As Global Warming is said to be melting the arctic glaciers, safe havens for offshore tax scofflaws are dwindling from increasingly strident global economic pressure applied to tax haven jurisdictions. Now, tax haven countries wishing to participate in the global financial system must come into compliance or at least take steps toward compliance with the OECD (Organization for Economic Cooperation and Development) standards of transparency and exchange of information.  In addition, foreign banks are dumping U.S. depositors, and, becoming more cooperative or compliant with FATCA (Foreign Account Tax Compliance Act), not wishing to become subject to withholding at source or the next UBS.  Meanwhile, the IRS aggressively pursues leads obtained from roughly 33,000 participants in the 2009 and 2011 Voluntary Disclosure Initiatives.  As a result, countries in which one is assured of invisibility are becoming fewer.    

MANY NOT PERSUADED

The Tax Justice Network in July published its report, “The Price of Offshore Revisited,” finding that between $21 and $32 trillion remains hidden worldwide by high net worth individuals in offshore accounts.  The amount if true would equal the size of the U.S. and Japanese economies combined. The report has been criticized but doubtless, the dollar value of offshore holdings is very large.

WISDOM OF STAYING OUT IN COLD

The risk of course is getting caught.  What then?  Well, if nabbed on faces both a civil penalty and criminal sanctions regime.

Civil Penalties

The civil penalty structure was changed by the American Jobs Creation Act of 2004 to include non-willful and willful individual penalties per violation:

• For Non-willful violations, up to $10,000.
• For willful violations, up to the greater of $100,000 or 50% of the transaction or value of the account at the time of the violation (i.e., the June 30 filing deadline, for each year that remains open under a six year statute of limitations).
• Where reasonable cause for the non-reporting is found to exist, no penalty is assessed.  

Since in either case the penalty is “up to” stated amount or percentage, IRS may assess a lower penalty even when no reasonable cause for not reporting is present.   IRS has enunciated certain mitigation of penalty factors in the Internal Revenue Manual but it is not clear whether these guidelines are still applicable or whether the reduced FBAR (Foreign Bank Account Report) penalty structure under the  2012 Offshore Voluntary Disclosure Program (OVDP) is now the sole means by which a taxpayer can obtain a lower than maximum penalty.  The maximum penalty is draconian and results in expropriation of the account when applied even for only the non-reporting violation (without doubling up for failure to keep required records).  If both penalties are assessed the total FBAR penalty (apart from income tax and civil fraud penalty) could be 600% of the account value (i.e., a 50% penalty for six years times two separate penalties (failure to report and keep records).

Criminal Penalties

The criminal penalties under 31 USC § 5322, which may be imposed in addition to the civil penalties, are also quite sobering:

• A fine of not more than $250,000 and up to five years in prior, or both for each violation, or,
• If the violation if part of a pattern of illegal activity, a fine of up to $500,000 and imprisonment of up to ten years.

WILLFULNESS

In civil income tax disputes the government’s position is initially presumed to be correct.  The taxpayer carries the burden of proving the government wrong.  In civil FBAR penalty cases, the government must prove that the violation was willful, that is, “an intentional violation of a known legal duty.”  The taxpayer on June 30 was aware of the FBAR filing requirement and intentionally, as opposed to inadvertently, chose to not file. It has been thought that willfulness has to be established by clear and convincing evidence (so stated in IRM) that would include some acts tending to show knowledge of the law and a voluntary choice not to comply.  A recent Fourth Circuit Court of Appeals case, U.S. v. Williams (Case No. 10-2230, July 20, 2012) the court decided:

• The government only had to prove willfulness by a preponderance of the evidence (balance of evidence weighing in its favor).
• Willfulness may include willful blindness, and,”can be inferred from a conscious effort to avoid learning about reporting requirements…. (One’s) signature (on a return) is prima facie evidence that (one) knew the contents.”  The 2000 Form 1040, Schedule B asked whether the taxpayer had an interest in a foreign financial account and required checking “yes” or “no.” Line 7a of Schedule B stated, “See instructions for exceptions and filing requirements for Form TD F 90-22.1” (commonly called FBAR). Williams had plead guilty to tax evasion but not to the FBAR violations and this undoubtedly influenced the court, but it remains to be seen how far IRS will pursue the theory of “willful blindness” and whether other courts will be reticent to find willfulness where no overt acts such as using a nominee entity are present.

IRS was first delegated FBAR responsibilities from FinCEN (Financial Crimes Enforcement Network) under the Bank Secrecy Act almost ten years ago. At first few taxpayers were aware of the FBAR filing requirement and IRS was perhaps less aggressive early-on in proposing penalty assessment.  But, the reference on Schedule B and notoriety of the UBS and other enforcement efforts has made ignorance of the law more difficult to establish as an escape from the civil penalties, especially, if the Fourth Circuit view of the level of proof required is more broadly adopted.

HOW LIKELY IS DISCOVERY AND PUNNISHMENT?

