IRS Cracks Down on Undisclosed Foreign Accounts

Peter D. Anderson
Director, Litigation Department
Richard M. Stone
Of Counsel, Tax Department
Published: New Hampshire Bar News
February 22, 2013

The message from the IRS to owners of undisclosed foreign financial accounts is clear: Enter the IRS Offshore Voluntary Disclosure Initiative (OVDI) or risk criminal prosecution and/or enormous civil penalties.

United States taxpayers are required to pay taxes on their worldwide income and to disclose the existence of foreign financial accounts on their tax returns. If the account or accounts have a value in excess of $10,000, taxpayers are also required to file a Report of Foreign Bank and Financial Accounts (FBAR) by June 30 of each tax year.

Criminal penalties associated with failure to report a foreign financial account are a maximum fine of $250,000 and up to five years in prison. The penalty for a non-willful civil violation is a fine of up to $10,000. However, if the violation is deemed willful, then the penalty is the greater of $100,000 or 50 percent of the account balance at the time of the violation. The foregoing penalties are applicable to each violation of the FBAR reporting rules.

Many clients are indecisive and apprehensive about making a voluntary disclosure, in light of the hefty penalties imposed by the OVDI. Some clients are willing to “take their chances” and avoid entering the OVDI. It is important to make these clients aware of IRS enforcement initiatives.

Since 2007 and beginning with the United Bank of Switzerland, the government has launched investigations of foreign banks that have resulted in disclosures of account-holder information to the IRS. The government has also been actively pursuing treaty requests with countries with which the United States has tax treaties. Finally, the government has at its disposal the recently enacted Foreign Account Tax Compliance Act (FATCA).

While the intricacies of FATCA are beyond the scope of this article, the act represents a major enforcement tool for the government. FATCA was signed into law in 2010, and already the United States has understandings or agreements with Ireland, Denmark, France, Spain, Germany, Italy, the United Kingdom and Switzerland, to implement information exchange regarding foreign accounts. And the government is aggressively pursuing agreements with other countries.

These government enforcement initiatives make it much more likely that the IRS will become aware of undeclared foreign accounts of US taxpayers. Once the IRS is aware of undeclared foreign account information, the OVDI is no longer an option available to a client, and much more severe penalties, civil and/or criminal, will likely be imposed.

According to the IRS, “Taxpayers with undisclosed foreign accounts or entities should make a voluntary disclosure because it enables them to become compliant, avoid substantial civil penalties and generally eliminate the risk of criminal prosecution.”

A voluntary disclosure also makes it possible to calculate, with a reasonable degree of certainty, the total cost of resolving offshore tax issues, the IRS has said.

“Taxpayers who do not submit a voluntary disclosure run the risk of detection by the IRS and the imposition of substantial penalties, including the fraud penalty and foreign information return penalties, and an increased risk of criminal prosecution,” the agency warns. “The IRS remains actively engaged in ferreting out the identities of those with undisclosed foreign accounts. Moreover, increasingly this information is available to the IRS under tax treaties, through submissions by whistleblowers, and will become more available as the Foreign Account Tax Compliance Act (FATCA) and Foreign Financial Asset Reporting (new IRC §6038D) become effective.”

The “increased risk” that the IRS refers to is dramatic, as thousands of names have already been disclosed to the IRS by foreign banks and cooperating tax authorities. The IRS is using these lists for both criminal prosecutions and civil audits and is aggressively pursuing information exchange agreements with other countries.

For calendar-year taxpayers, the voluntary disclosure period is the most recent eight tax years for which the due date has already passed. The OVDI disclosure is made by filing both the original returns and amended returns for the prior eight years to report all income and disclose the foreign accounts, filing all missing FBAR reports, cooperating fully in the OVDI process, signing agreements to extend the statutes of limitations, paying a penalty of 27.5 percent (reduced in only very limited cases) of the accounts’ highest balance over the eight-year period, paying a 20 percent accuracy penalty based on the total underpayment for the eight years, paying failure-to-pay penalties, and paying failure-to-file penalties, if appropriate.

The OVDI program is evolving and has many critics. However, the IRS has had tremendous success in raising revenue – as of June 2012, it collected more than $5 billion in back taxes, interest and penalties from 33,000 voluntary disclosures made under the first two programs in 2009 and 2011.