Criminal Tax Alert
The Internal Revenue Service recently announced a short-term modification to the long-standing IRS voluntary disclosure program for taxpayers with undisclosed offshore assets. Specifically, on March 26, the IRS released a set of three internal memoranda sent to officials in the Large and Mid-Size Business Division, the Small Business and Self-Employed Division, and Criminal Investigations regarding revised procedures for the processing of voluntary disclosure requests involving offshore issues (the “Foreign Bank Account Disclosure Program” or the “Program”). The modified procedures are to remain in effect through September 23, 2009, and taxpayers must come forward by that time in order to benefit from them.
Requirements of Voluntary Disclosure
In order to take advantage of the Foreign Bank Account Disclosure Program, taxpayers must submit a voluntary disclosure request that meets the requirements set forth in Internal Revenue Manual 18.104.22.168. Such a request, which historically takes the form of a letter from an attorney enclosing the taxpayer’s amended returns or offering to provide them, must be truthful, complete, and timely (as further discussed below), and it must identify the taxpayer. In addition, as per standard practice, the taxpayer must show a willingness to cooperate with the IRS in determining the taxpayer’s correct tax liability and must make good faith arrangements with the IRS to pay in full the tax, interest, and any penalties determined by the IRS to be applicable.
Whether a taxpayer is eligible for acceptance into the voluntary disclosure program is, as always, highly dependent on individual facts and circumstances. In general, since 2002, a taxpayer is not able to make a voluntary disclosure in the following circumstances: (1) the IRS has initiated a civil examination or criminal investigation of the taxpayer or notified the taxpayer that it intends to do so; (2) the IRS has received information from a third party alerting the IRS to the specific taxpayer’s noncompliance (whether or not the taxpayer is aware of the informant’s contact with the IRS); (3) the IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., a search warrant or grand jury subpoena); or (4) the IRS has initiated a civil examination or criminal investigation that is directly related to the specific liability of the taxpayer. Thus, in order to be considered timely, a voluntary disclosure must be received before any of these events occurs. A taxpayer can make a voluntary disclosure even if the IRS has information that might lead to an examination of the taxpayer, as long as none of these events has occurred and as long as the income involved is not of an illegal source. In discussing the Foreign Bank Account Disclosure Program, certain IRS officials have indicated that even if the IRS has a taxpayer’s name on a list from an outside source (such as a foreign bank), the taxpayer can still make a voluntary disclosure as long as the IRS has not opened an examination or investigation on that taxpayer. However, the scope of this exception to the informant prong is not clear from the materials released by the IRS in connection with the announcement of the Program.
Penalties Imposed Under Foreign Bank Account Disclosure Program
Consistent with historical practice, taxpayers who are accepted into the voluntary disclosure program will likely not be prosecuted for either tax or Bank Secrecy Act violations. Although this is not a guarantee and there is no immunity, provided the taxpayer meets the requirements of timely participation and is truthful, prosecution is unlikely.
The key benefit of the IRS guidance with respect to the Foreign Bank Account Disclosure Program is its clarification of the civil penalties applicable to the disclosing taxpayer. Under the guidance, the IRS will assess all taxes and interest due going back six years (or going back to the earliest year the unreported offshore account or entity was formed or acquired, if formed or acquired during the six-year look-back period), and taxpayers will be required to file or amend all returns, including information returns and Form TD F 90-22.1 (the Report of Foreign Bank and Financial Accounts, or “FBAR”). In addition, the IRS will:
- Assess either a Section 6662 accuracy-related penalty or a Section 6651 (failure to file) delinquency penalty for each of the six years in the lookback period; and
- In lieu of all other potentially applicable penalties (including FBAR penalties), will also assess a penalty equal to 20 percent of the amount in the foreign bank account or entities in the year with the highest aggregate account or asset value.
The reasonable cause exception may not be applied to reduce the accuracy or delinquency penalty, but the 20 percent penalty described above may be reduced to 5 percent if the taxpayer did not open the account or cause the entity to be formed, there was no activity during the period the account or entity was controlled by the taxpayer, and all applicable U.S. taxes have been paid on the funds in the account or entity.
Risks of Taxpayers Hiding Their Heads in the Sand
“For taxpayers who continue to hide their head in the sand,” Commissioner Shulman has warned, “the situation will only become more dire.” IRS agents are being instructed to pursue both civil and criminal avenues and to consider all available penalties for taxpayers who do not come in voluntarily. One Justice Department official commenting on planned prosecutions of nonprofit organizations for failing to disclose offshore accounts remarked, “Why me? has never been a constitutional argument.”
Potentially applicable penalties under the Internal Revenue Code include:
- Criminal prosecution with substantial sentences.
- Fraud penalties of up to 75 percent of unpaid tax under Sections 6651 and 6663 of the Code;
- Failure-to-file penalties of up to 25 percent (or 75 percent, if the failure to file is due to fraud) under Section 6651 of the Code;
- Failure-to-pay penalties of up to 25 percent under Section 6651 of the Code;
- Accuracy-related penalties of 20 percent to 40 percent under Section 6662 of the Code; and
- Various penalties for failure to file information returns, which can be substantial. For instance, failure to file Form 5471 (Information Return of U.S. Persons with Respect to Certain Foreign Corporations) or Form 5471 (Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business) may result in penalties of at least $10,000 to $50,000 per form under Sections 6035, 6038A, 6038C, 6046, and 6679 of the Code. The penalty for failing to file each Form 926 (Return by a U.S. Transferor of Property to a Foreign Corporation) is 10 percent of the value of the property transferred, up to a maximum of $100,000 (or with no limit if the failure to report was intentional) under Section 6038B of the Code.
The penalty for failure to file a FBAR is potentially even more significant than the tax-related penalties. For taxpayers who willfully fail to file a FBAR, the civil penalty per violation can be as high as the greater of $100,000 or 50% of the amount in the account. 31 U.S.C. Section 5321(a)(5). The IRS takes the position that this penalty would apply for each year an FBAR was not filed. Under this approach, two successive years of non-disclosure could potentially result in the forfeiture of the whole account and it is unclear whether further counts of willful failure to file are barred simply because the amount in the account is exhausted.
Taking Advantage of the IRS’s Offer
The IRS is urging taxpayers with unreported income to “immediately discuss with their tax professional their options to get right with the government, including taking advantage of coming in voluntarily” under the short-term voluntary disclosure program.
For more information, please contact any of the following lawyers:
Michael M. Lloyd, email@example.com, 202-626-1589
Kathryn Morrison Sneade
Shane T. Hamilton
George M. Clarke