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If You Are Thinking that Your Foreign Bank Is not Located in Switzerland...

and is a tiny hole in the wall in the middle of nowhere so I am safe, think again. Taxpayer Options: Taxpayers that have willfully chosen to pass on entering the 2009 or 2011 voluntary disclosure programs both have the following options.

1. Do nothing
2. Get into compliance on a go forward basis
3. Make a quiet disclosure (or take no further action where a quiet disclosure was already made)
4. Make a loud disclosure by entering the 3rd version of the Offshore Voluntary Disclosure Initiative (OVDI).

Analysis of Options:

1. Do nothing
Taxpayers that do nothing when faced with this problem are gambling that the IRS does not have the resources to detect their foreign account. In my opinion this is a grave mistake. Every participant in the 2009 and 2011 voluntary disclosure initiatives was required to provide the government with “intel” on the foreign bank(s) they had deposits with. In fact, data mining is considered a key feature of the voluntary disclosure regime. Participants have been required to provide information related to the creation and maintenance of their foreign accounts as well as identify advisors, and others who promoted tax evasion. The government routinely gathered information about activity that formed the basis of the UBS litigation.

UBS bankers were coming onto US soil and counseling US taxpayers that they could deposit funds overseas and that the existence of the account would never be revealed to the US government. Moreover they were advising that any investment income generated by the account would be tax free because if the US government did not know about the income generated by the account it could not tax the investment income. These actions were argued to be aiding and abetting income tax evasion and formed the basis of the suit against UBS. Many other banks around the world are suspected of doing the same thing. In fact, currently there is litigation against 11 additional Swiss banks for the same type of activity. As part of this litigation the main information sought by the US government is the names and account balances of US citizens and residents that have deposits with these Swiss Institutions.

If you are thinking that your foreign bank is not located in Switzerland and is a tiny hole in the wall in the middle of nowhere so I am safe, think again! Recently legislation called FATCA is expected to result in the submission of the names and account balances of every US resident and Citizen worldwide starting in 2014. FATCA forces foreign banks to turn over this information or face a 30% withholding requirement on transfers from U.S. institutions to the foreign bank. Most banks are expected to comply and turn over the names of US Citizens and Residents rather than lose 30% of deposits to the institution from US financial institutions. Up to now, only the United Kingdom has finalized a FATCA pact, pending approval by parliament. France, Germany, Italy, Spain, Switzerland and Japan have pending agreements and the Treasury is negotiating with at least 40 other countries for FATCA agreements.

Since the US government will eventually have actionable knowledge concerning your foreign account doing nothing is not a viable option in the face of the draconian penalty regime at the government’s disposal.

2. Get into compliance on a go forward basis
Some advisors are recommending that taxpayer’s merely get into compliance on a go forward basis and do nothing to address the past non-compliance gambling that the IRS does not have the resources to detect the foreign account. In my opinion this option is also not viable because of the ease with which the U.S. government can flag TDF 90-22.1′s with large balances on its radar screen. I have heard rumors that the Criminal Investigation Division (CID) has assigned a special agent to monitor for just this occurrence.

If I were a CID agent my thought process would be as follows for example.

John Smith has just reported a 1.3 million dollar account balance in the Cayman Islands. Let’s take a look at his prior returns. Hmmmm… for the last 3 years he has made $50,000 a year or so… Thus… the deposit could not have come from previously taxed U.S. income. Did Mr. Smith inherit this money? If he did he better have filed a form 3520 to report the inheritance or I get to hit him with a 35% penalty on the amount of the inheritance! Hmmmm…. No 3520 was filed. Gee… Since I can determine that the funds did not come from previously taxed earnings or from an inheritance there must be something fishy afoot here… Let’s audit this taxpayer. Matter of fact; let’s have the criminal investigation division take a look as well…

As you can see, this is not a viable option.

3. Make a quiet disclosure (or take no further action where a quiet disclosure was already made)
Note: It is still possible to convert a quite disclosure into a loud disclosure by entering into the third version of the OVDI program.

Some advisors are proponents of quiet disclosures. A quiet disclosure is where prior tax returns are amended to report the previously omitted foreign income and the delinquent TDF 90-22.1′s are filed. In a quiet disclosure the Criminal Investigation Division of the IRS is not made aware of the disclosure and again the taxpayer is banking that the IRS does not have the resources to detect the quiet disclosure. This approach has many proponents because if it successful the taxpayer only pays the additional income taxes they should have paid if they would have filed the previous returns correctly plus interest. Often, no penalties are assessed.

