For Americans in Israel, the U.S. Tax Man Cometh

It is estimated that hundreds of thousands of American citizens and holders of permanent residency status in the United States live in Israel. While U.S. citizens are required to file reports with the Internal Revenue Service about their incomes and holdings in foreign banks even if they live abroad, it is thought that large numbers of people who have dual American-Israeli citizenship and live in Israel have failed to do so.

The good news is that according to a new procedure, Americans living abroad will not incur a fine for undisclosed income in foreign accounts under some circumstances if they come forward about them on their own.

In Israel some changes afoot are a result of an agreement reached between Finance Minister Yair Lapid and the IRS, which demands that banks and other financial institutions in Israel report on accounts held by U.S. citizens. Those citizens who fail to disclose information about accounts as required by U.S. law will face stiff fines. Up to now, the penalty was 27% of the amount of money in a given account, but this week it was increased to 50%.

However, U.S. authorities will now be somewhat more lenient with Americans abroad under certain circumstances, should they voluntarily disclose previously unreported assets.

The new agreement between Israel and the United States was finalized in May between the Finance Ministry and the U.S. Treasury Department, carrying out the provisions of American legislation called the Foreign Account Tax Compliance Act. FATCA, as it is called, was passed by Congress in 2010 in an effort to rein in tax evasion by Americans holding bank accounts outside the United States.

The U.S.-Israeli agreement in this regard regulates the flow of information from Israeli banks and other financial institutions to the IRS via the Israel Tax Authority, and asks Israeli financial entities to provide information regarding accounts of American citizens and people with green cards – i.e., Israelis with permanent resident status in the United States. American tax authorities have entered similar bilateral agreements with a number of countries.

Yair Zorea, a lawyer in the international tax department at the accounting firm of PwC Israel Kesselman & Kesselman, recounts how he was contacted by a client in his 80s who is an American citizen and had $40 million in a Swiss bank account that had not been reported to the IRS.

“Several years ago the bank demanded that he confirm that he had reported the funds to the tax authority in the United States, or alternatively that he withdraw the money from the account,” Zorea says. The client had fled Europe to the United States during World War II, remained there for some decades and then immigrated to Israel.

“He has never set foot in the United States [since],” Zorea states, adding that the client also did not inform U.S. authorities of an inheritance that he received years later. “We calculated the penalties and they came to 50% of the money in the [bank] account, meaning he would have to pay $20 million. Ultimately, he preferred to withdraw the funds from the account and buy real estate with it in a foreign country,”

The existing Israeli-U.S. tax agreement is part of a broader trend toward encouraging disclosure and breaking down financial barriers. In June, Bank Leumi reported that it was in advanced talks with the U.S. Justice Department in an effort to resolve an investigation over suspicions that the bank had helped American customers evade taxes between 2002 and 2010. The case will cost the bank 950 million shekels (about $278 million).

The fine Leumi will pay includes taxes its customers had failed to pay in the United States on money stashed away in Leumi accounts. It also includes repayment by the bank of the revenues it derived from its American clients. And this is not just a problem for Leumi: Bank Hapoalim and Mizrahi Tefahot are also under investigation.

For Israelis who have American citizenship, however, there is generally good news now, after U.S. authorities have updated voluntary disclosure procedures. Now Americans living abroad can report income from offshore accounts without incurring fines.

Zorea: “There is a window of opportunity here for American citizens living in Israel who up to now have not filed reports with the U.S. tax authorities. With the help of the new directives, they can resolve matters within a relatively short time. Within a few weeks, they can arrange the relevant papers, file reports and turn a new page without fear of fines.”

And what do the U.S. authorities get in return? “It seems that they care less than they had in the past. It’s important for them to put people into their system, so as a result, they make the process easier and forgive the fines,” Zorea explains.

Before the new policy was instituted, taxpayers seeking to make a voluntary disclosure had two major options. There was a simple alternative for people whose U.S. federal taxes in the three years prior to disclosure did not exceed $1,500 after offsetting taxes paid in Israel: They were required only to report on their income for the previous three years and on their bank accounts for the previous six years. The second option for everyone else required disclosure of income and accounts for the previous eight years.

Now, Zorea says, the $1,500 limit has been eliminated, but tax scofflaws must now submit a declaration that their failure to report assets was done innocently and not with the intention to evade taxes.

U.S. tax laws are considered strict compared to other Western countries and the United States is the only country in the Western world that levies taxes based on citizenship – meaning that those defined as American citizens are required to file reports and pay taxes even if they don’t live in the United States and even if they have never even visited the country. Other Western countries, including Israel, impose taxes based on residency.

Amir Chenchinski, a lawyer at the accounting firm of Ernst & Young Cost Forer & Gabay, spells out the three basic obligations that most Americans have toward the IRS. They must file an annual return, assuming that the taxpayer has the requisite minimal amount of income. (Those who pay taxes in Israel generally get a credit on the amount they have paid.) The second obligation is the filing of an FBAR report detailing accounts held outside the United States. The third is payment of inheritance taxes.

FACTA, the legislation that paved the way for the bilateral agreement that Israel and other countries have signed to regulate information about overseas accounts held by U.S. citizens, may seem overly ambitious. However, Chechinski notes that “the United States, being the biggest power in the world, pressured country after country and ultimately all fell in line with this legislation and entered into agreements with the United States.”

“For those who have not settled this issue, there is an interest in doing so before the Americans contact them,” Chechinski warns, “at which point they will have to pay heavy fines.”

As to those Americans who do not have a particular connection to the United States and are thinking of renouncing their U.S. citizenship for tax reasons, even – there are tax-related consequences that need to be investigated before taking such a step. Chechinski says that in certain situations, for example in the case of people seeking to avoid inheritance taxes on a major bequest – some money may be saved, even though renunciation of citizenship is a “tax event” that can have negative tax implications. Still, with proper tax planning, he says, sometimes the taxes can be minimal.