The recent revelations about several world leaders and other wealthy individuals from the leaked Panama Papers have brought the whole issue of offshore bank accounts, investing in tax havens around the world and the use of shell companies into the news. The leaked files came from a Panamanian law firm, Mossack Fonseca. Among the famous names included were Russian President Vladimir Putin and British Prime Minister David Cameron. While your clients are likely not as famous as these folks, they may be impacted by some of the issues brought to light.

Shell Companies

Shell companies have legitimate uses. For example, in some countries land can only be owned by citizens of that country or local companies. A foreigner wishing to buy a home in one of these countries might establish a shell company there for the sole purpose of purchasing the home. They can also be set up in layers across several jurisdictions to conceal the identity of the owners or to launder money. They are relatively inexpensive and uncomplicated to set up. (For more, see: Why Is Panama Considered a Tax Haven?)

The Treasury Department is now on track to issue a rule that has been delayed that would force banks to seek the identities of people who are the beneficial owners behind shell companies. This is presumably the result of the uproar over the Panama Papers. According to a recent CNBC article, the rule, which is via the Financial Crimes Enforcement Network (FinCEN), would likely only require banks and brokerage firms to request information from customers regarding beneficial owners, but not require them to verify that information.

In fact, there is no way for banks to verify such information, according to Rob Rowe, a lawyer with the American Bankers Association. The ABA is "watching to see what happens with the Panama papers," he told CNBC. "That's always been the problem. Banks can collect information but there is currently no mechanism to verify it or keep it updated, outside asking the company," he added. (For more, see: Panama Papers Reveal the Secrets of Dirty Money.)

Offshore Bank Accounts

Offshore bank accounts may be used by the wealthy for legitimate reasons such as asset protection or for ease in managing certain investment holdings. These accounts can carry a stigma due to some illegal uses of them such as a conduit for tax evasion. Some offshore locations have lax reporting standards making it easier to conceal holdings and income from the authorities in the investor’s home country. Investors caught trying to hide these accounts and the investment gains or company profits tied to them can face some stiff penalties for their home country.

Tax Havens

While Mossack Fonseca is based in Panama, according to a CNN Money article they “…have incorporated tens of thousands of companies in Seychelles, an Indian Ocean archipelago often described as a tax haven.” Tax havens are countries that attract investors and businesses with lower tax rates and often somewhat lax reporting requirements. (For more, see: Panama Papers: Top 10 Banks for Offshore Companies.)

U.S. citizens are required to report all income and pay taxes on it regardless where in the world that it is earned. They are also required to report the assets in oversees accounts. Failing to do so carries stiff penalties. These penalties range up to the greater of 50% of the unreported balance in these accounts or $100,000 for each year in which you failed to file the required paperwork. This is in addition to any other IRS enforcement actions.

Additionally, the U.S. is trying to enact the Foreign Account Tax Compliance Act (FACTA). Under this law the U.S. has struck agreements with about 100 countries whereby their banks would report any accounts held by U.S. taxpayers in those countries. (For more, see: Panama Papers Tip of the Iceberg: Congress Aids Tax Cheats and Terrorists.)

Post Panama Papers

While the publicity surrounding the Panama Papers might cause some new rules or laws to be enacted that could make sheltering money in offshore accounts or shell companies more difficult, the wealthy will still find a way to do this in some fashion. U.S. citizens who have legitimate reasons for opening an offshore account or creating an offshore shell company might find themselves faced with additional barriers, even when doing so for legitimate reasons like buying property in a foreign country where they might choose to spend some or all of their time during retirement.

The Bottom Line

The Panama Papers have placed the spotlight on the world of offshore bank accounts, shell companies and tax havens. There are often valid reasons for a client having an offshore account or company. As their financial advisor you may or may not be well-versed in these types of arrangements. If there is a valid purpose you would be wise to work with your client to retain knowledgeable tax and legal counsel to make sure that all arrangements are done correctly and legally. The U.S. has been focused on catching citizens who use offshore accounts to dodge taxes and neither you nor your clients want to get caught up in this net, even unintentionally. (For more, see: The Top 10 Caribbean Tax Havens.)

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