What is Offshore Banking: Guide to Taxes and Legalities

What is Offshore Banking?

With the globalization of the US economy, the concept of offshore banking has become more common — and less shrouded in mystery and suspense.  There are many reasons why a U.S. Person may want to consider offshore banking as an option to either protect their assets, expand their global reach, or make it easier for an offshore business to operate in local currency. While in general, offshore banking may have a reputation as being seedy or only used to hide illicit funds — these presumptions are simply not accurate when considering operating in a global marketplace. It is important for taxpayers who are considering using offshore banking to understand the benefits and the risks it may pose.

Is Offshore Banking Legal?

Yes, there is nothing illegal about opening an offshore bank account. While in recent years, and primarily due to FATCA (Foreign Account Tax Compliance Act), it has become more difficult for US persons to open an offshore bank account, there is nothing inherently improper about having such an account. It is important to note though, that US persons who have foreign accounts are required to disclose this information annually to the IRS on one or multiple different international information reporting forms.

Is Offshore Banking Safe?

Whether or not offshore banking is safe or not is ‘relative’ depending on various factors. For example, if you are going to a non-treaty country that does not have strong banking regulations, then your money will be less safe than if you go to a foreign country that has strict regulations. While the term offshore is a general term, there are different rules and regulations depending on which country you operate your offshore banking in.

Is there Protection From Creditors?

Simply using offshore banking as a means for moving assets outside of the United States to avoid creditors may not accomplish the ultimate goal of keeping your assets away from creditors. That is because there are ways for creditors to try to go after assets that are overseas. With that said, it is usually much more difficult to go after an offshore bank account than it would be a US-based bank account. This is especially true if the account is placed into an offshore asset protection trust in a location such as Nevis or the Cook Islands.

Do I Pay U.S. Taxes on Offshore Account Income?

Another important fact to consider is that the United States follows a worldwide taxation model, otherwise known as Citizenship Based Taxation (CBT). While the name ‘Citizenship Based Taxation’ may give the impression that it is limited to only US Citizens, this is a misnomer as it also includes US Lawful Permanent Residents and Foreign Nationals who meet the Substantial Presence Test as well. The reason why this is important is that Taxpayers should be aware that any income generated from an offshore bank account such as dividends, interest, or capital gains is still taxable in the United States.

Do I Report Offshore Bank Accounts to the IRS?

There are many different international information reporting forms that a US taxpayer may have to file with the IRS and FinCEN when they have offshore bank accounts. Depending on whether they are maintaining offshore checking/savings accounts, investment accounts, and/or foreign trust accounts will determine whether they have to file forms such as the FBAR, Form 3520, Form 3520-A Form 8938, and PFIC Form 8621.

No FDIC

One other key factor to keep in mind when using offshore banks is that typically they do not offer FDIC-insured comparable protections. FDIC insured is unique to the United States and other countries that operate in more regulated and defined banking systems. By placing money offshore, there is always the risk that the institution will go under or that country’s banking regulations will change whereas it may become more difficult for a US person to access their money.

Current Year vs Prior Year Non-Compliance

Once a taxpayer has missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.