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Offshore Tax Amnesty Reopened Today

The Internal Revenue Service just announced the reopening of a special voluntary disclosure initiative designed to bring offshore money back into the U.S. tax system and help people with undisclosed income from hidden offshore accounts get current with their taxes.

The IRS decision to reopen this special disclosure initiative follows continuing interest from taxpayers with foreign accounts. Over 33,000 tax payers came forward during the 2009 and 2011 special voluntary disclosure programs.

This third initiative is very similar to the 2011 Offshore Voluntary Disclosure Initiative (OVDI) with a few key differences.  The overall penalty structure for 2012 is the same except the 25% penalty is now 27.5%, meaning that people who did not come in through the 2011 voluntary disclosure program will not be rewarded for waiting. However, the 2012 initiative does add new features.  The penalty framework essentially requires individuals to pay a penalty of 27.5 percent of the amount in the foreign bank accounts in the year with the highest aggregate account balance covering the 2003 to 2010 time period. Some taxpayers will be eligible for 5 or 12.5 percent penalties. Participants also must pay back-taxes and interest for up to eight years as well as paying accuracy-related and/or delinquency penalties.

The 2012 initiative offers clear benefits to encourage taxpayers to come in now rather than risk IRS detection. Taxpayers hiding assets offshore who do not come forward will face far higher penalty scenarios as well as the possibility of criminal prosecution. It is important to note the IRS has not announced any deadline to participate. As such, the IRS may modify the terms or close the amnesty at any time.

Some Foreigners and Many Recent or “Temporary” Immigrants Must Also Report Offshore Income, Companies, Trusts and Bank Accounts

Anyone considered a resident for tax purposes [1] is also potentially subject to the above penalties for non-compliance.  This can come as a surprise, because many recent immigrants, including those who intend to reside in the US only “temporarily” for various reasons, still haven’t realized they became tax residents in 2010 or earlier.  Among many other 2010 tax obligations due in 2011 such as reporting and paying tax on the 2010 sales of their foreign businesses and other assets, these persons must also report their foreign financial accounts, foreign corporations, foreign trusts, etc., or suffer the same consequences as a U.S. citizen, plus have to explain all this if they seek a visa renewal or permanent residency down the road.  Fortunately, carefully designed and executed pre-immigration tax planning can avoid the need to report foreign financial accounts, as well reduce income and estate taxation relating to foreign income and assets [2].

Common But Invalid Excuses for Not Reporting Foreign Bank Accounts

Whether as a citizen, permanent resident or “tax resident”, the person(s) who have a direct or indirect “financial interest” or “signature authority” in connection with the account are responsible for reporting it.  The definitions of these terms have been in considerable flux recently as the IRS attempts to cover the infinite variety of ways one can be associated with a foreign account.  Before deciding one is not required to report the account, a careful legal analysis should be conducted.  Here are some common excuses I have seen for not filing an FBAR:

  • I never accessed or benefited from the funds.
  • The funds were a gift / inheritance.
  • It’s not in my name; it’s in a trust.
  • It’s not my money, because:
    • I am just the trustee of the trust that owns the bank account.
    • I am only an officer/director of the corporation that owns the bank account
    • I am only a director of the foundation that owns the bank account.
    • I only have a power of attorney given to me by the individual who owns the account
    • I am just the legal guardian of the person who owns the account.
    • I am just holding it for a family member.
  • The money is in a non-interesting bearing account.
  • The money was earned before I became a tax resident
  • The money was earned outside the U.S.
  • My non-international tax attorney advisor told me I didn’t have to report it.
  • I only use the money in the account when I am outside the U.S.
  • The account is held by my disregarded U.S. Limited Liability Company, and I am definitely not a US tax resident

Generally speaking, none of the above by itself is an exception to the FBAR reporting obligation.  One of the most dangerous excuses I have heard for not filing an FBAR is that they already closed the account and either transferred the funds to a bank in the U.S. or to another individual outside the country.  While this may eliminate the requirement to file FBARs in future years, not reporting the account for the year in which the transfer occurred might actually be used in a criminal prosecution as evidence that the taxpayer consciously chose not to report the account and then attempted to conceal its existence.  Furthermore, whenever the foreign account is generating income or there is a foreign corporation or trust involved, the IRS requires additional forms that are probably also delinquent if the bank account wasn’t even reported in the first place, resulting in further penalties and criminal exposure.

The IRS is on the Warpath

The obligation to report offshore income, transactions and bank accounts is actually nothing new; there just hasn’t been much enforcement and as such too many tax advisors not familiar with international issues tend to underestimate the consequences. The IRS specifically warned us that they are allocating more resources towards enforcing foreign income and bank account reporting and they have indeed followed through by hiring more agents and even opening offices abroad.  Using a carrot and stick approach, the IRS already offered a partial amnesty in 2009 so taxpayers with unreported income and accounts from prior years could avoid criminal prosecution and enjoy reduced civil penalties by coming forward voluntarily.  Thousands of individuals took advantage of this carrot, but many more did not.  The IRS is already cross checking the databases of information they obtained from the last amnesty, as well as information obtained using tax treaties [3], through submissions from whistleblowers, informants and other sources.  We are already seeing them use the stick, and the IRS Commissioner has made it clear that this is just the beginning.

