Passive income under the Foreign Account Tax Compliance Act (FATCA) generally encompasses income derived from investments rather than active business operations. This primarily includes dividends, interest, and income from certain insurance contracts.
Here's a more detailed breakdown:
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Dividends: This includes regular dividend payments from stocks or other equity investments. Crucially, it also includes "income equivalent to dividends," often referred to as substitute dividends. These are payments made in lieu of actual dividends, typically in securities lending transactions.
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Interest: This covers income earned from interest-bearing accounts, bonds, loans, and other debt instruments. Similar to dividends, "income equivalent to interest" also falls under this category.
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Income from Insurance Contracts: Certain returns from investments within insurance contracts are considered passive income under FATCA.
Why is this important for FATCA?
FATCA requires foreign financial institutions (FFIs) to identify and report accounts held by U.S. persons to the IRS. Passive income is a key factor in determining whether an entity is considered a "Passive NFFE" (Non-Financial Foreign Entity), which necessitates identifying its substantial U.S. owners and reporting their information. Essentially, if an entity's income primarily consists of passive income and its assets primarily generate passive income, it will likely be classified as a Passive NFFE, triggering additional FATCA reporting requirements.
In summary, passive income under FATCA focuses on investment-related earnings, including dividends, interest, and specific insurance contract returns, and plays a vital role in identifying Passive NFFEs for FATCA compliance.
