On May 6, 2009, the Internal Revenue Service published guidance, in the form of answers to 30 “frequently asked questions,” about its recently announced voluntary disclosure settlement initiative for U.S. citizens and residents maintaining undeclared offshore bank accounts and/or entities. The voluntary disclosure program, announced March 23, 2009, offers taxpayers who comply the chance to avoid prosecution for possible tax evasion and reduce taxes, penalties and interest owed. The guidance follows in the wake of the U.S. government’s extensive efforts to force Swiss bank UBS and other financial institutions to disclose the names of U.S. citizens and residents holding potentially undeclared accounts.
Report of Foreign Bank and Financial Accounts
Taxpayers may hold foreign accounts for a number of legitimate reasons. However, the U.S. government is concerned that U.S. persons are using certain foreign banks to hide proceeds from illegal activities to evade U.S. federal taxes and for other non-tax evasion purposes. The Report of Foreign Bank and Financial Accounts (FBAR) is required because foreign financial institutions are not subject to the same reporting requirements as domestic financial institutions. Each U.S. person must file an FBAR if the person has financial interest in, signature authority or other authority over one or more accounts in a foreign country, and if the value of the account exceeds $10,000 at any time during the calendar year. The FBAR must be filed on June 30 following the end of the calendar year it is reporting and cannot be extended for any reason. In October 2008, Treasury updated and substantially changed the form to be used for any filing after December 31, 2008, to require more detailed disclosure from a broader base of filers.
The new version of the form includes revised instructions and definitions concerning who is required to file the FBAR. The new definitions potentially expand the group of persons required to file, but the extent of this group is unclear. For example, the form was revised to extend the disclosure requirement to any person “in and doing business in the United States.” The question of whether a foreign person is “in and doing business in the United States” is exceedingly problematic. The IRS received a number of questions and comments concerning the new filing requirement and, therefore, to reduce the burden on the public, announced on June 5, 2009, that it would temporarily suspend the reporting requirement with respect to those persons who are not citizens, residents or domestic entities. With respect to FBARs due this year, all persons may rely on the definition of “United States person” found in the instructions for the prior version of the FBAR, which defined a “United States person” as (1) a citizen or resident of the United States, (2) a domestic partnership, (3) a domestic corporation or (4) a domestic estate or trust. All other requirements of the current version of the FBAR are still in effect for FBARs due on June 30, 2009. Additional guidance will be issued with respect to FBARs due in subsequent years.
Civil and criminal penalties for non-compliance with the FBAR filing requirements are severe. Civil penalties for a non-willful violation can range up to $10,000 per violation. A finding of non-willful violation is likely to be found only in those cases where the taxpayer marked the appropriate box on Schedule B and reported the income from the foreign account, had no prior FBAR filing violations and cooperated with the IRS in its investigation. Civil penalties for a willful violation can range up to the greater of $100,000 or 50 percent of the amount in the account at the time of the violation. The IRS has six years to impose civil penalties on failure to file an FBAR. Criminal penalties for violating the FBAR requirements can range from a $250,000 to a $500,000 fine or 5-10 years’ imprisonment or both. Civil and criminal penalties may be imposed together.
Voluntary Disclosure Program
In the midst of the enforcement activity directed at UBS and other Swiss banks, the IRS unveiled a voluntary disclosure settlement initiative on March 23, 2009, that put in place a new penalty structure designed to encourage taxpayers with offshore assets to come into its voluntary disclosure program, offering those who comply the chance to avoid criminal prosecution and a battery of additional penalties. This settlement initiative will only be in effect for six months, until September 23, 2009. A voluntary disclosure will only be accepted by the IRS as a means to avoid criminal prosecution if the disclosure is completely accurate, truthful and fully discloses the amounts of all previously unreported income, the source of the income is not illegal income and the IRS has not already learned of the particular taxpayer’s non-compliance and has not initiated an investigation or examination of the taxpayer.
The guidance authorizes a three-prong strategy regarding the resolution of tax liabilities for those requesting voluntary disclosure. First, agents will assess all taxes and interest due going back six years. They also will require taxpayers to file or amend all returns, including information returns and the FBAR. Second, agents will assess either a 20 percent accuracy penalty or a 25 percent delinquency penalty on all years, with no reasonable cause exception allowed. Third, in lieu of all other penalties that may apply, including FBAR and information return penalties, IRS will look at the amounts in the foreign bank accounts or entities in each of the six years and impose a penalty equal to 20 percent of the amount of the accounts or entities in the year with the highest aggregate account/asset value. The IRS will reduce the latter 20 percent penalty to 5 percent in cases where (1) the taxpayer did not open or cause any accounts to be opened or entities formed (such as in the case of an inherited account), (2) there has been no activity during the period when the account or entity was controlled by the taxpayer and (3) all U.S. taxes have been paid on the funds in the account or entity. If the taxpayer is accepted into the voluntary disclosure program, the IRS will agree not to recommend to the Department of Justice that criminal charges be brought.
Questions Addressed in FAQ
In the new 12-page FAQ, IRS addressed a host of questions, including the various stages at which taxpayers can come into the disclosure program, the issue of “quiet” disclosures, the six-month time period for the current program and whether taxpayers will face penalties for certain failures to file FBARs. In one key development, the document contained a question about whether taxpayers should use the voluntary disclosure program if they have properly reported all their taxable income but only recently learned about their FBAR responsibilities. IRS said that, in such a case, taxpayers should not use voluntary disclosure but, instead, should file their delinquent FBARs with a statement explaining why the reports are late, along with copies of all relevant tax returns. In these cases, the government said it would not impose a penalty for failure to file the FBARs.
A fundamental issue addressed in the FAQ was how taxpayers should make their disclosures in the voluntary compliance program. IRS said taxpayers should send a letter to the nearest Special Agent in Charge, IRS Criminal Investigation, with all their identifying information, including name, address, Social Security number or other taxpayer identification number, passport number and date of birth. The letters should include an explanation of any previously unreported or underreported income, or incorrectly claimed deductions or credits related to undisclosed foreign accounts or entities, including the reasons for the errors or omissions.
IRS also addressed so-called “quiet” disclosures, or situations in which taxpayers have filed amended returns and are paying any related tax and interest for previously unreported offshore income without otherwise notifying IRS. Those taxpayers who have already made “quiet-disclosures” are eligible for the voluntary disclosure program, but must send previously submitted documents, including copies of amended returns, to their local CI office by Sept. 23, 2009. However, those making such disclosures should be aware of the risk of being examined and potentially criminally prosecuted for all applicable years since the IRS has stated that it does not consider a “quiet disclosure” to constitute a valid voluntary disclosure.
The Take Away
Voluntary disclosure is typically viewed favorably by the IRS and the Department of Justice when they consider criminal prosecution, but it is no guarantee of immunity from prosecution and it offers modest relief from civil penalties. Nevertheless, with the 2008 FBAR filing date of June 30, 2009, rapidly approaching, taxpayers should take these filing responsibilities seriously and, if appropriate to redress any prior years’ non-compliance, taxpayers should consider a voluntary disclosure within the six-month window that expires September 23, 2009.
