Introduction
For many years a large number of U.S. taxpayers have placed and may continue to place, money in foreign bank accounts. Many of these individuals, knowingly or unknowingly, violate federal law by not disclosing these foreign accounts on their federal income tax returns. In an effort to step-up enforcement of this filing requirement, the U.S. Department of Justice has successfully pierced previously secret banking in foreign jurisdictions. As a result, the Internal Revenue Service (IRS) is now gaining access to information regarding foreign bank accounts held by U.S. taxpayers. Many individuals are now scrambling to avoid criminal prosecution, massive monetary penalties, and even long prison terms for U.S. taxpayers determined to have held undisclosed foreign bank accounts.
The fear of prosecution has sparked interest in the IRS Voluntary Disclosure Program. It is important for our readers to understand that the Voluntary Disclosure Program is not really a program promulgated by any federal law. Rather, the Voluntary Disclosure Program is a long-standing policy of the IRS and the U.S. Justice Department to refrain from prosecuting taxpayers for evasion or false returns as long as the taxpayer comes forward before the government finds out about them. Taxpayers who wish to participate in the Voluntary Disclosure Program disclose their foreign bank accounts and unreported income to the IRS in exchange for escaping criminal prosecution. Taxpayers who are eager to avail themselves of the Voluntary Disclosure Program should understand that any such disclosure will result in a civil audit. The civil audit that follows the disclosure can prove to be full of minefields. This article is designed to enlighten our readers of Voluntary Disclosure Program in its current state.
Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts
For the most part, few taxpayers who hold foreign bank accounts do not understand the required filing requirements. Federal law provides that if a U.S. taxpayer has a financial interest in, or signature or other authority over, any financial accounts in a foreign country, including bank, securities, or other types of financial accounts, and if the aggregate value of these accounts exceeds $10,000 at any time during the calendar year, that individual must file a Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts with the IRS. The form must be filed with the Department of Treasury in Detroit by June 30 of the following year which the taxpayer had a financial interest or signature authority over a foreign account. The IRS can levy a failure to file penalty of up to $10,000 per year. However, the failure to file penalty may increase to the greater of $100,000 or 50 percent of the account balance per year if it is determined the violation was willful. The Government may even assess a criminal penalty of up to $500,000 and ten years in prison for such a violation. In addition, U.S. taxpayers are required by law to disclose all foreign interest earned on their U.S. tax returns. Furthermore, U.S. taxpayers are required by law to disclose all capital gains earned on foreign accounts.
Unlike other areas of tax law, the law is pretty clear on this topic. If a U.S. citizen had interest in or signature authority over a foreign bank account or accounts which had an aggregate value that exceeded $10,000, he or she must file a Form TD F 90-22.1. So what can an individual do if he or she had an interest in a foreign bank account and the account was not timely disclosed to the IRS? Many, U.S. taxpayers who did not timely disclose a foreign bank account attempt to take advantage of the Voluntary Disclosure Program. While this may be a recommended course of action for most, it as most legal matters should be carefully considered and weighed before deciding to proceed. For example, many individuals often do not understand that a civil tax audit follows all voluntary disclosure. As such, the totality of entry into the program should not be taken lightly.
The Current State of the Voluntary Disclosure Program
In 2009, the IRS announced a Global Voluntary Disclosure Program Initiative specifically for foreign bank account holders. The terms of the program permitted holders to disclose foreign bank accounts to the IRS in exchange for avoiding criminal tax prosecution. In most cases, the taxpayer agreed to pay a 20 percent penalty on the greatest aggregate amount of all foreign bank accounts held over the past six years. The taxpayer also promised to fully cooperate with the IRS in determining the correct amount of tax, interest, and penalties owed for the prior six years. The Global Voluntary Disclosure Program Initiative expired on October 15, 2009. However, the IRS claims they are still accepting voluntary disclosures which will allow taxpayers to escape criminal prosecution. Unfortunately, the IRS has yet to determine the extent to which failure to file penalties will be assessed for failing to timely report any foreign bank accounts.
Making the Voluntary Disclosure
Due to the uncertainties of the Voluntary Disclosure Program, any voluntary disclosure should be made with the advice of an attorney familiar with tax and criminal law. Before being accepted into the Voluntary Disclosure Program, the IRS will request a transmittal letter stating a written explanation as to why the individual wishes to take part in the program. There are significant risks associated with submitting such a correspondence to the IRS. This is because the IRS could decide to remove an individual from the Voluntary Disclosure Program and utilize the contents of the transmittal letter against the participant in a later criminal prosecution. Thus, the transmittal letter should contain no admissions of wrongdoing or longwinded explanations describing reasons for not reporting a foreign bank account or foreign income. Instead, the transmittal letter should simply say that the taxpayer is willing to fully cooperate with the IRS in determining his or her correct tax liability.
Second, an individual making a disclosure must be prepared to file amended tax returns with the IRS for the years he or she held undisclosed foreign accounts. In most cases, the IRS will not likely require a taxpayer to file amended tax returns more than six prior years. The amended tax returns must include all Form TD F 90-22.1 that should have been filed timely. Once the amended tax returns are filed, the IRS will audit each amended tax return in detail. Therefore, any such tax returns must be completely accurate and must fully disclose the amounts of all previously unreported interest income. An amended return that is false, misleading, or incomplete can result in a criminal investigation wholly separate from the matters in the voluntary disclosure program. In order to prepare truthful and accurate amended returns, the taxpayer will have to request from the foreign banks a detailed accounting summary, including all capital gains and losses. The taxpayer should also do an up to date interest computation and include that amount on the tax returns.
Dealing with the IRS after the Appropriate Tax Returns Have Been Filed
In order to avoid criminal prosecution, a taxpayer must be prepared to cooperate with an IRS civil auditor in order to determine the correct amount of tax, interest, and penalties owed. Besides potentially assessing a penalty for failing to timely disclose any applicable foreign bank accounts, one of the IRS primary objectives will be to determine whether to assess a penalty on any unreported income generated from the foreign accounts at issue. The IRS could attempt to assess either an accuracy-related penalty or a civil fraud penalty against a taxpayer on the amounts of unreported income. The difference between these two penalties is significant. If the IRS were to assert the accuracy-related penalty, they would assert a penalty equal to 20 percent of the underpayment of tax. The IRS could attempt to assess this penalty on the omission of income for the tax returns subsequently filed in the prior three to six years. The IRS could also attempt to assess the civil fraud penalty which is equal to 75 percent of the amount of the underpayment of tax. Unlike the accuracy-related penalty, there is no statute of limitations on this assessment. This means, in the right circumstances, the IRS could attempt to extend an audit beyond the traditional six years of a Voluntary Disclosure Program and extend the civil fraud penalty to years outside the scope of the disclosure. The difference in dollars between the accuracy-related penalty and civil fraud penalty can be in the hundreds of thousands of dollars. Consequently, all taxpayers participating in the Voluntary Disclosure Program should assume an IRS auditor will attempt to assess the fraud penalty and prepare accordingly.
Conclusion
In its current state, the Voluntary Disclosure Program may provide an excellent opportunity for individuals to come into tax compliance. However, anyone contemplating participating in the current program should proceed with caution. They should also retain the services of a competent counsel familiar with the process.