The problem with this approach is the IRS has stated publicly that they will criminally prosecute any taxpayer they detect has done this. To make things worse, many unscrupulous tax preparer advisers are advising this approach out of their own self-interest to the detriment of their client’s best interests. This approach results in a revenue stream for them in that they get to prepare the delinquent returns and TDF 90-22.1′s. Additionally they are able to protect their long-term relationship and future revenue streams with their client.

If the tax preparer does what he or she is ethically required to do, refer the client to a reputable tax attorney and have no further communication with the client upon discovery of the foreign account, the preparer knows that the tax attorney is ethically required to hire a new tax preparer to prepare the amended returns and TDF 90-22.1′s because the original preparer is likely to be the first witness called to testify against the taxpayer should the government criminally prosecute the taxpayer. To add insult to injury the preparer’s lack of knowledge as to the reporting requirements surrounding foreign accounts could have contributed to the creation of this tax nightmare as well.

Imagine how easy it would be for the IRS to detect a quiet disclosure. They receive at least 2 amended returns. The current year correctly reports the foreign income and the two open tax years are amended. The IRS receives the current year FBAR timely and the previous two tax years are amended. All the IRS has to do is look for this pattern of reporting to identify taxpayers that are making quiet disclosures.

To make matters worse the government upon discovering a quiet disclosure will deem the act of a quiet disclosure itself as an additional badge of fraud for a subsequent criminal prosecution. It is important to note that a subsequently discovered voluntary disclosure will not automatically result in a criminal conviction for tax fraud as the government still has to prove willfulness and be willing to commit significant resources to prosecuting the case. Each case must be analyzed on an individual facts and circumstances basis but for the reasons cited above this is not ordinarily a viable option except where exposure for criminal liability is determined by an experience tax attorney as extremely remote and a taxpayer is willing to gamble on the attorney’s judgment.

Note: It is still possible to convert a quite disclosure into a loud disclosure by entering into the third version of the OVDI program.

4. Make a loud disclosure
By entering into the third version of the OVDI program a taxpayer makes a loud disclosure. A loud disclosure consist of knocking on the front door of the IRS Criminal Investigation Division and disclosing in writing that you have foreign and possibly even domestic non-compliance issues which may or may not rise to the level of outright criminal behavior that you wish to correct. In essence, a deal is struck with the Criminal Investigation Division that goes like this – in exchange for the taxpayer’s promise to correct all foreign and domestic noncompliance with US tax law (including U.S. Government information reporting requirements) through full cooperation with the IRS’s civil division, the Criminal Investigations unit promises not to prosecute the taxpayer for any applicable tax crimes provided the taxpayer makes a full honest and complete effort to correct their prior income tax returns including paying (or arranging to pay) the additional taxes, penalties or interest.

My Clients routinely and understandably want to know what the worst case scenario is where they come forward. I tell them that the draconian penalties that are on the books were written to give the IRS a club to force people to come forward. The U.S. taxing system is based on voluntary compliance. From a policy perspective it makes little sense to bring the full force of law against those that make a voluntary effort to correct their non-compliance as this would discourage others from doing so as well.

The questions I get are as follows:

- How many prior year returns will I have to amend?
- What will I be penalized for the additional income tax reported on the amended returns surrounding my foreign and domestic non-compliance?
- What will I be penalized for the non-compliance surrounding the TDF 90-22.1′s?

The 2009 OVDP and 2011 OVDI and the current third version of these programs provide certainty when answering these questions.

By Lance Wallach, CLU, CHFC
Abusive Tax Shelter, Listed Transaction, Reportable Transaction Expert Witness
Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA faculty of teaching professionals, is a frequent speaker on retirement plans, abusive tax shelters, financial, international tax, and estate planning. He writes about 412(i), 419, Section79, FBAR, and captive insurance plans. He speaks at more than ten conventions annually, writes for over fifty publications, is quoted regularly in the press and has been featured on television and radio financial talk shows including NBC, National Public Radio’s All Things Considered, and others. He does expert witness testimony and has never lost a case.

Copyright Lance Wallach, CLU, CHFC

Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.

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