by Roger Russell

Recent rulings by federal courts have put the spotlight on a long-standing financial arrangement in which millions of taxpayers are knowingly -- and in some cases unknowingly -- evading taxes through the use of offshore financial mechanisms.

The rulings are giving ammunition to the IRS to track down both these tax evaders and the promoters.

In January the Internal Revenue Service launched the Offshore Voluntary Compliance Initiative, aimed at bringing taxpayers who used offshore payment cards or other offshore financial arrangements to hide their income back into compliance with the tax law. Under the OVCI, eligible taxpayers who step forward will avoid civil fraud and information return penalties, but they would have to pay back taxes, interest and certain accuracy or delinquency penalties.

They will also avoid criminal prosecution based upon application of the revised voluntary disclosure practice. Taxpayers who do not come forward now, however, will be subject to payment of taxes, interest, penalties and potential criminal prosecution.

In the latest ruling, the Tenth Circuit joined three other circuits in holding that when a defendant commits a series of evasive acts after incurring a tax liability, the statute of limitations begins to run on the date of the last affirmative act of evasion.

"This is very helpful to the IRS effort to track these arrangements because it extends the statute of limitations," said Selva Ozelli, an editor at RIA’s Weekly Alert, a Thomson business. "Instead of starting when the taxpayer first opened up an account, it kicks in based on the last act of evasion, which is when the taxpayer fails to report it on Form 1040, Schedule B Part III."

Credit card arrangements based in the Cayman Islands and other offshore tax havens have been used to set up accounts in which cardholders make purchases and avoid reporting income on the funds used to make payments. The scenarios range from a housewife buying underwear at the Gap to underworld figures laundering money.

"The initiative is very broad," said Ozelli. "It applies to any unreported offshore income that is accessed through any offshore financial arrangement, whether it be with foreign banks, financial institutions, funds, corporations, partnerships or trusts."

"The initiative is an important step to bringing taxpayers back into compliance with the law, to stopping the promotion of these abusive schemes, and to getting the IRS information on promoters and other participants," said Pamela Olson, Treasury assistant secretary for tax policy. "Taxpayers who do not come forward now will be pursued by the IRS and will be subject to more significant penalties and possible criminal sanctions."

"The whole goal of voluntary compliance is to figure what schemes are out there," said Marietta, Ga.-based attorney Vivian Hoard. "The main target is the promoters of these schemes."

Not all individuals involved in offshore financial arrangements are aware that they’re doing something wrong, according to Hoard. "Probably some of the participants are middle-class people who think they’re privy to a big tip about things that rich people are involved in. They think this is their big chance."

To be sure, Hoard added, there are many participants who are, plain and simple, "tax cheats."

"The irony is that they’ll spend hundreds of dollars to attend a seminar at a local hotel, but they never think of paying a CPA or tax lawyer to examine the validity of the transaction."

There are a variety of ways in which promoters organize a method for taxpayers to access their offshore funds. A recent scheme discovered by the IRS involved the sale of offshore entities, including banks and trusts, which were then "decontrolled."

In the decontrol process, the U.S. taxpayer investor paid $15,000 to $60,000 for the offshore entity, which was then sold to a so-called "Independent Foreign Owner" in exchange for a promissory note in an amount large enough to make it appear as if there was a bona fide and negotiated sale of the offshore entity to the IFO. The U.S. taxpayers then received back the funds they had transferred to the offshore entity through tax-free loans.

The primary tool the IRS has used to uncover the various schemes is the John Doe summons -- summonses to third parties requesting information on unidentified taxpayers. Beginning in 2000, the IRS has served summonses on American Express, Master Card and Visa for records of transactions in various offshore tax haven jurisdictions. "The John Doe summonses allow the IRS to get the names of taxpayers, and going backwards from there, they zero in on the promoters," said Hoard. "When CID shows up, people tend to cut deals and turn in others."

Taxpayers who want to participate in the OVCI must make a written request on or before April 15, 2003. Their request must also be made before the IRS has initiated any civil or criminal exam, or received information from a third party such as an informant. Moreover, the taxpayer cannot be a promoter of the arrangement or have derived income from illegal sources, and cannot have used the arrangement to support any illegal activities not related to taxes.

IRS spokesman Bruce Friedland said that the IRS is very pleased with the results of the OVCI. However, he warned, "there are no plans to extend the opportunity beyond April 15."

Hoard said that individuals who qualify for compliance should immediately make the request. "It’s the only sane choice for those who knew their conduct violated the tax law. Those who unwittingly became involved will also benefit but will likely have to fight for waiver of the delinquency and accuracy penalties," she said. "There is no downside -- either scenario is better than defending against a criminal tax prosecution."

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