The IRS and, after the recent G-20 Summit in London, most of the world have declared war against unreported foreign bank accounts and all those connected with them. In testimony to Congress, the Commissioner of the Internal Revenue Service stated, "[w]e cannot allow an environment to develop where wealthy individuals can go offshore and avoid paying taxes with impunity....[T]he IRS is aggressively pursuing these individuals and institutions that facilitate unlawful tax avoidance." Commissioner Schulman further stated: "[m]y advice to U.S. taxpayers who have undeclared offshore accounts and income is simple. The IRS has been steadily increasing the pressure on offshore financial institutions that facilitate concealment of taxable income by U.S. citizens. That pressure will only increase under my watch. Those who are unlawfully hiding assets should come and get right with their government through our voluntary disclosure process."
In light of U.S. and world pressure being brought to bear on this matter, it is strongly advised that those holding or controlling an undeclared offshore bank account seek immediate legal counsel.
United States taxpayers are taxable on their worldwide income, including any earnings on offshore bank accounts. Although there is nothing illegal in owning or controlling an offshore bank account, the earnings on the account are taxable and must be included in the U.S. taxpayer's tax return. Furthermore, there are certain reporting requirements which must be met. In general, U.S. taxpayers must disclose the offshore accounts by answering a question regarding foreign bank accounts that is contained in Schedule B of their Form 1040. The taxpayer need not disclose if the combined value of the foreign accounts was $10,000 or less during the year, otherwise the taxpayer must disclose the existence of the account. A taxpayer who responds affirmatively must then file with the Treasury Department a Report of Foreign Bank and Financial Accounts ("FBAR") by June 30 of the following year.
The failure to truthfully answer the question regarding foreign accounts or to file the FBAR may constitute a criminal offense and may subject the taxpayer to both civil and criminal penalties. The filing of a Form 1040 without truthfully answering the foreign account question also may subject the taxpayer to a fraud penalty of 75 percent of the tax ultimately due. The willful failure to file the FBAR may subject the taxpayer to a penalty of the greater of $100,000 or 50 percent of the account value for each year that the FBAR was not filed. As a result, the FBAR penalty for not filing may exceed the value of the account and result in personal liability for the penalty by the U.S. taxpayer.
Announcement of Program
To incentivize taxpayers to disclose previously undeclared foreign bank accounts and to pay the delinquent taxes on the earnings of those accounts, the IRS on March 23, 2009 announced a new penalty structure to be applied to voluntary disclosures of undeclared foreign accounts. The new initiative is in effect for six months with no guarantee it will be extended. Taxpayers taking advantage of this initiative can avoid criminal prosecution and certain penalties that otherwise might apply.
Voluntary Disclosure Practice
In order to be eligible, the taxpayer must make a voluntary disclosure of the delinquent returns, including the FBARs, for the previous six years. To constitute a "voluntary disclosure," the disclosure must be truthful, timely, complete, and the taxpayer must show a willingness to, or in fact, cooperate with the IRS in determining the taxpayer's correct tax liability. In addition, the taxpayer must make a good faith effort to pay in full the tax, interest and any penalties, or make an arrangement with the IRS to pay such tax, interest and penalties. The voluntary disclosure practice is not available to taxpayers with respect to illegal source income. A disclosure is timely if made before the taxpayer has been singled out for a civil examination or criminal investigation or been notified by the IRS that it intends to make such examination or investigation. Under this settlement initiative, a taxpayer will be able to take advantage of the program even though the IRS already has the taxpayer's name on a list from third party sources, as long as the IRS has not opened up an examination or investigation of that taxpayer. This is a relaxation of the rules that would otherwise apply to a voluntary disclosure.
Specifics of the Reduced Penalty Program
To fully take advantage of this initiative, the taxpayer will have to file corrected returns for the prior six years, including all information returns and the FBARs, and pay the delinquent taxes, interest and penalties as a result of including the previous unreported income from the foreign account. In addition, the taxpayer will have to pay an accuracy penalty of 20 percent of the delinquent taxes or a delinquency penalty of 25 percent of such taxes for each of the six years, and the reasonable cause exception will not apply. Finally, in lieu of all other penalties, including the penalty for the failure to file an FBAR, the taxpayer will have to pay a penalty equal to 20 percent of the highest value of the account at any time during the six-year period. This 20 percent penalty is reduced to five percent if the taxpayer did not open the account, there was no activity in the account during the period that the taxpayer controlled the account and all U.S. taxes have been paid on the funds in the account, except for the earnings in the account which have escaped U.S. taxation. It still has to be determined whether the taxes referenced with respect to the funds in the account are limited to income taxes or also includes transfer taxes. The IRS may take into consideration the facts and circumstances surrounding the account and may not assess the 20 percent penalty if it is excessive in light of the conduct of the taxpayer or the size of the account.
For taxpayers taking advantage of this initiative, it is anticipated that the IRS will interview taxpayers and third party contacts. In addition, examiners will request foreign based information through exchange of information agreements or treaties with the foreign country. Consequently, it appears that a voluntary disclosure under this initiative will subject the taxpayer to a full examination of the undeclared account and the unreported income from the account.
What Should Taxpayers with Foreign Accounts Do?
Since a voluntary disclosure is only available to a taxpayer who is not already the subject of an examination or investigation with respect to the offshore account, taxpayers with foreign accounts should act quickly and retain legal counsel familiar with voluntary disclosures to successfully guide them through the reduced penalty initiative. Taxpayer's counsel should first inquire of the IRS to determine if the taxpayer is already a target of an examination or investigation. If the taxpayer is not, the taxpayer should have amended or corrected returns prepared for the last six years showing the earnings from the offshore account and the resultant tax due. The amended returns and payment of the taxes and interest should be delivered to the IRS, together with the delinquent FBARs and the 20 percent or five percent penalty as the case may be. Based upon the corrected returns and the facts and circumstances the IRS will assess the penalties and interest owing.
Commissioner Schulman stated to Congress that those taxpayers who truly make a voluntary disclosure can avoid criminal prosecution. However, "[f]or those taxpayers who continue to hide their head in the sand, the situation will only become more dire." Commissioner Shulman's advice is that taxpayers who have an undeclared account "should come forward now under our voluntary disclosure practice and get right with the government."
For more information regarding this new initiative, please contact Thomas Wechter at 312.258.5756 or Robert Kolek at 312.258.5755.
ABOUT SCHIFF HARDIN LLP
The attorneys in Schiff Hardin's Tax Controversy Practice handle all manner of federal, state and local tax controversies, at the audit and administrative appeals levels and in tax litigation, as well as advising clients in connection with disclosure and tax penalty mitigation. We also represent taxpayers in connection with actual or potential criminal tax investigations.
Our tax attorneys also advise clients on the federal, state, local and foreign tax aspects of their business and investment activities including the structuring of complex business transactions, business combinations, financing transactions, joint ventures, private equity and investment funds. We also assist in the implementation of affirmative tax planning opportunities such as the award of equity-based compensation, tax-deferred exchanges and maximizing the use of foreign tax credits. We also counsel businesses in connection with FIN 48 tax disclosure issues.
For additional information, please contact us.
RECENT TAX PUBLICATIONS
"Offshore Bank Accounts and Voluntary Disclosure," Tax Alert (March 2009)