Offshore Tax Compliance – Is Voluntary Disclosure the Answer?

Citizens and residents of the United States are taxed on their worldwide income. Because the IRS is concerned about taxpayer attempts to hide assets and income subject to tax by the United States, the Internal Revenue service is attacking offshore structures. Different types of entities have been used in Abusive Offshore Tax Schemes which include: Foreign trusts, Foreign corporations, Foreign (offshore) partnerships, LLCs and LLPs, International Business Companies (IBCs), Offshore private annuities, Private banking (US and offshore), captive insurance companies, offshore bank accounts and credit cards, and Related-party loans.

These schemes are often part of very complicated structures created in order to pretend that a nonresident alien is the owner of the income and assets, when in reality the owner is a US taxpayer. The abusive offshore transactions normally involve what foreign authorities commonly refer to as “Tax Havens”, jurisdictions which provide for little or no tax on income from sources outside of those jurisdictions.

Generally, a taxpayer is able to file an amended return to correct errors on previously filed tax returns, or to file a return if no return had been previously filed. However, if the IRS then launches an investigation into a possible evasion, the taxpayer could face criminal prosecution. On the other hand, if the taxpayer is able to get into the IRS Voluntary Disclosure Program, the taxpayer may be able to avoid criminal action. The voluntary disclosure program has five requirements: 1- Legal source: it does not apply to illicit funds; 2-Timeliness: the taxpayer must be accepted into the program before the IRS has begun a civil or criminal investigation; 3-Completeness: the voluntary disclosure must be both truthful and accurate, and amended (or previously unfiled) tax returns must be prepared and submitted; the taxpayer cannot select what they want to disclose; 4-Payment: it requires payments of the tax at issue, plus interest, or to show a good faith effort to make a payment (in the form of an approved payment plan);and 5-Cooperation: the taxpayer must cooperate with the examination in all respects to keep the protection of the voluntary disclosure.

“The IRS established in 2001 the Qualified Intermediary Program (“QI Program) to take the attention of foreign investors to U.S. securities (more than 7000 foreign banks participate in the program). Until October 13, 2008, the IRS allowed the banks to promise to identify clients, withhold any taxes due on U.S. securities in their account (typically 30%) and send the tax money owed to the IRS), selling offshore banking services to U.S. Taxpayers to evade taxes. U.S. prosecutors allege UBS helped American clients hide as much as $20B in assets offshore, evading at least $300M in taxes; also, U.S. prosecutors allege UBS deliberately abused the Qualified Intermediary Program which helps the government, keep track of U.S. funds invested in foreign banks.”

Offshore accounts are not illegal for U.S Taxpayers, but hiding income in undeclared accounts is illegal and the taxpayers are subject to a felony (up to 5 years in jail) and subject to a civil penalty of $100,000 or 50% of the account (whichever is greater). The Bank Secrecy Act gives the Department of the Treasury authority to establish recordkeeping and filing requirements, and US citizens and residents are required to disclose foreign bank accounts (with over $10,000) through the annual filing of Form TDF 90-22.1- Report of Foreign Bank and Financial Accounts (FBAR). This form is part of the program that the Treasury uses to ascertain persons who might possibly be engaged in abusive offshore transactions.

As a result of the federal investigation into the Swiss Banks and UBS (the world’s largest private bank), the IRS Qualified Intermediary Program has intensified their search for hidden overseas accounts. The U.S. Internal Revenue Service is reaching agreements with other governments to discover tax evasion related to U.S Citizens and residents, who try to hide income in offshore tax havens. The IRS has prepared a proposal to change rules for Qualified Intermediary Program; the proposed new rules started in 2010. Under the new QI Program rules: Participating banks must alert the IRS of any potential fraud they detect, whether through their own internal controls, complaints from employees or investigations by regulators.

”The IRS is offering people with undisclosed income from offshore accounts an opportunity to participate in a new, voluntary disclosure initiative in order to get current on their tax returns. The 2011 Offshore Voluntary Disclosure Initiative (OVDI) will be available only through Aug. 31, 2011. However, taxpayers who made a good faith effort to comply may be eligible for an extension, detailed in the revised questions and answers. The 2011 initiative has a higher penalty rate than the IRS’s previous voluntary disclosure program, which ended on Oct. 15, 2009, but offers clear benefits to encourage taxpayers to disclose foreign accounts now rather than risk IRS detection and possible criminal prosecution. In addition, the 2011 initiative includes new guidelines to provide fairness to people with smaller amounts of undisclosed assets or unusual situations.

Note that participants in the voluntary disclosure program generally will be subject to a penalty equal to 25% of the highest aggregate account balance covering the 2003 to 2010 time period. However, certain taxpayers may qualify for a much lower 5% penalty rate. Marcum highly encourages taxpayers who own foreign bank accounts and have not previously filed the necessary reporting forms for those accounts to come forward and disclose their bank positions in order to avoid penalties and prosecution.

i – January 26, 2009 – by Gary S. Wolfe, A Professional Law Corporation. “US Taxpayer and the IRS Qualified Intermediary Program”
ii – 2011 Offshore Voluntary Disclosure Initiative – Internal Revenue Service – http://www.irs.gov/newsroom/article/0,,id=234900,00.html