Disclosing Foreign Accounts, Assets or Business Activity through the Offshore Voluntary Disclosure Initiative (OVDI) Program:
On January 9th 2012 the Internal Revenue opened a third version of the offshore voluntary disclosure program announcing the collection of more than $4.4 billion so far from the previous two version of the program.
The new offshore voluntary disclosure program is similar to the 2011 program in most ways, but for a few key differences. Unlike the previous program, there is no set deadline for people to apply with the current program. However, the terms of the program could change at any time going forward including increasing penalties or the IRS could decide to end the program entirely at any point.
The overall penalty structure for the new program is currently the same as in the 2011 Offshore Voluntary Disclosure (OVDI) program, except for taxpayers in the highest penalty category which has been raised from 25 percent to 27.5 percent of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the eight full tax years prior to the disclosure. That is up from 25 percent in the 2011 program. Some taxpayers will be eligible for 5 or 12.5 percent penalties; these remain the same in the new program as in 2011.
Participants must file all original and amended tax returns and include payment for back-taxes and interest for up to eight years as well as paying accuracy-related and/or delinquency penalties.
Taxpayers in limited situations can still qualify for a 5 percent penalty and taxpayer's whose offshore accounts or assets did not surpass $75,000 in any calendar year covered by the new OVDI program will still qualify for a12.5 percent penalty. As under the prior programs, taxpayers who feel that the penalty is disproportionate may opt instead to be examined by opting out of the program. Note: Entering the program is the only assured way of mitigating the risks of criminal prosecution even where an opt-out may be contemplated.
The IRS has indicated that additional details will be available within the next month on IRS.gov. In addition, the IRS will be updating key Frequently Asked Questions and providing additional specifics on the offshore program.
Have you committed income tax evasion involving a foreign account, asset or business activity?
One of the most basic premises, but often the least understood by taxpayers, is that U.S. Citizens and Residents are taxed on their worldwide income. This misunderstood concept coupled with the fact that, until recently, the vast majority of U.S. tax advisors were unaware of the information reporting requirements surrounding foreign accounts, foreign investments and foreign business activity have created a massive tax trap for unwary taxpayers.
The government has identified the following three actions, found in three or more tax years, as resulting in a high probability for consideration for criminal charges for income tax evasion.
- Repeated failure to file Form TDF 90-22.1 where a citizen or resident has greater than $10,000 on deposit in a foreign bank or institution at any one time during a given tax year
- Repeated failure to include the investment income generated by the account as income on the taxpayer's income tax return.
- Repeated failure to indicate the existence / location of the foreign account on schedule B of the taxpayer's income tax return.
Each of these actions is considered a badge of tax fraud; however, a distinction must be made between a taxpayer's negligence versus a taxpayer's willful behavior. The government's hardest element in proving a tax crime is to prove, beyond a reasonable doubt, a taxpayer's intentional violation of a known legal duty. Many of the taxpayers that I have taken through a voluntary disclosure wanted to avoid having the government second guess their actions as being willful rather than negligent where the unreported income was significant and a consistent pattern of non-reporting existed between the tax years 2003 through 2010. Many taxpayers' chose to disclose and pay penalties even where they were convinced their actions were merely negligent rather than leaving open the possibility of a criminal conviction.
Additional badges of fraud in this area may include:
- Transferring your foreign account from a foreign bank under investigation to a foreign bank not under investigation.
- Failing to complete form 8939 during the 2011 tax filing season
- Failing to report income earned through foreign business activity
- Failing to report foreign income from assets held overseas - i.e. rental income
- Failing to file from 3520 for foreign inheritances or distributions from foreign trusts
- Failing to file from 5471
The government views noncompliance surrounding foreign income as its number one compliance problem and has successfully lobbied congress to draft some of the most draconian penalties ever written in the income tax arena to date. Because of its lobbying efforts the IRS now has the power to penalize taxpayers with simultaneous criminal and civil sanctions for noncompliance surrounding foreign accounts.
