The Internal Revenue Service announced on February 26, 2008, that it was commencing enforcement action against approximately 100 U. S. persons whose names were on a list of account holders at LGT, the largest bank in Liechtenstein. This followed close on the heels of the announcement of United States Senator Carl Levin (D-Mich.) on February 21, 2008, that he intends to have the Senate Homeland Security and Government Reform Permanent Subcommittee on Investigations look into the same matter. This subject has been of growing interest since German tax enforcement officials opened high profile tax evasion inquiries into prominent Germans who may have had undisclosed accounts at that bank.

These are significant events. The IRS action will target the individual persons whose identity was revealed in the material removed, apparently unlawfully, from LGT by a disgruntled former employee. Sen. Levin’s Committee will likely cast a broader net, and to place his work in context, it was his Committee that conducted the first significant investigation into whether persons at the global accounting giant KPMG had engaged in the mass marketing of abusive tax shelters; soon after his Committee’s report was published, a grand jury investigation began that has resulted in numerous guilty pleas and criminal indictments and prosecutions. So if Sen. Levin unearths additional information beyond the 100 or so names now in the possession of the IRS, the Service, and the Department of Justice as well, will pay close attention and are likely to open their own additional inquiries based on such information.

There are likely many more than 100 persons who file U.S. tax returns and who have undisclosed assets at LGT and similar banks in tax haven countries. Many of these accounts were inherited from parents or grandparents who set them up years ago, some in adverse circumstances prior to or during World War II. Some accounts may well have been largely untouched over the years, for many, out of fear of detection by the Internal Revenue Service or other authorities.

These inquiries are obviously not good news for anyone who has hidden foreign assets or income from the U. S. tax authorities. Bank secrecy in tax haven jurisdictions such as Liechtenstein is becoming an increasingly flimsy reed of protection, and otherwise law abiding persons with undisclosed foreign assets run the risk of being caught up in investigations focused on terrorism and money laundering. If criminal investigations ensue, there will be the potential of prosecution even leading to incarceration, and substantial civil penalties for anyone found to have willfully violated federal tax laws as to reporting the existence of and income from foreign accounts.

Notwithstanding the IRS’s and Sen. Levin’s announcements, however, there is time for fast acting account holders to make their peace with the IRS and at least avoid criminal punishment. The IRS has a longstanding “Voluntary Disclosure Policy,” under which it will generally not seek criminal prosecution of any taxpayer who comes forward and satisfies its criteria. While the IRS often points out, and the Policy itself specifies, that it does not provide full “immunity,” the IRS historically has welcomed voluntary disclosures, and neither I nor colleagues of mine who handle such matters have ever seen a true voluntary disclosure “blow up” into a criminal prosecution. In practical effect, the Policy presents an opportunity for many people who may be caught up in the LGT matter to eliminate the risk of a future criminal proceeding.

Importantly, however, the policy will not be available to any person within the group of 100 or so individuals now known to the IRS to have accounts at LGT. For these people, under the terms of the Voluntary Disclosure Policy, it is too late.

There are five key components to an effective voluntary disclosure:

  • Legal Source: Irrespective of any other factor, the Voluntary Disclosure Policy does not apply to any funds derived from unlawful activity. The assets at issue must be of a “legal source.”
  • Timeliness: In order to be recognized as an effective voluntary disclosure, the taxpayer must come forward before the IRS has begun a civil or criminal investigation of his tax affairs (whether the taxpayer is aware of such investigation), or before the IRS is in possession of information from a third party that would directly lead to that taxpayer. It is this latter clause that eliminates the possibility of a Voluntary Disclosure as to those 100 whose names have been disclosed to the IRS.
  • Completeness: The person making a Voluntary Disclosure must file truthful and accurate amended (or delinquent) tax returns. One may not “selectively correct” prior tax filings to fix some errors but not others.
  • Payment: An effective Voluntary Disclosure requires payment of the tax at issue, plus interest, or at least good faith efforts on the part of the individual to make payment.
  • Cooperation: Most voluntary disclosures do not result in a full audit, but if one ensues, the taxpayer is required to cooperate in all respects with the examination, or the protection of the voluntary disclosure is lost.

Every taxpayer’s case is different, and there are a number of issues that arise in examining whether a voluntary disclosure is appropriate. One such issue is how many years the taxpayer must correct – in many cases, practitioners recommend going back no more than six years, as that is the statute of limitations for criminal tax prosecutions in the U.S. In some cases, for a variety of reasons, a taxpayer may go back and correct filings for fewer than the previous six years.

A second issue is the manner of the disclosure itself, as, depending on the facts of the case, one might make an effective voluntary disclosure simply by filing amended (or delinquent) returns accompanied by payment, or one might surface overtly with IRS officials to provide relevant facts to obtain their view that the Voluntary Disclosure Policy would apply. This issue is especially significant in light of the fact that the IRS now has 100 or so names.

Third, there are often complex tax reporting and accounting issues arising from the nature of the assets held in the foreign accounts, currency exchange calculations, estate v. income tax issues, and even account ownership questions where a Foundation or various beneficial owners may be involved. Fourth, there are often questions regarding the separate U. S. Treasury form (Form 90-22.1 – the “FBAR”), an annual information return required of U.S. persons who control or have interests in foreign financial accounts. And finally, the Policy does not provide protections from civil penalties, although the IRS is often lenient as to such penalties when taxpayers have truly come forward in good faith to account for their funds.

Complications aside, the IRS’s Voluntary Disclosure Policy provides an opportunity for those worried about eventual detection to make their peace with the IRS at, relatively speaking, what is often a reasonable price, especially where the benefit might be the avoidance of a criminal inquiry. U.S. persons who have accounts, directly or held through related entities, at LGT, and professionals worldwide who have counseled such persons or their families, would be well-advised to consider pursuing a Voluntary Disclosure before matters explode beyond the point where the Policy might protect against criminal prosecution and sanction.

This article is designed to give general information on the developments covered, not to serve as legal advice related to specific situations or as a legal opinion. Counsel should be consulted for legal advice.