FATCA stands for the Foreign Account Tax Compliance Act, is the US government’s attempt to rein in non-reporting of income from foreign-held assets by US citizens. The regulation will also force US citizens invested in the off-shore, tax-exempt funds of US PE firms and hedge fund managers to report their income.

Q. This is the Foreign Account Tax Compliance Act, and its causing a lot of commotion in the world of privately placed securities. First off, what’s the basic idea here?
A. It’s a big step in the government’s long-running efforts to stop US citizens from holding assets overseas and not reporting the income from them. One interesting point right off the bat is that this is largely a US-only problem: most jurisdictions around the world don’t tax the citizens on all their worldwide income in the way we do. FATCA requires foreign financial institutions to report accounts held by US citizens

Q. Well, that sounds good, but how can the US enforce those rules against foreign institutions?
A. Through a requirement that anyone in the US paying money – dividends, rents, royalties, capital gains, etc. – to a foreign financial institutions check to see if that institution is in compliance. If not, the US payor has to withhold 30% of the money the foreign party is owed. By the way, that’s also how we ensure foreigners pay basic taxes on their US source income, so its an established and effective system so long as the foreign institution has any business with the US at all.

Q. OK, but what’s the big problem for hedge funds and private equity funds?
A. Remember that most of the big ones have set up foreign feeder organizations, often in the Caymans, to handle foreign investors but also US tax exempt investors… that’s one of the things that Romney got a lot of heat about. So they’re going to have to comply with the new FATCA rules, which can be sort of burdensome.

Q. And what’s it mean for individual investors?
A. One thing for sure: if you’re holding assets overseas and haven’t been reporting the income, now might be a good time to think twice about that! If the government is going to find out about a foreign account you have – and remember, there’s nothing illegal about holding foreign accounts per se – you want to be the one breaking the news.