From a civil perspective, the non-reporting of the TDF 90-22.1, carries a $10,000 a year penalty for each failure to file where a taxpayer's failure to file is deemed merely negligent. If however, the taxpayer's non-reporting is deemed willful, the penalty is ½ of the account balance for each year the form was not filed. Where willful failure to file is asserted the penalty for not filing the form can easily result in a multiple of the account balance being assessed. For example, a foreign account with a $1,000,000 balance could be assessed a $3,000,000 penalty. From a criminal perspective a taxpayer can be prosecuted for income tax evasion which carries the potential for a 5 year jail sentence, $250,000 fine, and restitution for the cost of the prosecution.
Taxpayer Options:
Taxpayers that either just learned they have the problem delineated above or those that have willfully chosen to pass on entering the 2009 or 2011 voluntary disclosure programs both have the following options.
- Do nothing
- Get into compliance on a go forward basis
- Make a quiet disclosure (or take no further action where a quiet disclosure was already made)
- Make a loud disclosure by entering the 3rd version of the Offshore Voluntary Disclosure Initiative (OVDI).
Analysis of Options:
1. Do nothing
Taxpayers that do nothing when faced with this problem are gambling that the IRS does not have the resources to detect their foreign account. In my opinion this is a grave mistake. Every participant in the 2009 and 2011 voluntary disclosure initiatives was required to provide the government with "intel" on the foreign bank(s) they had deposits with. The government routinely gathered information about activity that formed the basis of the UBS litigation. UBS bankers were coming onto US soil and counseling US taxpayers that they could deposit funds overseas and that the existence of the account would never be revealed to the US government. Moreover they were advising that any investment income generated by the account would be tax free because if the US government did not know about the income generated by the account it could not tax the investment income. These actions were argued to be aiding and abetting income tax evasion and formed the basis of the suit against UBS. Many other banks around the world are suspected of doing the same thing. In fact, currently there is litigation against 11 additional Swiss banks for the same type of activity. As part of this litigation the main information sought by the US government is the names and account balances of US citizens and residents that have deposits with these Swiss Institutions.
If you are thinking that your foreign bank is not located in Switzerland and is a tiny hole in the wall in the middle of nowhere so I am safe, think again! Recently legislation called FACTA is expected to result in the submission of the names and account balances of every US resident and Citizen worldwide starting in 2013. FACTA forces foreign banks to turn over this information or face a 30% withholding requirement on transfers from U.S. institutions to the foreign bank. Most banks are expected to comply and turn over the names of US Citizens and Residents rather than lose 30% of deposits to the institution from US financial institutions.
Since the US government will eventually have actionable knowledge concerning your foreign account doing nothing is not a viable option in the face of the draconian penalty regime at the government's disposal.
2. Get into compliance on a go forward basis
Some advisors are recommending that taxpayer's merely get into compliance on a go forward basis and do nothing to address the past non-compliance gambling that the IRS does not have the resources to detect the foreign account. In my opinion this option is also not viable because of the ease with which the U.S. government can flag TDF 90-22.1's with large balances on its radar screen. I have heard rumors that the Criminal Investigation Division (CID) has assigned a special agent to monitor for just this occurrence.
If I were a CID agent my thought process would be as follows for example.
John Smith has just reported a 1.3 million dollar account balance in the Cayman Islands. Let's take a look at his prior returns. Hmmmm... for the last 3 years he has made $50,000 a year or so... Thus... the deposit could not have come from previously taxed U.S. income. Did Mr. Smith inherit this money? If he did he better have filed a form 3520 to report the inheritance or I get to hit him with a 35% penalty on the amount of the inheritance! Hmmmm.... No 3520 was filed. Gee... Since I can determine that the funds did not come from previously taxed earnings or from an inheritance there must be something fishy afoot here... Let's audit this taxpayer. Matter of fact; let's have the criminal investigation division take a look as well...
As you can see, this is not a viable option.