When asked this question, my answer is always, “Very likely is you are caught.”  This is not a cute response.  The real question is not how likely, but whether you could absorb the consequences.  Some risks, however, unlikely, are outliers that are too consequential to assume.  The 100 year hurricane like Andrew may never come again but I still carry wind insurance.  I would not play Russian roulette even if the gun had 1,000 chambers.  I cannot afford to lose these bet and therefore do not assume the risk.

The Department of Justice only brings about 4,000 criminal cases each year.  The FBAR civil penalty is not subject to IRS levy but must generally be collected by the government bringing a suit to collect within 2 years of assessment.  Looking realistically at government manpower resources, it is unlikely that everyone caught will be charged criminally or that every FBAR penalty assessed will be collected. Eugene McCarthy said, “The only thing that saves us from the bureaucracy is inefficiency.” Still, those who do feel the government boot on their backs may be destroyed.   

THE 2012 OVDP

On January 9, 2012 IRS announced (IR-2012-5) that it reopened the Offshore Voluntary Disclosure Program and has posted 55 new FAQS (June 26, 2012) with the following new features:

• Unlike the previous initiatives there would be no pre-established end date for the 2012 program although IRS states it may withdraw or change terms, such as the penalty amount, at any time.
• The OVDP FBAR penalty is increased from 25% to 27.5% calculated in essentially the same manner as under the 2011 program.

COLD GETTING COLDER

Why is this a good time for those still out in the cold to come back into the tax reporting system?  Some reasons to ponder are:

• From those who have already entered IRS Voluntary Disclosure windows, IRS has obtained and continues to amass substantial information about other banks and other US persons with unreported offshore financial accounts.
• Additional cases involving banks other than UBS have been initiated and others are now under review by IRS and will be forthcoming.
• The HIRE Act imposes new Foreign Financial Asset Reporting on Form 1040 in 2011 and substantially increases the already draconian civil penalties that apply to unfiled FBAR reports.  Criminal problems for those who ignore the new reporting requirement are also exacerbated.
• The HIRE Act extends the civil statute of limitations for reporting violations to six years
• The IRS has successfully obtained convictions and guilty pleas in a significant number of criminal cases regarding UBS account holders, bankers and promoters.  Undoubtedly, more criminal cases will be brought.
• New treaties and information sharing agreements with tax haven governments have been signed and others are in the works. There are now fewer hiding places that cannot be pierced.
• Entering the program allows one to calculate with reasonable certainty to total dollar cost of settling one’s tax and reporting obligations.
• Being accepted into the program allows one to avoid possible severe criminal fines, jail time and restitution payments for plea agreements as well as the negative effect on one’s reputation and civil rights from being adjudicated a felon.

IRS Commissioner Shulman has stated that this new voluntary disclosure program is the “last best chance for people to get back into the tax system.”  The path is not easy and the toll charge is substantial but many will likely agree that the new program beats rolling the dice on getting caught with one’s pants down.  That eventuality is becoming more likely and the government’s punishment paddle is larger and more painful to bear. 

MAIN FEATURES OF THE 2012 OVDP

The 2012 OVDP is essentially the same as the earlier initiatives (See other articles on my website for a complete discussion of the original initiatives).  The main features of the 2012 OVDP are:

