Offshore Banking Isn’t Illegal, But Hiding It Is

What Are the Ramifications of Offshore Banking?

If you were interested in the Panama Papers scandal, you might be curious about offshore banking. Perhaps you have been considering stashing some of your money offshore? Perhaps you have hesitated because you don’t want to wind up in trouble with the Internal Revenue Service (IRS).

Offshore banking has an allure for some, but it’s actually a lot more mundane than it appears.

Key Takeaways:

  • Using the services of a bank outside of your home country is not illegal if it is done for legitimate reasons.
  • Some foreign banks will start an account from a foreign customer with as little as $300 while others will not do business at all with foreign customers because of compliance requirements.
  • Offshore bank accounts must be declared to the holder's home country for tax reasons; however, some countries allow foreigners to earn capital gains tax-free.
  • Individuals may choose to keep their money offshore if there is instability in their own country, and they fear losing their investments.

How Offshore Banking Works

First, let’s nix misleading terms such as “stash,” “hide,” or even “offshore bank account.” Using the services of a bank outside of your home country is not illegal. And although the term “offshore” literally applies in some cases—a bank account in the Bahamas, for example—doing business in Canada could be just a drive away.

The practice is not just for the wealthy. Some foreign banks will take as little as $300 of your money and start an account. Like banks everywhere, those overseas set their own account minimums and other terms for customers.

On the other hand, some foreign banks will not do business with some foreign clients because of the required compliance. The Organization for Economic Cooperation and Development (OECD) and the World Trade Organization (WTO) have rules that require banks to report information on their foreign customers. Each country complies with these laws differently. Some countries don’t comply at all. 

What About Swiss Bank Accounts?

The famed “Swiss bank account,” or James Bond-like accounts that places rich people’s money out of the grasp of their own country’s government, the IRS, for example, come with strict Swiss privacy laws. This privacy is the reason for their popularity.

In the past, Swiss banks didn’t even attach names to accounts. However, Switzerland has agreed to turn over information to foreign governments on their account holders, effectively ending any tax evasion that could have come with having an unreported, or hidden, account.

The Benefits of an Offshore Account

Tax evasion was not the only reason to hold a Swiss bank account. There are plenty of legitimate reasons to hold money out of your home country. First, there’s the tax treatment. In many countries, you can earn money tax-free. How would you like to put your money to work in another country, earn capital gains and pay zero taxes to that country? That’s technically possible when you move your money offshore.

Even the United States allows the practice. In recent years, the United States has become one of the world’s favorite tax havens. Nevada, Wyoming, and South Dakota now hold a large amount of foreign money, but the reason is not primarily for favorable tax treatment. 

One of the main advantages of keeping foreign money in the United States, Switzerland, and other developed nations is their stability. People living in nations with political and economic upheaval fear that their money, as well as their lives, could be in danger. What if the economy collapses? What if there’s a civil war? What if their government comes after them for some reason? If their money is kept overseas, it’s harder for their own government to seize it. 

Overseas bank accounts also give account holders more opportunities to invest internationally and serve as a currency hedge against a possible collapse in their home currency. Less important but notable is that due to currency exchange rates, in other countries, an investor might be perceived as a high-roller, As such, that person might receive the benefits that come with being wealthy, although this might not be the case in the United States.

Note that you are not off the hook for U.S. taxes if you earn or hold money abroad. The IRS requires that Americans file the IRS FBAR form and report any money exceeding $10,000 in the aggregate that is held in foreign accounts. There is a foreign-earned income tax exclusion for the money you earn abroad, but the rest is taxable.

Special Considerations for Offshore Accounts

There’s nothing illegal about establishing an offshore account unless you do it with the intent of tax evasion. The Foreign Account Tax Compliance Act (FATCA) requires banks around the world to report balances and any activity of American citizens to the IRS or face fines.

Some U.S. firms that hold foreign money claim to use a team of lawyers to make sure they are reporting their foreign activity to their home country accurately and legally. Inevitably, there will be people who use the system to profit illegally. The United Nation's Office on Drugs and Crimes estimates that the proceeds from illicit funds and money laundering amounts to between 2-5% of global GDP (or about USD $2 trillion).

In summary, holding money in an offshore bank account is not illegal, and it is also not tax-exempt. As long as you have legitimate business reasons, you can invest in “secret” bank accounts—although it will not really be secret at all.

I've Lived Overseas and Have a Foreign Bank Account, Is This Legal?

If you have an overseas bank account, you must simply declare its existence with the IRS using a FACTA. However, if it has more than USD $200,000 worth in the account and you live abroad (or more than $50,000 and live inside the U.S.), you must file the more comprehensive IRS Form 8938.

Why Is Hiding Offshore Financial Accounts Illegal?

Hiding money or assets housed overseas is illegal for two reasons. One is that it can result in tax avoidance. The second is that these funds could be used for money laundering or other illicit activities. As a result, these monies must be declared, even if they are not subject to taxation.

Why Keep Money Offshore?

There are several reasons for holding an offshore account. You may have lived or worked overseas for an extended period and needed a local bank account. Or, you may want exposure to foreign interest rates or investments that can only be obtained using an overseas account to diversify a portfolio.

Is Trading Currencies (Forex) an Offshore Activity?

In most typical cases, people who trade currencies in the forex market do so through a domestic broker. This broker handles the positions involved, and as a result, the positions are also considered to be held domestically (i.e., onshore).

Article Sources
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  1. Organization for Economic Cooperation and Development. "Further Guidance."

  2. Federal Department of Finance. "FATCA Agreement."

  3. Washington Post. "US tax havens lure wealthy foreigners and tainted money."

  4. Internal Revenue Service. "Report of Foreign Bank and Financial Accounts (FBAR)."

  5. Internal Revenue Service. "Foreign Account Tax Compliance Act (FATCA)."

  6. United Nations Office on Drugs and Crime. "Money Laundering."

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