The Internal Revenue Service has been seriously pursuing reduction of the tax gap associated with unreported foreign assets and income for a few years now. The effort has included efforts to secure information from foreign banks, credit card issuers, tax return disclosure and voluntary disclosure by taxpayers.
The first voluntary disclosure initiative instituted by the IRS was in 2009. It offered taxpayers who were not already under IRS investigation the chance to come forward and pay back taxes and penalties for up to a six-year period, but only face a maximum 20 percent penalty with respect to failure to comply with foreign bank account reporting requirements.
The 2009 effort resulted in an estimated 15,000 voluntary disclosures, which included information about banks and promoters involved with those foreign bank accounts. While the IRS rated the voluntary disclosure initiative a success, according to its own estimates the effort left many more bank accounts undisclosed than had been disclosed as part of the initiative. With many more undisclosed foreign accounts still estimated to be out there, the IRS has now initiated a second voluntary disclosure initiative for 2011.
THE NEW VOLUNTARY INITIATIVE
The IRS will always try to reward the taxpayers who came forward first, so it is not surprising that this second voluntary disclosure initiative is not quite as generous as the first. The deadline for this second initiative is Aug. 31, 2011. As with the 2009 initiative, a voluntary disclosure will only be accepted if the IRS Criminal Investigations Division does not already have the name of the taxpayer in connection with a current foreign account investigation, and if the taxpayer is not currently under audit.
The period covered by the new disclosure initiative will be eight years, rather than the six years for the first initiative - again, not rewarding taxpayers for waiting. The disclosure applies to foreign assets as well as foreign bank accounts. The maximum penalty for failure to disclose foreign bank accounts will be 25 percent, rather than the 20 percent under the first voluntary disclosure initiative. This is still better than the potential 50 percent penalty provided for in the statute. The penalty will continue to apply to the highest aggregate account balance during the applicable time period.
New to this second round of voluntary disclosures are some exceptions that can reduce the potential penalties to as low as 12.5 percent or even 5 percent. The 12.5 percent penalty applies to taxpayers whose offshore accounts or assets did not surpass $75,000 in any of the calendar years 2003 to 2010 covered by the 2011 disclosure initiative.
This new initiative also reaches back to cover the estimated 3,000 taxpayers who made voluntary disclosures to the IRS after the deadline for the 2009 initiative had expired. Tax practitioners had warned the IRS that subjecting such voluntary disclosures to criminal prosecution merely because they had missed the IRS deadline would have a chilling effect on getting taxpayers to voluntarily come forward.
The IRS seems to have agreed by now including this group under the new voluntary disclosure program. It is not clear whether the IRS will view voluntary disclosures made after the Aug. 31, 2011, deadline as generously. The IRS has promulgated a list of 53 frequently asked questions providing more details about the program.
THE IMPETUS FOR DISCLOSURE
A major impetus for voluntary disclosure under the 2009 program was the fact that the IRS had a whistleblower from Swiss bank UBS, and was also pressuring countries to relax bank secrecy laws where tax fraud could be alleged. The impetus for voluntary disclosure could be even stronger now.
The IRS has received about 4,000 account names with respect to UBS, and expects to receive about 3,500 more. It appears that UBS is notifying taxpayers whose names are to be disclosed. These notices may have stimulated some of the 3,000 "voluntary" disclosures since the 2009 program expired.
The IRS has also, however, announced that the first voluntary disclosure program provided information on banks and promoters in over 60 countries. The IRS is likely to be using this information to try to obtain information on U.S. account holders at banks in many of those countries.
New legislation passed in the U.S. in 2010 would require foreign banks to start making disclosures of foreign-owned assets or risk withholding on payments made to those banks. Many countries with traditionally strong bank secrecy laws are working on modifications to create tax fraud exceptions to help their banks comply with these new requirements.
This new legislation will also require taxpayers to disclose foreign assets and accounts on
their tax returns. Rather than just the Foreign Bank Account Reporting requirements that were separate from the tax return, now the tax return itself will require disclosures, even more directly involving the tax return preparer in the disclosure process. These new disclosure requirements apply to tax years beginning after March 18, 2010, so they will apply to the 2011 calendar year. These new disclosure requirements come with their own penalties, in addition to the FBAR penalties.
Other whistleblowers are also emerging. Wikileaks has indicated that it intends to reveal account information received from a whistleblower who worked at Julius Baer. Those disclosures also purportedly include information from other banks as well. This entire environment is likely to make U.S. taxpayers much less secure than they were even in 2009 that their foreign assets can remain hidden from the IRS. The IRS is also publicizing a number of criminal prosecutions to try to drive home the point.
PLANNING WITH CLIENTS
Tax practitioners will want to have another discussion with their clients about this second voluntary disclosure program, even if they feel they did a thorough process with their clients in 2009.
This should include a discussion of the new foreign asset and account tax return disclosure requirements starting this year, the new penalties associated with failure to make those disclosures, the new information likely to be available to the IRS as a result of voluntary disclosures made by other taxpayers under the first voluntary disclosure program and negotiations with foreign countries with respect to relaxation of bank secrecy laws, and even information with respect to potential Wikileaks disclosures.
The discussion should also continue to include a review of the FBAR reporting requirements and penalties and a comparison to the maximum penalties and avoidance of criminal prosecution available under the new voluntary disclosure program.
Estimates back in 2009 indicated that there might be as many as 50,000 taxpayers with undisclosed foreign accounts. Having found 15,000 of them through voluntary disclosure and a few more of them through investigatory means, the IRS still has a long way to go to eliminate most of the tax gap associated with undisclosed foreign assets.
The first voluntary disclosure program provided evidence that many undisclosed foreign accounts were not necessarily set up to conceal assets or income from the IRS. Many belong to relatively recent immigrants who may be unfamiliar with U.S. tax law requirements. Many may have been inherited from foreign relatives without realizing that inheriting the account changes the tax obligations of the inheriting U.S. citizen or resident.
The number of voluntary disclosures made after the deadline for the 2009 disclosure program and the uncertain status of those disclosures until the IRS decided to accept them into this new disclosure program indicates that it would be helpful to advise clients of the new voluntary disclosure program as soon as possible, so that there is time for those who wish to disclose to get the information together for eight years worth of original or amended tax returns and the funds available to cover the associated taxes, interest and penalties before the Aug. 31, 2011 deadline.
The potential penalties associated with foreign asset and account disclosure and FBAR reporting when combined can become confiscatory, adding up to as much or more than the value of the foreign assets themselves. Voluntary disclosure provides not only a way to avoid potential criminal prosecution, but also penalties that could totally wipe out those foreign assets. AT
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.
