The Internal Revenue Service recently announced a revised penalty framework (the penalty initiative) to encourage US taxpayers with undisclosed offshore accounts to participate in its voluntary disclosure program.
The penalty initiative is part of a concerted effort by the IRS to identify those taxpayers who maintain (or have signatory authority over) undisclosed accounts in foreign banks and financial institutions and bring such taxpayers into compliance with regard to their reporting and tax payment obligations.1 In announcing the penalty initiative, IRS Commissioner Douglas Shulman said that taxpayers who “come in voluntarily will get a fair settlement…. [and will] avoid criminal prosecution.”
Commissioner Shulman added that for “taxpayers who continue to hide their head in the sand, the situation will only become more dire” and that the IRS has instructed its agents to “fully develop these cases, pursuing both civil and criminal avenues and to consider all available penalties, including the maximum penalty for the willful failure to file the [Report of Foreign Bank and Financial Account] and the fraud penalty.”2
Under the penalty initiative, the IRS will resolve these matters with eligible taxpayers on the following terms:
The taxpayer must file or amend all returns, including the Report of Foreign Bank and Financial Account (FBAR), and pay taxes and interest for the past six years unless the account or entity was formed within the last six years, in which case the assessment is made from the year of formation of the entity or account;
The taxpayer will pay either an accuracy penalty (20 percent of the underpayment of tax or 40 percent for a substantial valuation misstatement) or delinquency penalty (up to 25 percent of tax due) on all years with no application of the reasonable cause exception; and
The taxpayer will pay a penalty of 20 percent of the amount in the foreign bank accounts in the year with the highest aggregate account or asset value.3
Taxpayers considering whether to participate in the penalty initiative must act quickly, because the penalty initiative will only apply to those voluntary disclosures made before September 23, 2009.
Taxpayers will only receive the benefits of the penalty initiative if they are eligible. To be eligible, inter alia, the taxpayer (i) cannot have “illegal source income”; (ii) cannot currently be the subject of a civil examination or criminal investigation; and (iii) must fully cooperate with the IRS in determining the taxpayer’s correct tax liability and make good faith arrangements with the IRS to pay the tax, interest and any applicable penalties.4
The penalty initiative is one result of the ongoing litigation between the IRS and Swiss-based UBS AG (UBS) over the disclosure of information regarding its US depositors holding offshore accounts. On February 18, 2009, UBS and the Department of Justice entered into a deferred prosecution agreement pursuant to which UBS agreed to pay the US government $780 million in fines, penalties, interest and restitution. Under the deferred prosecution agreement, UBS also agreed to provide the US government with the identities of and account information of certain US depositors pursuant to an order issued by the Swiss Financial Market Supervisory Authority.
To date, UBS has provided the names of about 250 of approximately 52,000 US depositors that maintained accounts at UBS. It appears that these names are depositors UBS advised the IRS it had determined may have committed “tax fraud” (in contrast to tax evasion, which is not a crime in Switzerland) within the meaning of the Swiss-US Income Tax Treaty (Treaty) and thus the information is exchangeable under Article 26 of the Treaty. The US government continues to press UBS for additional information and is still seeking to compel it to provide the IRS with the identities of the remaining account holders.
The US government is wasting little time in bringing criminal actions against individuals whose names and account information were disclosed by UBS to the US government pursuant to the deferred prosecution agreement. The New York Times reported on April 2, 2009, that the Department of Justice has opened approximately 100 criminal investigations against US depositors of UBS. That same day, federal prosecutors brought the first criminal case against a UBS depositor with the arrest of a South Florida accountant who, through a British Virgin Island nominee company, had control over and access to a previously undisclosed account with UBS in Switzerland. On April 14, 2009, a second UBS depositor was the first to plead guilty to filing a false income tax return in connection with a financial account (a corporate account of which the customer was the beneficial owner) and income earned on such account at UBS. This individual faces up to three years in prison.
Voluntary disclosure pursuant to the penalty initiative may or may not be appropriate for every US taxpayer (including green card holders) with a financial interest in or signatory authority over one or more undisclosed offshore accounts. Taxpayers should seek the advice of counsel and should share all information related to foreign accounts with such counsel in order to receive the maximum benefit of such a consultation. Regardless of an individual taxpayer’s circumstances, counsel can provide guidance as to the best available options.
Whether a taxpayer qualifies for voluntary disclosure depends on the individual facts and circumstances involved in each case. However, even if a taxpayer is not eligible to participate in the penalty initiative, there may still be a benefit to contacting either the IRS or the Department of Justice before being contacted by one of their representatives. Moreover, a taxpayer may also consider making a “quiet” disclosure by filing amended returns and/or FBARs in limited circumstances, such as when all income has been reported and tax paid but no FBARs have been filed.
Particularly in view of the government’s stated interest in encouraging taxpayers to come forward and disclose existing accounts, and despite the issuance by the IRS of responses to Frequently Asked Questions, questions remain about the implementation of the penalty initiative (and the voluntary disclosure program generally). For instance, some questions remain as to how the government will calculate the penalties to be imposed.
Taxpayers with unreported income in offshore accounts should also discuss the state tax ramifications of any disclosure to the IRS with their tax counsel. This is important because disclosure by taxpayers of unreported federal income is likely to trigger state reporting and payment obligations. Taxpayers considering disclosure should be aware that six states, including New Jersey, Maryland and Connecticut, have recently announced their own tax amnesty programs and at least five other states are considering such programs. These programs not only provide an opportunity to report any unreported offshore income, they also provide the chance to disclose any previously omitted items of income. State tax amnesty programs generally involve a waiver of some or all civil and criminal penalties and may also reduce the amount of interest due from taxpayers who participate in such programs. Like the penalty initiative, these programs are generally offered only for limited periods of time.
DLA Piper is representing several taxpayers participating in the voluntary disclosure program (including the penalty initiative), as well as financial institutions with an interest in accepting deposits from taxpayers participating in the voluntary disclosure program.
For more information, please contact the authors.
Most recently, the Department of Justice filed a “John Doe” summons on April 15, 2009 with a federal court in Denver seeking the credit card records of US merchants with money in offshore bank accounts. The Department of Justice asked the federal court to approve the summons on one of the nation’s largest payment card processors, First Data Corp. The federal court approved the request. The IRS expects that the information obtained in response to the summons will identify merchants who may use offshore accounts to evade their US tax liabilities. Additional “John Doe” summonses should be anticipated.
2 The civil penalties for failing to file a required FBAR are generally up to the greater of $100,000 or 50 percent of the total balance of the foreign account in each year. Absent other criminal conduct, the criminal penalty for willful failure to file an FBAR could be up to $250,000 and five years in prison.
3 The penalty is reduced to 5 percent if (a) the taxpayer did not open or cause any accounts to be opened (i.e., the account was inherited); (b) there has no been activity in the account during the time it has been held by the taxpayer; and (c) all applicable US taxes have been paid on the funds in the account (only the earnings have escaped taxation).
4 Cooperation may include an interview of the taxpayer by the IRS or the Department of Justice.