For U.S. taxpayers with undisclosed offshore accounts or business activities, now is a critical time to review the legal and tax status of their arrangements, and to weigh their available options very carefully. In recent months, the Internal Revenue Service (IRS) has been waging an intense battle over undisclosed foreign accounts owned by U.S. taxpayers, most publicly with respect to accounts held at UBS. As a result, the stakes for those involved - and those similarly situated - have risen dramatically.
Continued confidentiality over foreign accounts and activities is by no means assured in the future. Furthermore, the IRS has stated its intention to vigorously pursue U.S. taxpayers with undisclosed offshore income who do not participate in its current "voluntary disclosure" program. Recent guidance issued by the IRS provides greater clarity to taxpayers weighing the potential benefits of voluntary disclosure of their offshore activities. Because this voluntary disclosure program closes in September 2009, however, time is of the essence.
The IRS Voluntary Disclosure Program
The immediate opportunity is presented to those U.S. taxpayers who (1) have or control offshore assets derived from a lawful source; (2) are not already under examination by the IRS; and (3) cooperate fully with the IRS in disclosing and correcting their tax and filing status. To seek enrollment in the program, a taxpayer must file a preliminary disclosure identifying the taxpayer and briefly describing the circumstances. Assuming the IRS determines the taxpayer is not already in its investigative databases, the taxpayer will generally be "accepted" into the voluntary disclosure program.
Once accepted, the program requires the taxpayer to prepare and file amended returns going back six years, and to file whatever other delinquent or inaccurate forms or returns may be necessary for offshore accounts, trusts or other controlled entities. The program will also generally require an interview with an IRS criminal agent. Once the interview has been conducted and the paperwork is assembled, the taxpayer's disclosure will be referred to a special IRS office in Philadelphia established to process all of these offshore disclosures.
The "Carrots" and the "Sticks"
The IRS is touting two principal benefits of the program. First, while not guaranteed, there is a virtual assurance from the IRS that voluntary disclosures will not be referred to the Department of Justice or otherwise considered for criminal prosecution. Depending on the dollar amounts at issue, and the underlying indicia of fraud, this "carrot" may be larger or smaller in the overall analysis for a given taxpayer.
The second benefit is the enhanced certainty as to the ultimate civil penalty that will be imposed. Though there are some caveats and exceptions, the basic proposal is that taxpayers will be required to pay (1) all additional taxes and interest due on unreported income; (2) an accuracy-related penalty on the unreported income; and (3) an overall penalty in lieu of other penalties amounting to 20 percent of the amount in the foreign accounts in the year with the highest aggregate asset value.
Whether or not this 20 percent penalty amount seems fair in a given case, the maximum possible civil, fraud and other penalties associated with undisclosed foreign assets and activities can often exceed this amount. For example, recent IRS guidance provides a simplified example in which the voluntary disclosure penalty framework would result in a total payment of $386,000; by contrast, the penalties the IRS might impose in the same example absent a voluntary disclosure amount to approximately $2.3 million. And absent voluntary disclosure, the taxpayer still faces the threat of criminal prosecution.
Indeed, even if it appears that a taxpayer does not stand to save significant money by participating in the voluntary disclosure program, the real "carrot" in a given case may be the relative certainty of the financial outcome at the time the taxpayer must decide whether or not to come forward. And, depending on the facts, the assurances that criminal prosecution will be avoided may also be very meaningful for a particular taxpayer.
As far as the "sticks" are concerned, the IRS guidance is very clear that those who do not take advantage of the program will be dealt with far more severely. The IRS also recently indicated that "quiet" filings, in which taxpayers seek to correct their past reporting failures by quietly filing amended or past-due returns without participating in the voluntary disclosure program, will generally be treated with suspicion. Nevertheless, quiet filings or other approaches may be the appropriate response for some taxpayers, depending on their particular facts. The IRS is clearly intent on increasing its international enforcement efforts, and recent statements from the Obama Administration suggest that government pressure on financial institutions and foreign "tax havens" will continue to mount. New and additional incentives to "whistleblowers" could also increase the risks to taxpayers with undisclosed offshore assets or activities.
Whether the IRS voluntary disclosure program is appropriate for a given taxpayer will require a delicate weighing of many factors and, ultimately, a careful judgment call. Because the opportunity closes in September, however, taxpayers concerned about these issues must begin analyzing them with their advisors as soon as possible.