Criminal and Civil Penalties that Could Apply if a Taxpayer is Detected Prior to Making a Disclosure
Besides criminal exposure, here are some of the civil penalties that could apply if a taxpayer gets caught prior to submitting a valid voluntary disclosure:

  • A penalty for failing to file the Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, commonly known as an “FBAR”). United States citizens, residents and certain foreigners must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign accounts exceeded $10,000 at any time during the year. Generally, the civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.
  • A penalty for failing to file Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts. Taxpayers must also report various transactions involving foreign trusts, including creation of a foreign trust by a United States person, transfers of property from a United States person to a foreign trust and receipt of distributions from foreign trusts under IRC § 6048.This return also reports the receipt of gifts from foreign entities under section 6039F.The penalty for failing to file each one of these information returns, or for filing an incomplete return, is 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.
  • A penalty for failing to file Form 3520-A, Information Return of Foreign Trust with a U.S. Owner. Taxpayers must also report ownership interests in foreign trusts, by United States persons with various interests in and powers over those trusts under IRC § 6048(b).The penalty for failing to file each one of these information returns or for filing an incomplete return, is five percent of the gross value of trust assets determined to be owned by the United States person.
  • A penalty for failing to file Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations. Certain United States persons who are officers, directors or shareholders in certain foreign corporations (including International Business Corporations) are required to report information under IRC §§ 6035, 6038 and 6046.The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
  • A penalty for failing to file Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. Taxpayers may be required to report transactions between a 25 percent foreign-owned domestic corporation or a foreign corporation engaged in a trade or business in the United States and a related party as required by IRC §§ 6038A and 6038C. The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
  • A penalty for failing to file Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation. Taxpayers are required to report transfers of property to foreign corporations and other information under IRC § 6038B. The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.
  • A penalty for failing to file Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships. United States persons with certain interests in foreign partnerships use this form to report interests in and transactions of the foreign partnerships, transfers of property to the foreign partnerships, and acquisitions, dispositions and changes in foreign partnership interests under IRC §§ 6038, 6038B, and 6046A. Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit.
  • Fraud penalties imposed under IRC §§ 6651(f) or 6663. Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax.
  • A penalty for failing to file a tax return imposed under IRC § 6651(a)(1). Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 percent of the balance due, plus an additional 5 percent for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 percent.
  • A penalty for failing to pay the amount of tax shown on the return under IRC § 6651(a)(2). If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent.
  • An accuracy-related penalty on underpayments imposed under IRC § 6662. Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty.

In cases where the government can prove the failure to report was intentional, criminal exposure can include:

  • Possible criminal charges related to tax returns include tax evasion (26 U.S.C. § 7201), filing a false return (26 U.S.C. § 7206(1)) and failure to file an income tax return (26 U.S.C. § 7203). Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. § 5322.
  • A person convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.

[1] The laws determining whether someone is a U.S. resident for tax purposes are very complex and have many exceptions and mechanisms that can be used to delay or avoid tax residency while still spending ample time in the U.S.  The general rule is that a foreigner who is present in the U.S. for 183 days or more during the calendar year is a tax resident that year.  In counting the 183 days, however, the rules require adding 1/3 of the days present in the US during the prior year and 1/6 of the days present in the US the year before that.  For example, a foreigner who spent a total of 60 days traveling in the US during 2008 on business trips and vacations, 120 days in 2010 doing the same plus looking for a suitable second home in Weston, and 143 days in 2011 temporarily relocating their family and visiting with them, will be a tax resident in 2011 (143 + 90/3 + 60/6 = 183) without proper planning and regardless of their holding most types of visas.

[2] Foreigners with US investments or businesses or who spend over 30 days per year in the US should engage an international tax attorney to undertake “pre-immigration” planning to minimize their US income and estate tax obligations.  This planning generally consists of, among other things, finding ways to defer that certain date one legally becomes a resident for tax purposes and therefore subject to taxation on not just their US income and assets, but also any income or assets they have anywhere else in the world.  This deferral can be accomplished by something as simple as arranging their personal affairs in a certain manner, to making special tax elections with the IRS if qualified, and if available invoking international tax treaties such as the one between the US and Venezuela.  Planning also entails arranging one’s worldwide wealth in order to accelerate the recognition of foreign income or gain from the disposition of business or other assets outside the US prior to becoming a tax resident, so they are taxed only on those items outside the US if at all.  Conversely, planning can be done to defer taking foreign deductions and losses until after becoming a US tax resident.  For estate and gift tax purposes, planning mainly consists of transferring foreign assets in ways that they will no longer be taxed if the person dies subject to US estate tax on their worldwide assets.  Note, the laws that determine when someone becomes a tax resident for estate and gift tax purposes are quite different from the laws used for income tax purposes and usually result in earlier tax residency.

[3] The U.S. has greatly expanded its network of information exchange agreements with tax authorities worldwide, including popular “offshore” jurisdictions such as the Cayman Islands and British Virgin Islands.

[4] As an attorney and CPA giving tax advice for almost 20 years and who also had the honor of working for the U.S. Tax Court in Washington, D.C., I have come to know some excellent accountants who are effective advocates against the IRS. While the services of a good tax accountant are normally required to assist in the preparation of a voluntary disclosure package, however, it’s important to note that there is no federal accountant-client privilege with respect to criminal matters. In fact, the CPA can be compelled to testify against their client and all their records and e-mails can be subpoenaed as evidence. As such, it’s important that any taxpayer with this or any other type of possible criminal exposure speak with a tax attorney first, and then have the attorney hire the CPA to assist with any voluntary disclosure under a special arrangement where the accountant is also covered by the attorney-client privilege.