by C. Jean Ryan

The use of offshore "tax havens" by U.S. taxpayers has long been targeted by the IRS as a frustrating loss of tax revenue. U.S. corporations often rely on intricate multi-jurisdictional structures to minimize or defer the U.S. tax bite, but the simplest offshore mechanism used by U.S. individuals to avoid tax is an unreported financial account in an non-U.S. jurisdiction—the traditional numbered Swiss account. Because of strict bank secrecy laws, the IRS does not have access to the financial records that would permit an examination of offshore accounts held by U.S. taxpayers. To combat the lack of information from the foreign financial institutions, the IRS has imposed an ever-increasing number of information return filing requirements for U.S. taxpayers with foreign connections, and an ever-escalating array of penalties for failure to file the required returns.

The simplest reporting obligation is the box on Schedule B of a U.S. individual income tax return which asks the direct question: "At any time during [relevant year], did you have an interest in or a signature or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account?" If the "yes" box is checked, the taxpayer is directed to file Form TDF 90-22.1, otherwise known as the "FBAR" (Report of Foreign Bank and Financial Accounts), if the aggregate value of the accounts exceeds $10,000 at any time during the year. The FBAR is due by June 30, so the deadline for filing the FBAR for 2008 is June 30, 2009. The current penalty for a nonwillful failure to file an FBAR when one is required is not more than $10,000 per year, but the penalty for a "willful" failure to file an FBAR can be as high as the greater of 50% of the total balance of the foreign account or $100,000 for each year the account was not reported to the IRS.

The IRS has recently gained ground in its fight to gain access to information on these accounts. In July 2008 the IRS served a "John Doe" summons on UBS AG, Switzerland’s largest bank, demanding that UBS provide the IRS with the names of what may be as many as 52,000 U.S. taxpayers with undeclared UBS accounts holding over $14 billion of assets. The Swiss government has opposed the IRS action on the grounds that the enforcement of the summons would violate Swiss sovereignty and international law. In early 2009, the U.S. entered into an agreement with UBS relating to the IRS allegation that UBS conspired to defraud the U.S. by impeding the IRS, which included (in addition to UBS’s payment of $780 million in fines, penalties, interest and restitution) an agreement by UBS to discontinue its business of providing services to U.S. persons with undeclared accounts.

In late 2008, and continuing through 2009, UBS sent a variety of letters to U.S. depositors giving them short deadlines for closing their undeclared accounts and, in many cases, requesting their permission to give their names to the IRS in response to the John Doe summons. Other European banks followed suit with their own letters to depositors believed to be U.S. persons requiring that their accounts be closed.

In March, 2009 the IRS offered a six-month "voluntary disclosure" program in an effort to bring unreported accounts onshore. This program expires on September 23, 2009. The deal offered by the IRS is simple: the taxpayer must amend all returns from 2003 to present to include the earnings on the previously unreported account, pay the additional tax on the amended returns together with a penalty on the tax (generally 20%) and interest, and in lieu of the laundry list of additional penalties that could apply, including the FBAR penalties and other information return penalties, pay a penalty equal to 20% of the amount in the foreign bank account or entity in the year with the highest aggregate account or asset value from 2003 to present.

Although a forfeiture of 20% of the balance of the account does not sound like a bargain, it could be much less than the penalties that otherwise would be imposed. An example issued by the IRS in May, 2009, assumed a $1 million unreported account that earned $50,000 per year interest from 2003 through 2008. The price tag for the voluntary compliance program would be $386,000, plus interest, including tax of $105,000, a 20% penalty on the tax of $21,000 and an additional penalty of $260,000, which is 20% of the ending account balance of $1,300,000. In contrast, without the program, the tax and penalty on the tax would remain the same, but the FBAR penalty would total $2,175,000, and the taxpayer also would be potentially subject to a 75% fraud penalty on the tax and additional information return penalties if the account was held through a foreign entity such as a trust or corporation and no information return was filed for that entity.

IRS explanations of the program offer relief to taxpayers in one circumstance. If the taxpayer has properly reported all income but failed to file the FBAR, then no FBAR penalty will be imposed. This is a common circumstance where a child is given signature authority over, but no ownership interest in, an account held by an elderly parent. Without the program, that child is potentially subject to the 50%/$100,000 penalty for each year.

The IRS has made it clear that they intend to seek maximum penalties for all unreported offshore accounts for taxpayers who do not participate in the program. U.S. taxpayers who have an interest in or signature authority over an undisclosed foreign account or ownership in a foreign entity should immediately seek the advise of a tax attorney on their options.

If you have any questions about any of the techniques discussed above, please contact C. Jean Ryan at Sideman & Bancroft.

This publication is for informational purposes only and is not intended to provide legal or tax advice, or to create an attorney-client relationship.

Pursuant to IRS Circular 230, unless expressly stated to the contrary, any tax advice is not intended and cannot be used to (i) avoid penalties under the Internal Revenue Code or (ii) promote, market or recommend any transaction or matter to another party.