Offshore Tax Enforcement, Voluntary Disclosure, And Undeclared Foreign Accounts

This article was originally published in ALI-ABA Estate Planning Course Materials Journal, December 2011

1. Introduction

   1. For the past several years the worldwide business press has been full of stories about potentially thousands of U.S. taxpayers who may have undeclared accounts all over the world. Through a variety of mechanisms, the U.S. government has obtained information about American account holders and their assets from jurisdictions previously thought nearly impenetrable. Many developments are public; others are occurring in quiet conference rooms in Washington, D.C., and elsewhere and may never become fully known to the public.

   2. Recent developments portend the gradual erosion of the traditional concept of bank secrecy and increased transparency among nations regarding financial information. In large part, a consensus has emerged that disclosure of heretofore secret bank data is now routinely warranted not just to protect against more heinous crimes, such as terrorism, narcotics, money laundering, and financial fraud, but more simply to promote the tax and fiscal interests of a given nation.

   3. This article discusses methods of enforcement, incentives, and deterrence being used by the U.S. government to bring U.S. taxpayers into compliance, to prosecute alleged wrongdoers located both in and outside the United States, and to penetrate long-standing protections for bank information maintained in many countries outside the United States.

2. Criminal And Civil Exposure In Undeclared Account Cases

   1. A variety of reporting requirements exist for U.S. citizens and residents, including individuals, corporations, partnerships, trusts, and estates, involving foreign accounts and other foreign holdings. The willful failure to comply with these requirements can be prosecuted as criminal offenses under U.S. law and subject the persons involved to substantial civil money penalties. Non-willful conduct can result in the assessment of tax, interest, and penalties. The statute of limitations for criminal tax offenses is six years. The statutes of limitations on civil penalties vary by the specific penalty involved, but the most serious of the civil penalties either have a six-year, or no, statute of limitations.

   a. Income Tax

   i. U.S. taxpayers are required to report and pay tax on their worldwide income. This includes reporting investment income earned on financial accounts located outside the United States. U.S. tax reporting also requires taxpayers to disclose the existence of any foreign accounts on the individual's U.S. tax return. Schedule B of Form 1040, and other tax forms, requires filers to check a box answering whether they have signature authority or a financial interest in any foreign accounts and if so to list the names of the countries where the account(s) are held.

   ii. Criminal penalties exist for willful failure to report income and willful filing of a false return. In addition, the IRS may assess tax, interest, and penalties equal to as much as 75 percent of any tax understatement for civil fraud and lesser percentages for incorrect filings.

   b. Foreign Bank Account Reporting

   i. U.S. law also requires filing a separate information return, a TD F 90-22.1, Report of Foreign Bank and Finance Accounts, known as an FBAR, by June 30 following each calendar year. This form is not filed with the tax return but is sent to a separate IRS service center in Detroit. There are no extensions to this deadline.

   ii. A non-willful failure to file an FBAR can be penalized up to $10,000, but a willful failure to file can result in a civil penalty of as much as 50 percent of the value of the foreign account, with no cap for each violation, per year. 31 U.S.C. §5321(a)(5). Thus a taxpayer with a substantial undeclared foreign account may face the prospect of a civil penalty for a multiyear, willful failure to file the FBAR that would not just exhaust the balance of the entire account but may result in the taxpayer having to pay additional funds.

   iii. The statute of limitations on FBAR penalties is six years. The IRS has the burden of proving willfulness and must engage in special judicial proceedings to collect the penalty if imposed. So, in ordinary times, a practitioner should be able to negotiate it downward, or away altogether, especially in the case of inherited accounts or where other factors exist indicating a taxpayer was unaware of the FBAR filing requirement or otherwise acted with reasonable cause. As noted below, the IRS has a new 2011 voluntary disclosure initiative. IRS agents have no discretion to lower penalty amounts below those set forth in program guidance.

   iv. The penalty for failing to file the FBAR can apply to anyone who violates, or causes any violation of, the filing requirement. 31 U.S.C. §5321(a)(5). Recently U.S. government officials have stated they believe the FBAR penalty can be assessed and collected...