Definition
The term offshore bank refers to a financial institution that is located in a country different than the residence of the depositor. Individuals and corporations may open an offshore bank account to reduce or avoid income taxes.
Explanation
While the term offshore bank originally referred to the Channel Islands and its proximity to the United Kingdom, the term is commonly used to describe any non-domestic bank that provides the accountholder an advantage relative to domestic banks. Two advantages offshore banks provide their customers include:
Stability: offshore banks can be a safer location to maintain deposits if the government is unstable, when the domestic economy is facing a downturn, or when the country is at war.
Privacy: an outcome of the 1934 Swiss Banking Act, services offered by offshore banks may include anonymous accounts. Offshore banks do not always report interest income to domestic authorities too.
This second advantage, privacy, can be leveraged by individual seeking to avoid paying income taxes to local authorities. However, just because interest income is earned on money held in an offshore bank does not relieve the taxpayer of their obligation to report it on their income tax return. In fact, the Internal Revenue Service explicitly states:
"If you are a U.S. citizen or resident alien, you must report income from all sources within and outside of the U.S. This is true whether or not you receive a Form W-2 Wage and Tax Statement, a Form 1099 (Information Return) or the foreign equivalents."
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