The Foreign Account Tax Compliance Act (FATCA) was a provision of the Hire Act, which was passed by Congress in March of 2010. The IRS has made several delays in the implementation of FATCA but more than four years later; it finally took effect. It is a little known IRS rule that went into effect on July 1 but could have broader implications than most Americans realize.

The purpose of FATCA is to crack down on Americans who are using foreign bank accounts to avoid paying U.S. taxes. The IRS has signed Inter-governmental Agreements (IGAs) with dozens of countries so far, and is in the process of negotiating with several more. These agreements set the terms by which foreign financial institutions (FFIs) can comply with FATCA while remaining in accordance with their country’s data protection and confidentiality laws.

Provisions of FATCA: Under FATCA, foreign banks are required to report information to the IRS about U.S. customers in accordance with their country’s IGA. In addition, they are required to withhold payments/income of 30% from such accounts unless appropriate documentation is provided to show that there is no obligation to withhold. Also, foreign financial institutions that fail to comply with the provisions of their country’s IGA will be subject to a 30% withholding penalty plus interest.

The Possible Unintended Consequences of FATCA: Foreign bank account disclosures to the IRS are already sharply on the rise ahead of FATCA. There were over 500,000 FBAR filings for tax year 2010, about double what was reported just a few years earlier. However, there is concern about other effects of the FATCA provisions, particularly what they will do to the U.S. dollar.

For many decades, the U.S. dollar has been considered the world’s reserve currency. For example, commodities such as oil have been traded in U.S. dollars for a long time on the world markets. In addition, foreign banks in many countries offer “dollar accounts” for citizens that want to keep their money in a seemingly more stable currency.

However, as the FATCA implementation date approaches, a growing number of banks in Europe and other places are refusing to take U.S. customers. The feeling among many is that it is just too difficult to comply with FATCA and it is not worth risking the liability of a 30% withholding penalty for compliance failure.

It is unclear how widespread this trend is or will be. If more financial institutions make this decision, they may very well stop exchanging U.S. dollars as well. This could have a severely negative effect on the dollar and has the possibility to end its longstanding status as the world’s reserve currency.

Whether FATCA will sink the U.S. dollar or not remains to be seen. However, one thing is certain; Americans with foreign bank accounts that fall within the scope of FATCA must start reporting them to the IRS or risk serious penalties. If you are unsure if your account falls under these requirements, speak with a small business accountant right away. Remember, the IRS does not accept ignorance as a valid reason for tax avoidance.