On February 18, something happened that should be taken as a wake-up call by investors with secret foreign bank accounts: UBS AG signed a deferred prosecution agreement with the U.S. Department of Justice that resulted in the names and private Swiss account records of 300 U.S. taxpayers being released to the IRS.

The reverberations of the agreement ran strong in the community of offshore bankers, advisors, lawyers and other practitioners whose businesses depend on bank secrecy. Many of these advisors had been telling their customers not to worry about the well-publicized federal investigations into offshore accounts because bank secrecy was thought to be impenetrable.  That perception, it turns out, was misguided. U.S. taxpayers with secret accounts are at risk-a reality that was underscored by the criminal charges recently brought against a yacht broker and an accountant in Florida for allegedly failing to disclose foreign bank accounts in their tax returns.

The environment is such that anyone with an offshore account needs to make sure they're in compliance with local, state and federal tax laws, regardless of why the accounts were originally set up or even if the accounts were inherited.

The primary consideration for clients and their advisors should be whether a "voluntary disclosure" can be achieved.  The voluntary disclosure is a method by which a taxpayer discloses past noncompliance. This could include underreporting income earned in a foreign account (from dividends, interest, capital gains, etc.), failing to file income tax returns, failing to file IRS forms required for foreign corporations, partnerships, trusts and "disregarded entities," and failing to file or falsely filing a Report of Foreign Bank and Financial Accounts (FBAR). The IRS and most states-which have their own form of voluntary disclosure-will typically refrain from criminally prosecuting a taxpayer who makes a voluntary disclosure and will only require the payment of the appropriate taxes, interest and penalties.

The IRS and most states require that a taxpayer's voluntary disclosure is "timely" and "complete" and that the unreported assets or income are not from illegal sources. The taxes due must also be paid and the taxpayer must "cooperate" with the government.

Earlier this year, the IRS announced a six-month initiative allowing taxpayers with undisclosed offshore accounts and offshore entities to make voluntary disclosures with reduced civil penalties, thus reducing the overall tax cost of the voluntary disclosure.  This initiative requires:  (1) contact with the IRS's Criminal Investigation (CI) division and disclosure of the taxpayer's name, Social Security or employer identification number and a description of the facts and circumstances of the accounts; (2) the filing of amended or overdue tax returns for the last six years (2003-2008); and (3) payment of the tax, interest and penalties.  The penalties are 20% of the tax due for each of the six years and one 20% FBAR penalty applied to the highest balance on deposit in the offshore account during the six-year period.  With looming fraud penalties equal to 75% of the tax due and FBAR penalties of up to 50% of the amount on deposit in each of the tax years of noncompliance, the initiative offers an immediate and tangible incentive to step into the light before September 23, when the program is scheduled to end.

Although guidance relating to the voluntary disclosure program is available on the IRS's Web site at irs.gov, the making of a voluntary disclosure, including those that fall under the offshore account initiative, is fraught with peril for the inexperienced and poorly advised.  The Department of Justice, which prosecutes violations of the tax code and bank secrecy statutes, says it has 30 prosecutors around the country pursuing criminal investigations of offshore account holders. IRS agents are similarly engaged.  Thus, each prospective voluntary disclosure needs to be evaluated in terms of its ability to withstand a criminal prosecution.  In particular, it is imperative to determine whether the IRS has information about the account holder's secret account.  If it does, voluntary disclosure is not an option and information provided to the IRS can be used against the taxpayer in a criminal case.

What does this mean for the account holder?  What should the account holder do? Consider the following common scenario.  Mr. and Mrs. X emigrated to the United States 20 years ago.  While they were citizens and residents of a foreign country they established, from money earned in their home country, a numbered Swiss bank account because of concerns over political or social instability or religious persecution where they lived.  The Swiss account became their nest egg, providing them with financial security.  When they emigrated to the United States, they left the account in Switzerland.  Mr. and Mrs. X told no one about this account.  When asked whether they had a foreign bank account in the U.S. tax return organizer provided by their CPA, they answered "no."  When they provided interest, dividends and capital gains information, they failed to include any activity from the Swiss account.  Mr. and Mrs. X never brought any of the money from the Swiss account to the U.S., but when they vacationed in Europe, they paid their expenses in cash taken out of the account.

