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Looking for a case study in how not to develop and implement tax policy? The Foreign Account Compliance Tax Act (FATCA) is the perfect place to start.
FATCA, slated to take effect July 1, was signed into law by President Obama in 2010 to target U.S. citizens who evade federal tax obligations by stashing money in overseas accounts. The promise was that extensive reporting obligations on both foreign financial institutions and U.S. citizens living and working abroad, with heavy penalties for non-compliance, would hold tax cheats to account and bring in billions of dollars in revenue.
But as has become par for the course with the nation’s bloated and dysfunctional tax code, the new law is rife with unintended consequences—the hallmark of a poorly conceived policy. And a long string of implementation snafus and delays only serve as further evidence that FATCA is not ready for prime time.
The most recent indication arrived on May 2, when the Internal Revenue Service (IRS) announced that FATCA compliance enforcement against financial institutions would be relaxed for the law’s first two years, so long as the institutions were making a “good faith effort” toward compliance.
FATCA supporters argue that treating the first two years as a “transition period” will serve to ease anxiety and create broader acceptance of the law.
"If the first several months are a disaster, it could lead to calls for its repeal," said J. Richard Harvey, a former IRS adviser who helped draft the law, tells The Wall Street Journal. "By signaling they will ease enforcement, they are hopefully taking some of the pressure off the initial implementation."
But it’s not entirely clear what will constitute a “good faith effort” in the eyes of IRS regulators, and how that determination will be made. That runs the risk of making enforcement a wholly subjective and discretionary act on the part of the IRS. Given the agency’s record of selective targeting of right-leaning political organizations that came to light last year, it will only add to the climate of unease and uncertainty that surrounds FATCA.
As we’ve detailed previously, FATCA’s flaws are numerous. The law was initially scheduled to take full effect in July 2013, but has been repeatedly pushed back. A flawed online registration system was scrapped in 2012, at a cost of $8.6 million, and rebuilt from the ground up. Slow progress at issuing regulations and developing the vast web of intergovernmental agreements that will govern FATCA have compounded the uncertainty.
No Relief for Overseas U.S. Taxpayers
Banks and other financial institutions have greeted the news of the enforcement delay with a sigh of relief. But there’s no such relief for the American taxpayers living and working overseas, who starting July 1 will find themselves subject to the law’s heavy-handed mandates and unforeseen consequences.
As Nigel Green, CEO of the deVere Group financial advisory firm, has warned, FATCA runs the risk of turning Americans overseas into “financial pariahs” as foreign financial institutions decline their business in order to sidestep U.S. tax reporting requirements.
“An increasing number of our U.S. expatriate clients are telling us that the potential onset of FATCA is making their lives difficult,” Greene explains in a January interview with the International Business Times. “Why? It’s expensive and highly complex for foreign financial institutions, such as non-U.S. banks, to become FATCA-compliant. As a result, many are simply rejecting business from American expats and firms operating globally – even if they have been clients for many years.”
While U.S. officials have downplayed the rejections and blocked accounts, it’s happening with some frequency. On May 2, The Wall Street Journal reported that Deutsche Bank AG, Germany’s largest bank, had notified U.S. account holders in Belgium that their accounts would be closed by June 10, citing compliance burdens imposed by FATCA. Similar horror stories abound among members of the American expatriate community.
In response, many of those Americans are voting with their feet. Over the last several years, FATCA’s intrusive and expensive mandates have spurred American citizens living abroad to surrender their passports and renounce their citizenship.
In 2013, 2,999 Americans and permanent residents renounced their citizenship or U.S. legal residency; for the first quarter of 2014, that number was 1,001. (By comparison, only 231 Americans expatriated in all of 2008.)
The number of expatriations in 2013 was an all-time high, and if current trends continue, 2014 could be another record year, according to tax attorney Andrew Mitchel, who tracks expatriation trends at his International Tax Blog.
While people cite differing reasons for renouncing their citizenship, the FATCA tax regime looms large as a decisive factor for many. And most don’t conform to the stereotype of wealthy international jet-setters—more likely, they’re middle-class earners whose work or family connections lured them overseas and they found themselves caught in the FATCA regulatory dragnet.
The Treasury Department’s stock response to critics has been to suggest they’re overstating the problems with FATCA. Yet a late 2013 report from the IRS’s own Office of the Taxpayer Advocate serves to validate the questions and concerns raised by FATCA critics, noting that the law “has the potential to be burdensome, overly broad and detrimental to taxpayer rights.”
“FATCA carries with it the potential for substantial resource burdens and significant due process concerns that will arise to the extent that the regime is not correctly and effectively implemented in practice as well as properly conceived in theory,” the IRS report notes.
But there’s little evidence that the agency has taken heed of the advocate’s report—and Americans living and working overseas are growing increasingly edgy as the July 1 FATCA launch grows nearer.