• The 27.5% penalty is applied to the highest aggregate account balance (value of all accounts combined) during the 8 year OVDP period.
  • Not only financial assets, but real estate or other assets related to tax noncompliance are to be included in the aggregate value subject to penalty regardless of the form of ownership.  This requirement could become a quagmire regarding what other assets are related to tax noncompliance from failing to report income or where unreported income accumulated funds were used to purchase other assets that do not produce income (e.g., artworks).  This process will require tracing of funds.
  • Financial account transfers are not to be double counted provided the taxpayer can prove the transfer.
  • Accounts unrelated to the noncompliance, not belonging to a related person or certain entities (e.g. foreign trust where beneficiary or controlled foreign corporation), over which the taxpayer had a mere signature authority will not be counted in the penalty calculation.
  • In no case will the total penalty imposed under the 2012 OVDP be more than the penalty the participant would have paid assuming imposition of the maximum penalty under existing law without regard to the reasonable cause exception which is not available and assuming the penalty is willful.  Taxpayers who have reasonable cause for non-filing or who can establish non-willful reporting should not participate in the program or, having entered the program, may opt-out under procedures established by IRS. The examiner will make the comparison during his or her review. Taxpayers who opt-out will be subject to income tax examination for all tax years where fraud is proved or no returns had been filed and FBAR examinations for the 6 year statute of limitations period for FBAR penalty assessment.
• In very limited situations a taxpayer can be eligible to pay only a 5% or 12% lower penalty level:
• The look back period for the highest balance is eight years (2004-2011) for taxpayers who have not filed their 2011 Form 1040.  Taxpayers who have not filed the 2011 FBAR but who have obtained a valid extension for filing their 2011 return should make their submission after October 15, 2012 that the 2011 FBAR will be covered by the program.
• Payment of tax, penalty and interest must also be made with one’s submission (or good faith arrangements to pay).
• FBARs and original or amended offshore related information returns must be filed for the periods 2004-2011.
• Agreements to extend the statute of limitations on assessment of tax must be signed and provided to IRS.
•  The participant must pay the 20% accuracy related penalty, failure to file penalty, if applicable (can be 25% of unpaid tax), and failure to pay penalty.
•  Recognizing problems encountered in the first program with IRS applying Foreign Passive Investment Company (FPIC) tax rules to the disclosed offshore accounts, an election is available for an alternative resolution of PFIC issues which may offer partial relief to some; but, accounting for these arcane rules under either approach remains dauntingly complex.
•  Participant must submit a Foreign Account or Asset Statement for each previously undisclosed foreign account or asset held during the disclosure period.
•  A participant under certain circumstances may avoid filing returns for certain dissolved sham entities merely used for camouflage by submitting a Statement of Dissolved Entities under penalties of perjury.
•  Participants will still have to cooperate fully in answering questions and providing information during the voluntary disclosure process.  Providing false or refusing to provide information will cause a person to be rejected from the program and may lead to criminal prosecution.
•  Participants and IRS will execute a Closing Agreement on Final Determination Covering Specific matters (Form 906).  This is a contractual final settlement of the specific matters covered but does not preclude IRS from auditing the years covered for other items.
•  Those already being civilly audited or criminally investigated by the IRS are not eligible for the program.
•  Preclearance that one is not under investigation may be requested as follows:
  • Fax to the CILeadDevelopmentCenter:
    • Taxpayer name
    • Date of birth
    • Social Security number
    • Address
    • Signed Power of Attorney (if requested by representative). The POA must specifically authorize the representative regarding “income tax, civil penalties and FBARs for 2004-2011 years).”
    • Request pre-clearance in before making an offshore voluntary disclosure.
    • CI will notify the taxpayer or representative via fax whether or not they are cleared to apply.
    • Taxpayer so cleared should submit the initial OVDP letter within 45 days.
      • Mail OVDP letter to Offshore Voluntary Disclosure Coordinator.
      • CI will notify by mail if preliminarily accepted or not accepted into program.
      • The letter will state all acts participant must complete and documents and returns participant must submit within 90 days of the date of the acceptance letter.
      • Merely filing amended returns with the IRS service center will not qualify as a voluntary disclosure for criminal tax violations in the eyes of IRS and taxpayers who have made a so called “quiet disclosure” may be subject to the full civil penalty regime and may be criminally prosecuted.  IRS says it is reviewing amended returns for this purpose. Taxpayers who made quiet disclosures in this fashion can apply to be included in the 2012 OVDP.
      • Taxpayers who did report all (no de-minims exception) income from an offshore account but failed to file the FBARs or foreign information returns should file the returns with an explanatory cover letter statement, or, in the case of Form 5471, file an amended Form 1040.  No penalty will be assessed for late filing of the foreign forms.  CAVEAT:  Taxpayers falling into this category should be interviewed by an attorney initially to make certain, under the umbrella of privilege, that the taxpayer is being truthful and has present no exacerbating factors that would suggest another course of action.  Then a CPA can prepare the return.  The explanation should be reviewed by an attorney again to make sure it is completely truthful and accurate.
      • Taxpayers in a class of persons covered by a John Doe summons issued by IRS may apply so long as they have not yet been specifically identified.
      • Hypothetical questions posed to IRS by professionals will be answered by IRS but are not a voluntary disclosure.  A taxpayer who becomes identified while a hypothetical question is pending will not be eligible for the OVDP.
      • Participants must submit a Taxpayer Account Summary with Penalty Calculation (IRS now supplies an Excel format on its website).
      • Participant must submit copies of all account statements if aggregate account value exceeds $500,000 and other participants must supply the statements, if requested by the auditor.
      •  Following a timely complete submission a civil examiner in IRS will review the submission for completeness, accuracy and correctness.  This is not a formal audit and a participant may not appeal the examiner’s findings.
      • IRS has posted all required documents and forms on www.IRS.gov.

CONCLUSION: WHAT TO DO?

Often quoted George F. Nordenholt, said “No matter how big and tough a problem may be, get rid of confusion by taking one little step toward solution.  Do something.”

Those with unreported offshore accounts are wise to consult counsel and carefully consider this new program because an IRS posse is hot on the trail of offshore tax scofflaws; safe havens are evanescing amidst new information exchange agreements and mounting international pressure, and escape from jail tickets are certainly becoming rarer and more expensive to procure.   Deciding whether to enter the program involves multi-factor considerations:

• Have tax crimes or non-tax crimes (e.g., Bank Secrecy Act) been committed and are they provable to the standard of proof required? If criminal prosecution is likely, enter the program.
• If not concerned about criminal charges, and delinquent or amended returns are filed, what are the potential penalties outside of the program, upon audit?
• Would the FBAR penalty be less than the OVDP penalty outside the program and would the IRM mitigation guidelines, if still applicable, apply?
• How will the OVDP FAQS apply to particular taxpayer situations?
• Will the government be able to prove an income understatement and willfulness if the taxpayer does nothing about past transgressions and begins filing forward truly and accurately?

The above determinations should not be made by a CPA but with the assistance of an attorney familiar with these matters and having the benefit of an attorney-client privilege.

 © 2012 by Robert S. Steinberg, Equire
All rights reserved