Do these facts expose Mr. and Mrs. X to possible indictment for tax evasion, conspiracy, filing false income tax returns and willful failure to file FBARs?  The answer is yes.

The first thing a secret account holder should do is retain an attorney who is experienced in criminal tax matters. A taxpayer's first inclination is often to speak about his situation with the trusted accountant who prepares his tax returns.  This is a bad idea.  Unlike attorneys, accountants are not obligated to keep client matters confidential.

Nor are they shielded from disclosing client data if they are subpoenaed to testify by prosecutors. The absence of an attorney-client privilege essentially means the accountant is a prospective witness against the client. Should the matter of the secret account be pursued criminally, the government will seek to establish the client's willful nondisclosure by having the accountant testify that he was never informed about the account by the client.  The accountant will typically do so, not wanting to appear complicit or lacking in due diligence.

An attorney will want to retain a new accountant who will work under the attorney's direction in evaluating the tax ramifications of the client's conduct.  This is important because if a voluntary disclosure is made, every item in the amended tax return must be correct, not just the items impacted by the foreign account.  An independent review by a new accountant is helpful in this regard.  Since the voluntary disclosure program requires that the returns and all submissions be truthful and complete, an amended return that discloses the foreign bank account but incorporates other false or fraudulent items can itself become the vehicle for criminal prosecution.

The attorney and the accountant will need to evaluate the client's tax exposure and how much he owes the government. In order to do this, they will need at least six years of account records (asset statements, income statements and capital gain and loss schedules) from the foreign institution, as well as all account opening records and other correspondence in the institution's files.  Obtaining this information takes time and persistence, which is why making this request is a top priority.  For the protection of the client, the attorney should decide where the documents should be sent and who should request them.  Usually this will be the attorney, pursuant to a power of attorney recognized by the foreign institution.  In this era of increased government scrutiny and active U.S.-based investigations of foreign institutions, the records should not be mailed or couriered directly to the client from the institution.  

Finally, the account holder should "do no harm."  This means a number of things in this context.  No records should be altered or destroyed.  The funds on deposit or the securities held in the foreign account should not be moved to another institution or into another foreign country as this could be construed as obstructing justice or, in some circumstances, money laundering.  An accurate Form TDF 90-22.1 for the year 2008 should be prepared prior to June 30, the due date.

Well before September 23, the closure date for offshore voluntary disclosures, the attorney must evaluate whether the account holder qualifies to participate in this program.  Voluntary disclosure requires satisfaction of the following criteria:
1. The taxpayer cannot currently be under audit or notified that an audit is about to commence;
2. The taxpayer cannot be under criminal investigation for any crime, whether or not it's related to taxes;
3. The funds or assets in the secret account cannot have originated from illegal sources;
4. The taxpayer must be willing to cooperate with the IRS, including meeting with CI agents and making a full and complete disclosure;
5. The taxpayer must pay or make arrangements to pay the tax, interest and penalties.

Once it's determined the client has met all the criteria, the voluntary disclosure can be commenced at the federal and state level.  When the process concludes, the account holder will have come into compliance with U.S. tax law and can then decide whether to maintain or move the account, including to the U.S. if so desired.  If the account remains foreign, the holder must file an FBAR each year by June 30 of the succeeding year and report any income earned in the account in his tax returns.  Best of all, the taxpayer will be able to sleep at night without fear of possible criminal prosecution.

Barbara T. Kaplan is a shareholder of the international law firm of Greenberg Traurig LLP and chair of its New York tax department. She concentrates her practice in tax controversy, tax litigation and criminal tax matters.