Now that the IRS has ended its partial amnesty program for U.S. citizens who voluntarily disclose offshore accounts, what options are left for those who still have undisclosed accounts?
Let's try to answer this question by looking at a hypothetical couple, Mr. and Mrs. Smith, who are U.S. citizens and have an account with a foreign financial institution. The Smiths have never reported their ownership of or the income from this account on their U.S. federal income tax returns, and they have never filed Treasury Form TD F 90-22.1 (the Report of Foreign Bank and Financial Accounts, often known as the "FBAR") disclosing this account as they are required to.
The Smiths have become increasingly concerned about their criminal and civil exposure and wish to come forward to the IRS. Unfortunately, the Smiths have missed the October 15, 2009 deadline to qualify under the IRS' temporary offshore voluntary disclosure program that began on March 23, 2009. This temporary program provided for a significant reduction in penalties if taxpayers voluntarily disclosed their noncompliance. The IRS, however, stated that the program would not be extended.
Despite the expiration of the program, Mr. and Mrs. Smith still have the ability to disclose their accounts and avoid criminal and civil charges, although they will likely face stiffer penalties than they would have under the partial amnesty program.
If the IRS detects the Smiths' noncompliance before they voluntarily come forward, the Smiths face possible criminal prosecution. Making a false statement on a tax return is punishable by imprisonment of up to three years, for example, and willfully failing to file an FBAR is punishable by imprisonment of up to five years.
While a great deal of attention has been focused on holders of accounts with UBS (including those individuals who have recently entered guilty pleas), high-level IRS officials have repeatedly announced that their inquiry will not stop at UBS and that the government will aggressively attempt to detect noncompliant U.S. clients of other financial institutions, both in Switzerland and elsewhere. For example, IRS Commissioner Douglas Shulman stated on August 19 that the "IRS will vigorously pursue tax cheats around the world, no matter how remote or secret the location. And we will work with other governments where possible to obtain the information we need. Wealthy Americans who have hidden their money offshore will find themselves in a jam."
Similarly, Kevin Downing, a senior trial counsel in the Justice Department's Tax Division who has been at the helm of the prosecutions against UBS and its customers, was recently quoted in the tax press as saying, "If they think this is just UBS, they're mistaken. ... UBS is not an anomaly. This is just the beginning. We're going after foreign banks and professionals." In fact, the IRS has recently created a new "elite" office within its large and mid-size business division that will be focused on investigating what it refers to as the "global high-wealth industry."
Moreover, the Smiths should be aware that even if their past noncompliance is not detected by the government, they will be committing new crimes each year if they fail to report their ownership of a foreign financial account and any income from this account on their U.S. federal income tax returns and FBARs for any years in which the foreign account was in existence. Even though the criminal statute of limitations is generally six years, as a year drops off the back end, a new year is added at the front end. This approach will leave the Smiths in peril because they will never be out from under the specter of criminal prosecution.
The Smiths also face significant civil penalties. For example, the Smiths may be subject to a civil fraud penalty of 75% of the taxes they did not pay. The Smiths may also be subject to a civil penalty for willfully failing to file FBARs of the greater of $100,000 or 50% of the highest balance of the account per year. There is no "ceiling" on this FBAR penalty, so it could potentially wipe out the Smiths' foreign account and then deplete their domestic assets. Moreover, there are other significant penalties that may apply for failing to file IRS forms relating to offshore entities, such as Form 5471 (relating to foreign corporations) and Form 3520 (relating to foreign trusts), among others.
Avoiding Criminal Prosecution
Contrary to what some would believe, even after October 15, the Smiths may still avoid criminal prosecution by making a qualifying "voluntary disclosure" of their noncompliance to the IRS. The long-standing practice of the IRS is generally not to recommend criminal prosecution for taxpayers who make a qualifying voluntary disclosure. There have been no suggestions that this long-standing practice terminated after the expiration of the partial amnesty program. It is entirely possible, however, that the IRS may make some changes to this practice. For example, although prior to the partial amnesty program many practitioners felt that mailing delinquent returns to an IRS service center can qualify as a voluntary disclosure, it is possible that the IRS may require a more formal and detailed submission to the IRS Criminal Investigation Division.
Under the long-standing voluntary disclosure practice, in order for the Smiths' disclosure to constitute a qualifying voluntary disclosure, the disclosure must be "timely," which generally means that the disclosure must be made before the IRS receives information about the Smiths' noncompliance and before the IRS notifies the Smiths of a tax audit. Furthermore, the Smiths' disclosure must be truthful and complete, they must cooperate with the IRS in determining their correct tax liability and make arrangements in good faith to fully pay the liability. Moreover, the source of their unreported assets cannot be derived from illegal activity. (For this purpose, the proceeds of a tax evasion scheme that does not involve illegal activities is not deemed to be from illegal activity.)