3. Make a quiet disclosure (or take no further action where a quiet disclosure was already made)
Note: It is still possible to convert a quite disclosure into a loud disclosure by entering into the third version of the OVDI program.
Some advisors are proponents of quiet disclosures. A quiet disclosure is where prior tax returns are amended to report the previously omitted foreign income and the delinquent TDF 90-22.1's are filed. In a quiet disclosure the Criminal Investigation Division of the IRS is not made aware of the disclosure and again the taxpayer is banking that the IRS does not have the resources to detect the quiet disclosure. This approach has many proponents because if it successful the taxpayer only pays the additional income taxes they should have paid if they would have filed the previous returns correctly plus interest. Often, no penalties are assessed.
The problem with this approach is the IRS has stated publicly that they will criminally prosecute any taxpayer they detect has done this. To make things worse, many unscrupulous tax preparer advisers are advising this approach out of their own self-interest to the detriment of their client's best interests. This approach results in a revenue stream for them in that they get to prepare the delinquent returns and TDF 90-22.1's. Additionally they are able to protect their long term relationship and future revenue streams with their client. If the tax preparer does what he or she is ethically required to do, refer the client to a reputable tax attorney and have no further communication with the client upon discovery of the foreign account, the preparer knows that the tax attorney is ethically required to hire a new tax preparer to prepare the amended returns and TDF 90-22.1's because the original preparer is likely to be the first witness called to testify against the taxpayer should the government criminally prosecute the taxpayer. To add insult to injury the preparer's lack of knowledge as to the reporting requirements surrounding foreign accounts could have contributed to the creation of this tax nightmare as well.
Imagine how easy it would be for the IRS to detect a quiet disclosure. They receive at least 2 amended returns. The current year correctly reports the foreign income and the two open tax years are amended. The IRS receives the current year FBAR timely and the previous two tax years are amended. All the IRS has to do is look for this pattern of reporting to identify taxpayers that are making quiet disclosures.
To make matters worse the government upon discovering a quiet disclosure will deem the act of a quiet disclosure itself as an additional badge of fraud for a subsequent criminal prosecution. It is important to note that a subsequently discovered voluntary disclosure will not automatically result in a criminal conviction for tax fraud as the government still has to prove willfulness and be willing to commit significant resources to prosecuting the case. Each case must be analyzed on an individual facts and circumstances basis but for the reasons cited above this is not ordinarily a viable option except where exposure for criminal liability is determined by an experience tax attorney as extremely remote and a taxpayer is willing to gamble on the attorney's judgment.
Note: It is still possible to convert a quite disclosure into a loud disclosure by entering into the third version of the OVDI program.
4. Make a loud disclosure
By entering into the third version of the OVDI program a taxpayer makes a loud disclosure. A loud disclosure consist of knocking on the front door of the IRS Criminal Investigation Division and disclosing in writing that you have foreign and possibly even domestic non-compliance issues which may or may not rise to the level of outright criminal behavior that you wish to correct. In essence, a deal is struck with the Criminal Investigation Division that goes like this - in exchange for the taxpayer's promise to correct all foreign and domestic noncompliance with US tax law (including U.S. Government information reporting requirements) through full cooperation with the IRS's civil division, the Criminal Investigations unit promises not to prosecute the taxpayer for any applicable tax crimes provided the taxpayer makes a full honest and complete effort to correct their prior income tax returns including paying (or arranging to pay) the additional taxes, penalties or interest.
My Clients routinely and understandably want to know what the worst case scenario is where they come forward. I tell them that the draconian penalties that are on the books were written to give the IRS a club to force people to come forward. The U.S. taxing system is based on voluntary compliance. From a policy perspective it makes little sense to bring the full force of law against those that make a voluntary effort to correct their non-compliance as this would discourage others from doing so as well.
The questions I get are as follows:
- How many prior year returns will I have to amend?
- What will I be penalized for the additional income tax reported on the amended returns surrounding my foreign and domestic non-compliance?
