmental reporting agreements with a number of partner countries. However, a key loophole remains in place. Under those agreements, foreign financial institutions do not have to investigate or share information about accounts if those accounts are held by foreign entities or other institutions that have been issued a Global Intermediary Identification Number (GIIN) by the IRS.
In Brockman’s case, he allegedly created offshore shell companies but portrayed them as financial institutions, which allowed him to obtain GIINs for those entities. The problem, according to the Senate Finance Committee report, is that there are “hundreds of thousands” of entities in FATCA partner jurisdictions that have GIINs approved by the IRS. Lawmakers believe this could enable large-scale tax evasion and money laundering, because it is easy to obtain a GIIN. In order to obtain a GIIN, an entity must file Form 8957, Foreign Account Tax Compliance Act Registration, with the IRS or register online. According to the Senate report, applications are “almost always approved without meaningful investigation or due diligence from IRS personnel.”
“The IRS simply does not have the personnel or the capabilities to adequately monitor whether these offshore entities are properly identifying and reporting accounts belonging to U.S. persons,” the report says.
Next Steps on the Road to Enforcement
The Senate Finance Committee has some ideas about how the IRS can close this GIIN loophole. Among them, the Committee suggests the IRS should strengthen the IRS Whistleblower Office and offer stronger incentives for potential whistleblowers. It also suggests the IRS should screen GIIN applications more rigorously and impose extra due-diligence requirements on large transfers of funds into relatively small, closely held foreign financial institutions.
Lastly, the Senate Finance Committee is urging the IRS to use its new funding to hire more revenue agents and boost its enforcement activities. In particular, the Committee wants the IRS to increase its audits of partnerships and increase information sharing and coordination with its partner jurisdictions. The Senate Finance Committee report casts a strong spotlight on U.S. taxpayers with offshore financial accounts and it is clear that lawmakers want as much transparency as possible. As such, U.S. taxpayers with foreign financial accounts should seek the advice of an experienced international tax professional to understand the changing landscape and ensure they comply with FATCA.