Offshore Accounts–The Current State Of Law And Compliance

US Supreme Court

By Stephen J. Dunn  

This post examines the rapidly-developing U.S. law of U.S. persons’ foreign accounts, and ways of complying with it.

The Problem

Many Americans have had foreign financial accounts.  Some used the accounts for business or persona travel.  Some inherited foreign financial accounts.  These people typically did not realize that they were required to report income from their foreign accounts on their U.S. income tax returns, or that they were required to report such accounts on an annual Form FinCEN 114 (“FBAR”) filed with the U.S. government.

Other Americans used foreign accounts to hide financial assets from the U.S. government, and evade U.S. income tax. Switzerland, with its strict bank secrecy laws, was a favorite venue for such accounts.

Swiss banks welcomed and cultivated such account relationships.  Swiss banks carefully guarded depositors’ identity.   Swiss banks generally issued no account statements for such accounts.

Some Swiss banks sent representatives into the United States to solicit account relationships, even servicing such accounts through branch or affiliate offices in the U.S. No Forms 1099 were issued on such accounts prompting depositors to report income from the accounts on their U.S. income tax returns, or the Internal Revenue Service to look for such income on the depositors’ tax returns.  The accounts included deposit accounts as well as brokerage accounts.

Under the Agreement between the United States of America and Switzerland for Cooperation to Facilitate the Implementation of FATCA, dated February 14, 2013 (the “Agreement”), Swiss banks must make aggregate disclosures concerning accounts which were in existence on December 31, 2013, and are owned by which a U.S. person who refuses to consent to disclose the account to the U.S. government.  An aggregate disclosure is limited to the total number of recalcitrant U.S. account owners, and total balance of their accounts.  There is a mechanism under the Agreement for the U.S. government to procure the identity and account balance of recalcitrant U.S. account holders included in aggregate disclosures.

The United States Department of Justice has prosecuted Swiss banks for conspiracy to defraud the U.S. government out of tax revenues, resulting in guilty pleas.  Other Swiss banks are under investigation by the DOJ for complicity in tax evasion.  To avoid prosecution, or imposition of a penalty of from 20% to 30% of the balance of U.S. persons’ account balances, Swiss banks have been urging U.S. who closed accounts at their bank since August, 2008 to voluntarily disclose their accounts to the U.S. government.  These banks have been urging U.S. persons to consent to disclose their closed accounts to the U.S. government, and threatening to disclose to the U.S. government the identity and account information of U.S. persons who will not consent.  Such unconsented disclosures would be an outrageous breach of trust.  They would also violate the Swiss banks’ fiduciary and implied contractual duties of confidentiality to the former depositors, as well as Swiss banking secrecy laws.

The Law

The Internal Revenue Code requires U.S. persons to report their worldwide income.  A foreign tax credit is available to U.S. taxpayers for foreign tax paid on their income.

The statute of limitations on assessment of income tax is three years, and it begins to run when the tax return is filed.  There is no statute of limitations on assessment of income tax underreported by reason of fraud.  Fraud requires the taxpayer to have knowledge of the law, or to recklessly disregard it.  The government has the burden of proving fraud, by clear and convincing evidence.

The statute of limitations on a criminal prosecution for filing a fraudulent income tax return is six years, and it begins to run upon filing of the fraudulent income tax return.

Beginning with income tax returns filed in 2012, U.S. taxpayers are required to report their foreign financial assets on Form 8938, Foreign Financial Assets, filed with their income tax return.  “Foreign financial asset” is broader than “financial account,” and may include, for example, rental real property.  Taxpayers are subject to a penalty for failing to file a required Form 8938.

The Bank Secrecy Act requires U.S. persons with financial interest in, or signature authority over, foreign bank accounts with an aggregate balance over $10,000 at any time during a calendar year to report the foreign accounts on an FBAR filed for that calendar year.  An FBAR for a given calendar year is due to be filed by the succeeding June 30.

Paths to Compliance

In 2009, the IRS introduced its Offshore Voluntary Disclosure Initiative,offering holders of foreign accounts an opportunity to avoid the Bank Secrecy Act’s draconian penalty for failure to report foreign accounts on an FBAR, and prosecution for failure to report income from foreign accounts on an income tax return.  In return, the account holder had to—

  • Waive statute of limitations on assessment of income tax.
  • File amended income tax returns as required for the last eight years.
  • Waive statute of limitations on assessment of FBAR penalty.
  • File FBARs for the last eight years.
  • Pay income tax reported as owing on income tax returns, 20% accuracy penalty, and interest.
  • Pay FBAR penalty equal to 25% of the highest aggregate balance of the foreign accounts over the last eight years (5% if the noncompliance was not willful, 12.5 % if the aggregate balance of the foreign accounts did not exceed $75,000).

The OVDI still exists as the Offshore Voluntary Disclosure Program. Under it the penalty for failure to timely file FBARs is 27.5% of the highest aggregate balance in the foreign accounts over the preceding eight years.

Any taxpayer who has an undisclosed foreign financial account will be subject to a civil penalty not of 27.5%, but of 50%, if, at the time of submitting his preclearnace letter to IRS Criminal Investigation, an event has occurred constituting a public disclosure that the foreign financial institution, or another person who facilitated the taxpayer’s account at the foreign financial institution, is under investigation, or is cooperating in an investigation, by the IRS or the U.S. Department of Justice concerning accounts beneficially owned by U.S. persons, of has been identified in a John Doe summons concerning such accounts.  The U.S. Department of Justice publishes a list of such foreign financial institutions. To reap the benefit of the OVDP, a disclosure must be truly voluntary.

On June 18, 2014, the IRS announced its Streamlined Compliance Procedures for foreign accounts.  Under these procedures, the taxpayer must:

  • File Form 1040, U.S. Individual Income Tax Return, or form 1040X, Amended U.S. Individual Income Tax Return, as appropriate, reporting previously unreported income from foreign accounts for the last three tax years (the open years on income tax assessment statute of limitations).
  • Pay income tax and interest, but no penalty, with respect to the Forms 1040 or 1040X.
  • File FBARs for the last six years (the open years on the statute of limitations for assessment of an FBAR penalty).
  • File a non-willfulness statement, certifying that (1) the taxpayer is eligible for the Streamlined Procedures, (2) that the taxpayer has now filed all required FABRs, and (3) that the failure to file tax returns, report all income, pay all tax, and submit all required information returns, including FBARs, was due to non-willful conduct.

If the taxpayer is a resident of the United States, he must also pay an FBAR penalty equal to 5% of the highest aggregate balance of the taxpayer’s foreign accounts over the preceding six years.

Congress enacted the requirement that U.S. persons file FBARs, and the draconian penalty for failure to file a required FBAR, to curb the use of foreign accounts to evade U.S. income tax.  It follows that the FBAR penalty ought not apply where the U.S. person owes no U.S. income tax on his or her foreign accounts.  The IRS has confirmed this, most recently on June 18, 2014.  If a taxpayer owes no income tax with respect to foreign accounts, but has failed to file one or more FBARs, and is not under civil examination or criminal investigation by the IRS, and has not been contacted by the IRS concerning one or more FBARs due but unfiled, then the taxpayer need only file hisor her delinquent FBARs to comply with U.S. law.

Issues

Issues we are seeing in this area of practice include:

  • What is an account?
  • What is a foreign account?
  • What is a “financial interest” in an account?
  • Who is a U.S. person?
  • What is willfulness?

Future posts will examine these and related issues. Stay tuned.

August 20, 2014

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