- What will I be penalized for the non-compliance surrounding the TDF 90-22.1's?
The 2009 OVDP and 2011 OVDI and the current third version of this programs provide certainty when answering these questions.
Analysis of Amount of Exposure for Those That Continue to Hide:
As an incentive to drive taxpayers into the OVDI program the U.S. government continues to ramp up its efforts in searching for and flushing out income tax evaders who continue to utilize undisclosed foreign accounts, entities or assets to hide income. Because the IRS has devoted massive resources to publicizing the reporting requirements for offshore assets along with implementing the 2009 and 2011 and the current foreign bank account and asset voluntary disclosure initiatives, taxpayer's that are investigated or audited for non-compliance surrounding the reporting of foreign bank accounts or overseas assets, will face an uphill battle in proving they were unaware of their tax reporting obligations. Or, said another way, that their actions were merely negligent based on ignorance rather than willful with the intent to evade taxation.
The U.S. Government is currently taking the following types of actions in an attempt to flush out noncompliance concerning foreign accounts, assets or business activity:
1. Grand Jury Subpoenas directly to taxpayers suspected of income tax evasion surrounding foreign accounts, assets or business activity:
Perhaps the most aggressive strategy for combating foreign income tax evasion surrounding foreign accounts or assets is where the government is currently issuing subpoenas to individuals suspected of housing funds in Swiss or other off-shore bank accounts that demand copies of their foreign bank statements dating all the way back to 2003.
These subpoenas are out of the ordinary in that they ask the investigated individuals themselves rather than the foreign banks for the statements. These grand jury generated subpoenas specifically asks for copies of statements depicting the highest annual balance for each year since 2003. Anyone who fails to comply with the terms of the subpoena risks being held in contempt of court and facing fines or jail time which often will not end until the jailed individual agrees to comply with the terms of the subpoena.
2. Investigations surrounding Switzerland's banking industry
Switzerland's perceived role as being the world capital in suborning and facilitating U.S. income tax evasion via its 1934 law mandating total privacy of bank accounts has been ground zero for the US government's attack on income tax and foreign asset noncompliance. It is estimated that Switzerland houses $2 trillion in global capital.
UBS, the biggest Swiss bank, paid $780 million and turned over details concerning 4,450 U.S. account holders to end prosecution by the U.S. Government. The U.S. Justice Department is currently conducting criminal investigations of 11 other Swiss Banks including Credit Suisse, Julius Baer and Basler Kantonalbank.
Switzerland's Wegelin & Co. was the employer of three Swiss bankers charged with conspiring to help U.S. clients hide more than $1.2 billion from American tax authorities by making sales pitches to U.S. taxpayer-clients who were fleeing UBS. The indicted bankers allegedly told American clients not to worry about the I.R.S. because their bank "had a long tradition of bank secrecy," adding that they had advised "their U.S. taxpayer-clients that the bank was less vulnerable to United States law enforcement pressure because, unlike UBS, the bank did not have offices outside Switzerland."
3. Investigating Correspondent Banking
The Wegelin & Co indictment shed light on an obscure corner of hidden offshore wealth concerning the relationships some smaller banks have with bigger banks for moving clients' money around the world called correspondent banking. In correspondent banking, the smaller bank is the customer of the larger bank, which acts as an agent, or conduit, by accepting deposits, processing other wire transfers and handling other business transactions on behalf of the smaller bank's clients. Correspondent banking is a staple of the global financial system which allows smaller banks around the world without an overseas presence to send money to clients in other countries via larger banks in those countries.
Details in the Wegelin & Co. indictment surrounding this perceived "shifting activity" signal that U.S. authorities are increasingly probing correspondent banking relationships.
The gravity of this development is compounded when you consider that nearly every large-to-mid-sized bank in the United States and other countries provides correspondent services which fuel transfers in the billions of dollars daily around the world. It is currently believed that the Wegelin & Co. indictment is ultimately aimed at building evidence against the smaller banks around the world that ultimately place amounts on deposit in Switzerland and against the U.S. clients of the smaller banks around the world. Moreover, in 2001, a report by the Senate Permanent Subcommittee on Investigations, an investigative panel, found correspondent banking was a main conduit for money launderers.
