Taxpayers with undisclosed income from offshore accounts are under mounting pressure to come forward to the Internal Revenue Service.
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The deadline for the second special voluntary disclosure initiative is Aug. 31, 2011, and affected taxpayers need to begin as soon as possible. The initiative - like the first program, which expired in 2009 - is designed to bring offshore money back into the U.S.
But unlike the first program, which merely required taxpayers to come forward by the deadline, the new initiative requires taxpayers to file all original and amended tax returns and include payment for taxes, interest and accuracy-related penalties. (To differentiate between the two, the IRS refers to the 2009 effort as a "program," while the current one is an "initiative.")
"I have clients from the 2009 program that still don't have their amended returns in," said Jean Ryan, a tax partner at the law firm of Sideman & Bancroft. "The problem is in getting the offshore banks to comply. They're not particularly cooperative, so it's difficult to get accurate information that an accountant is willing to sign. If you start now to get information from multiple overseas accounts, it could take months."
Moreover, just finding an accountant with the time to perform the work could prove difficult, said Kevin Packman, a partner at the law firm Holland & Knight and chair of its Offshore Tax Compliance Team. "Most CPAs say they'll find it hard to take on new clients to do all that work," he said. "There may be eight years of past-due returns. Unless a taxpayer has account statements from a foreign bank, it can take six months just to get them."
Bob McKenzie, an attorney and tax partner at Arnstein & Lehr, agreed: "[Many] banks are not giving the information promptly. It took almost a year to get the information for some persons who came forward under the 2009 program. And some require the client to go physically to the situs of the bank. Clients have had to fly around the world to get the information to comply."
"In addition to reduced penalties under the initiative, taxpayers with undisclosed offshore accounts can avoid criminal prosecution for their unpaid taxes and may be eligible for significantly reduced penalties," said McKenzie. "Generally, the civil penalty for willfully failing to file a Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts) can be the greater of $100,000 or 50 percent of the total balance of the foreign account per violation."
BUILDING ON ROUND ONE
The first special voluntary disclosure program closed with 15,000 voluntary disclosures on Oct. 15, 2009. Since that time, more than 3,000 taxpayers have come forward to the IRS with bank accounts from around the world.
The new initiative has an overall penalty that is higher, so that people who did not come in through the 2009 program will not be rewarded for postponing disclosure. For the new program, the penalty is 25 percent of the amount in the foreign accounts for the year with the highest aggregate balance covering the 2003 to 2010 period. Some taxpayers will be eligible for 5 or 12.5 percent penalties. Participants also must pay back taxes and interest for up to eight years, as well as accuracy-related and/or delinquency penalties.
"This includes the value of an entity if the entity had unreported income associated with the purchase of whatever is in it," said Packman. "For example, if the entity purchased real estate, and used unreported funds to purchase it, the value of the real estate is subject to the penalty."
"Migratory individuals may leave pieces behind when they get to the U.S.," noted Jay Weill, who is also a tax partner at Sideman & Bancroft. "For example, they may have inherited property from an uncle in another country and left it there, or considered it as a family investment. It may not be clear to the individual who should be reporting information in certain situations."
The two lower penalties, 12.5 percent and 5 percent, are fairly limited, according to Packman. The 12.5 percent penalty is for those with offshore accounts or assets that did not surpass $75,000 in any calendar year covered by the initiative. The 5 percent penalty applies to those who are foreign residents and were unaware they were U.S. citizens, and those whose ownership in the account is the result of an inheritance. Under the second category, the taxpayer must not have opened the account, must have exercised minimal contact with the account, must not have withdrawn more than $1,000 from the account in any year covered by the voluntary disclosure, and must be able to establish that all applicable U.S. taxes have been paid on funds deposited to the account (only account earnings have escaped U.S. taxation).
WILL CLIENTS COMPLY?
It's not certain who will be eligible for anything other than the 25 percent penalty, noted George Clarke, tax partner at Washington, D.C.-based law firm Miller & Chevalier. "You don't know for sure that you're eligible," he said. "For example, people who are currently under investigation but don't know it are not eligible. If they have reason to believe that the government might have their names, they have to decide which path to take."
"If the dollar amounts are low or they think they have a strong case that their behavior was not willful, it can cut both ways," he said. "One way is to 'let them come after me and I'll defend myself.' Or they can be proactive, and go in and say, 'I have reason to believe you have my name but there's no evidence that I was out to evade tax.'"
Not all voluntary disclosure submissions are accepted, Packman indicated. "Criminal prosecution is a potential outcome from a disclosure which is found not to qualify."
Moreover, he warned, tax professionals should be aware that it is a violation of Circular 230 to represent a taxpayer on a prospective basis if the taxpayer is noncompliant and elects not to resolve the noncompliance through a voluntary disclosure: "The IRS has made it clear that they don't want taxpayers to make a 'quiet' disclosure. Essentially, that means filing delinquent items with a service center and hoping that it will be processed without penalties. An advisor who helps a taxpayer make a quiet disclosure may be violating Circular 230."