The Internal Revenue Service on February 8, 2011 announced a new voluntary disclosure program for the holders of undisclosed offshore bank accounts. As expected, the new program has tougher penalties than the expired program, and it has a close deadline of August 31, 2011, but the IRS is sweetening the offer in several respects. This time the Service is promising not to refer those who come forward to the Department of Justice for prosecution, and the IRS has created a new 12.5% penalty for small account holders.
The expiration of the last IRS voluntary disclosure program in October 2009 created a dilemma for taxpayers and the IRS that the service is now seeking to resolve. By insisting on a higher penalty for taxpayers who missed the October 2009 deadline, the IRS deterred some taxpayers from coming forward. Since the past deadline, the IRS has studiously avoided specifying what penalty regime would apply, leaving taxpayers to assume the worst. The maximum penalty that the IRS can impose for willful failure to declare a foreign account is 50% of the account value per year. Civil and criminal tax penalties could apply to any unreported income.
In addition, the IRS can refer taxpayers to the U.S. Department of Justice for criminal prosecution for the money laundering crime of failure to disclose an offshore account, and IRS Commissioner Doug Shulman has placed a very high priority on efforts to prosecute offshore account holders. To date, the Justice Department has announced guilty pleas or indictments of 21 taxpayers whose Swiss bank accounts were disclosed by a former employee of one of the Swiss banks. Moreover, the IRS is widely reported to be stepping up its enforcement and following leads to other banks in Hong Kong, China, the Cayman Islands, and many other bank secrecy jurisdictions. In addition, new whistleblowers are emerging. Both the IRS and the Department of Justice have gained information on foreign accounts and service providers from cooperating witnesses, and both agencies have taken full advantage of their authority to collect information through "John Doe" summonses to credit card processors an other financial intermediaries to uncover the existence of offshore accounts. Given facts disclosed in other prosecutions, the IRS will closely scrutinize consulting and insurance contracts with foreign firms, unusual expenses, foreign purchases of art, antiquities and other valuables, foreign income producing property, and the use of foreign shell corporations.
Details of the New Program
Under the new program, the IRS will impose a 25% penalty on taxpayers with undeclared foreign accounts who come forward with full documentation by August 31, as part of the new voluntary disclosure initiative. The 25% penalty is applied to the highest combined account balance of all undisclosed foreign accounts during the 8 year period from the beginning of 2003 to the end of 2010. The 2009 program applied a 20% penalty to the highest balance from 2003 to 2008, so the new program imposes a penalty 5 percentage points higher, and it applies to a wider range of years. In addition, taxpayers must agree to pay any applicable tax, interest, and penalties for the 8 years covered by the program two to five years longer than the IRS normally is able to look back.
There are two significant changes in favor of taxpayers in the new program. First, there is a new reduced penalty of 12.5% in cases where the aggregate value of undisclosed offshore accounts never exceeded $75,000 during the 2003 to 2010 period. In a FAQ document released when the IRS announced the new initiative, the IRS makes clear that even small temporary increases above the $75,000 threshold will be viewed as disqualifying. On the other hand, the IRS has also created an opportunity for taxpayers with small accounts who came forward earlier as part of the 2009 voluntary disclosure initiative to have their penalty adjusted if they would qualify under the new small account rule.
Another important change in comparison to the 2009 program is that the IRS is promising not to refer taxpayers for criminal prosecution. In its FAQ document, the IRS states that "when a taxpayer truthfully, timely, and completely complies with all provisions of the voluntary disclosure practice, the IRS will not recommend criminal prosecution to the Department of Justice." As in the past, the taxpayer must not already be under criminal investigation, for example, because the taxpayer's account was previously disclosed to the IRS as a result of the much-publicized UBS litigation. Nevertheless, this clear promise not to seek prosecution is a departure from past practice and undoubtedly will encourage more taxpayers to come forward.
Another beneficial feature of the voluntary disclosure program that remains the same is that there is a reduced 5% penalty for taxpayers who can establish all of the following: 1) that they didn't open the account; 2) paid all U.S. taxes on funds deposited; 3) have not withdrawn more than $1,000 from the account in any covered year; and 4) have maintained infrequent contact with the bank in question. Foreign residents who genuinely are unaware that they were born in the United States and therefore are U.S. citizens are also eligible for the reduced 5% penalty. In practice, these conditions have rarely ever been met, because the IRS interprets them strictly against the taxpayer.
The "Quiet Disclosure" Option
During the 2009 voluntary disclosure program, the IRS warned taxpayers not to attempt to come in quietly, by filing any unfiled foreign bank account reporting forms (TD F 90-22.1, commonly known as the FBAR) or amended income tax returns without identifying themselves as part of the voluntary disclosure initiative. These so-called quiet disclosures satisfy the taxpayer's legal obligations, but they require the IRS to sift through its returns to discover those taxpayers who would otherwise be subject to penalties if they came in more openly. In a FAQ document, the IRS threatened to apply stricter penalties than those applicable to taxpayers participating in the program and it repeats those warnings in the FAQ released in connection with the new program.
The IRS states that a penalty higher than 25% will apply to any foreign account holder who attempts to make a "quiet" disclosure during the existence of the new program, and it will not rule out a criminal referral. According to some reports, the IRS has identified thousands of quiet disclosures made during the 2009 program its Detroit FBAR filing center, and it may be preparing to take action against the taxpayers involved.
The IRS also now says that taxpayers who attempted to make a quiet disclosure in the past to avoid penalties are eligible for the benefits of the new voluntary disclosure program if they submit an application, together with their previously filed returns, by the August 31 deadline.
The new IRS offshore voluntary disclosure initiative provides near certain immunity from prosecution for criminal tax and money laundering penalties that could apply to citizens and U.S. residents with signature authority over any undeclared foreign bank accounts. Taxpayers with small or inactive foreign accounts may be eligible for a reduced penalty and can benefit even more from the program. Finally, taxpayers with undeclared accounts who have attempted to make a "quiet" disclosure to the IRS may want to enter the program to reduce the risk that the IRS might identify a quietly disclosed return and apply a penalty higher than 25% of the maximum aggregate account balance or refer the taxpayer for criminal prosecution.