4. Pending settlement with Swiss Banking Industry and Swiss Government
A large sector of the Swiss banking industry and the Swiss Government is attempting to hammer out a civil settlement with the U.S. Government covering any wrongdoing. As part of any such settlement, the U.S. Treasury Department is expected to obtain the identity of all Swiss accounts owned by U.S. taxpayers. In order to facilitate the identification of U.S. account holders the banks are increasingly using sophisticated technology, such as face recognition software, to prevent depositors from hiding their true identity.
5. The implementation of FACTA
The new tax rules that are a part of the Foreign Account Tax Compliance Act (FACTA) of 2010, which applies to individuals and financial institutions, were specifically enacted as part of an effort to cut down offshore tax evasion. Banks worldwide are bracing for new U.S. regulations aimed at reducing tax evasion, which are expected to affect hundreds of billions of dollars' worth of deposits worldwide. "The stated policy objective of FACTA is to have transparency so that worldwide governments can work together to avoid offshore tax evasion," says Manal Corwin, deputy assistant secretary for international tax affairs at the U.S. Treasury Department.
6.The implementation of form 8938 for the 2011 tax filing season
A new filing requirement for 2011 is that if the value of your foreign assets is greater than $100,000 at the end of 2011, or if they exceeded $150,000 at any point during 2011, then you need to file Form 8938, Statement of Foreign Financial Assets. This form is specifically designed to identify Foreign Income Generating Assets that have previously not been reported for tax purposes.
7. Scrutiny over those that renounce citizenship
More and more Americans living outside the United States are renouncing their US citizenship on account of increasing tax obligations and stringent reporting requirements. In the Philippines during 2010 for example, more than 1,500 people gave up their US citizenships. Citizens suspected of doing so for the sole purpose of avoiding taxes are barred from re-entering the US under a little known provision in immigration reform called the "Reed Amendment," which was enacted in 1996. Additionally, If a taxpayer decides to leave the U.S. and declare a different country as their tax home in an attempt to avoid paying U.S. taxes, they must follow an official exit procedure.
8. Foreign Non filer investigations
The US has income tax treaties with more than 42 countries through which the IRS can ferret out foreign tax filing information by US citizens living in those countries and thus compile a list of persons who have not been filing their U.S. income tax returns. Tax delinquents who subsequently return to the US after living abroad for so many years may likely find themselves swamped by tax assessments and penalties and may be faced with property seizures.
9. Expats in Asia under investigation
American expats living in Asia are specially coming under close inspection, with their Asian bank accounts being targeted and criminal investigations being intensified since there are suspicions that a lot of overseas companies were set up specifically to avoid payment of US taxes.
Conclusion:
For the reasons cited above I believe taxpayers with compliance problems surrounding foreign accounts have only one viable option where the risk of criminal prosecution is assessed as high by a reputable tax attorney. Make a loud disclosure as soon as possible before the opportunity to do so is foreclosed through the government's extraordinary efforts to detect your foreign accounts succeeds. Lastly, if you also have domestic non-compliance issues that could lead to criminal prosecution in their own right, they can be addressed at the same time as your foreign non-compliance issues through a voluntary disclosure.
How the Tax Law Offices of David W. Klasing Can be of Assistance
The Tax Law Offices of David W. Klasing can help you get back into compliance and avoid the impending wrath of the IRS and state taxing authorities. The first step is to determine how severe a problem you have. It could be as simple as filing the missing FBARs and requesting penalty abatement for reasonable cause where all of the foreign income has been duly reported. Or as involved as filing 8 years of amended returns to report the foreign income, 8 years of FBAR's and then guiding you through making a Voluntary Disclosure to the criminal investigations division of the IRS.
Contact our office online or call 866-974-8429 for a reduced rate initial consultation.
