New Tax Law Threatens Financial Markets

The Law of Unintended Consequences has been confirmed once again by Congress.

Passed as an enhancement to an already failing tax regime, Congress enacted what is known as the Foreign Account Compliance Act.

Sounds like a good idea. After all, who would complain about making taxpayers report and pay tax on their foreign financial accounts?

As it turns out, most of the world’s financial and many non-financial institutions are not only unhappy but are beginning to retaliate in ways neither Congress nor the Treasury seem to have seriously taken into account.

For nearly four decades, Congress and the Treasury have been chasing the mythical pot of untaxed gold which they believe exists in “tax havens” around the world. Ignoring, of course, that the United States is the biggest tax haven of all.

Foreign accounts have been required to be reported by U.S. taxpayers since the 1970s by what is commonly referred to as FBAR filing with the U.S. Treasury and not the IRS. The IRS, on its own, upped the ante by issuing withholding regulations impacting foreign financial institutions know as the Qualified Intermediary rules.

The result of this tax regime is that foreign financial institutions and even non-financial institutions are starting to refuse to have Americans as customers or even buying American securities and other investments.

The impact is just becoming noticeable in the investment markets while the tax revenues projected by Congress have not yet to be seen.

In a recent New York Times article, Law to Find Tax Evaders Denounced, a former Treasury adviser is quoted as saying the new legislation is “really kind of insane.”

What is the goal of this tax regime?

As observed by the head of global tax compliance for Deloitte, “They’re trying to force every financial institution in the world to sign onto this regime.”

Why is the Congress and the Treasury using a sledgehammer on financial institutions which the United States needs as friendly investors?

The claim is that the Treasury will be able to get an additional $10 billion a year in taxes.

The non-U.S. institutions claim that if they comply, they will have to spend between $200 billion to $300 billion of costs plus become directly subject to civil and, possibly, criminal liability.

What would you do if you were not an American institution and the IRS demanded that you become subject to IRS assessing penalties or fines that could put you out of business, if not in jail?

The foreign financial institutions are doing the same thing you would if stuck in this position. They are already refusing to have American customers and some have begun dumping any form of U.S. securities.

For those who invest, do business, or just have some form of an account outside the United States, this is notice that your tax returns are going to become a lot more expensive to prepare.

If you don’t have a foreign tax professional on retainer, it’s time to get one.

For all who are investors in the U.S. markets, expect some thin trading and volatile markets.

In my view, this is just a small snowball but heading quickly down a very high mountain covered in very deep snow.

There isn’t much any of us can do to change Congress, but there is still time to realize that the American investment markets are threatened by this tax regime.