All the attention focused on the Panama Papers may have made you more curious about offshore banking. Perhaps you’ve even been thinking of going the “sophisticated investor” route and stashing some of your money offshore, but have hesitated because you don’t want to wind up in trouble with the IRS. Well, offshore banking may have the allure of something out of a spy movie, but it’s actually a lot more boring and mundane than it appears.
How Offshore Banking Works
First, let’s cut out all of the movie-style words like, “stash,” “hide” or even “offshore bank account.” Using the services of a bank outside of your home country isn’t illegal. And although the term “offshore” literally applies in some cases – like the Bahamas – if you’re doing business with Canada, chances are you could drive there.
The practice isn’t 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 related to customers’ accounts. For a detailed look, read How to Open and Access an Offshore Bank Account.
On the other hand, some foreign banks won’t do business with any foreign clients because there’s a lot more compliance that goes along with it. The Organization for Economic Cooperation and Development (OECD) and the World Trade Organization (WTO) have put rules in place that require banks to report information about their foreign customers. Each country complies with these laws differently. Some countries don’t comply at all.
What About Swiss Bank Accounts?
You’ve probably heard of the famed “Swiss bank account,” that James Bond-like account that puts rich people’s money out of reach of their own country’s government – like the IRS, for example. It’s true that the Swiss have strict privacy laws, and in the past didn’t even have names attached to the accounts. But 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 account when an account holder didn’t report it.
The Benefits of an Offshore Account
Tax evasion wasn’t 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 some fat capital gains and pay zero taxes to that country? That’s technically possible when you move your money offshore.
Even the United States allows it. In recent years, the United States has become one of the world’s favorite tax havens. States like Nevada, Wyoming and South Dakota now hold a large amount of foreign money, but the reason is not primarily for the favorable tax treatment.
One of the main advantages of places like 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 stashed 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, due to currency exchange rates: In other countries you might be seen as a high-roller and get the benefits that come with being part of the wealthy clientele, although in the United States, you might not be seen or treated that way.
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 form known as the FBAR reporting any money exceeding $10,000 in the aggregate that is held in foreign accounts. There is a foreign-earned income tax exclusion for money you earn abroad (click here for IRS information), but the rest is taxable.
What Makes It Illegal?
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. (For more on this topic, see The Tax Implications of Opening a Foreign Bank Account.) Some U.S. firms that hold foreign money claim to use a team of lawyers to make sure individuals and companies are reporting their foreign activity to their home country properly and legally.
Inevitably, there will be people who use the system to profit illegally. Around $1.6 trillion in illicit funds flow through the United States, according to the United Nations; Switzerland reportedly still keeps mum about a significant amount of secret money.
The Bottom Line
Holding money in an offshore bank account isn’t illegal, but it doesn’t make it tax exempt. As long as you’re going offshore for legitimate business reasons, such as those laid out above, you can feel comfortable going for it and tell all of your friends that you have one of those “secret” bank accounts – although it’s not really secret at all.