Disclosing Offshore Accounts – A Second Chance

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Your client of many years, a successful second-generation winery owner, just confided that she has had bank accounts in France in her name for decades.

Her now-deceased parents opened the accounts for her when they inherited from the Loire-based side of the family.  She discovered the accounts when she turned 25, and she has allowed the interest to accumulate.  The accounts are held in a Loire regional bank and total the equivalent of approximately $2 million.  Client has paid tax on the interest in France, but has not paid any U.S. tax related to the accounts.  It did not occur to her that it was necessary.

Carolyn Lee

Client, a sponge for financial news, noticed in early 2009 that the Department of Justice had turned its laser-like attention to US citizens with bank accounts in the Swiss branches of UBS.  For the first time, when Client reviewed her 2008 federal tax return, Part III, Foreign Accounts and Trusts, on Schedule B of the 1040 appeared in high relief.  Cable news reporters began to pepper their stories with references to “‘F’ Bars.”  A little research told Client this FBAR was a Foreign Bank Account Report (aka IRS Form TD F 90-22.1).  The IRS requires US taxpayers with an interest in offshore accounts to file an FBAR no later than June 30 for the prior tax year.  And don’t send the FBAR to Fresno.  No.  The IRS set up a special unit in Detroit to attend to the filings.

Client read enough to know her French accounts were potentially big trouble.  The solution, as she understood it, was to participate in something called a voluntary disclosure program.  Client found her way to IRS.gov and devoured the forty-plus FAQs about the program with the same intense scrutiny she brought to her winery’s marketing and distribution agreements.

The IRS’s 2009 voluntary disclosure program looked to Client like les Champs Elysees to one sizeable check payable to the Government.  Payments of back taxes, interest, and penalties on unreported income for the prior six years.  An additional 20% penalty on the highest aggregate value of the undeclared foreign accounts and assets in that period.  The extra penalty alone amounted to almost $400,000 for Client.  The articles included threats of criminal investigation and prison time, though the IRS claimed it would not recommend criminal prosecution for taxpayers who voluntarily came forward.  The program ran from February 2009 to October 15, 2009.  Client, otherwise tax-compliant, considered that she wasn’t on the UBS list and decided to play audit roulette.

Time passed with no ominous envelopes in the mail bearing an IRS return address.  Nonetheless, the Loire accounts that once represented Client’s retraite during her golden years in a chateau with modernized plumbing began to haunt her.  When Client learned earlier this year that the IRS was opening a second offshore voluntary disclosure initiative (OVDI), she decided to reveal all to you.  You invite Client into the office to review her options.

This Client is keen to understand her exposure.  This is not saying Client is any more ready to write that sizeable check payable to the Government.  Pas on votre life.  She may yet choose not to act, but this time she will be informed.  Client is accustomed to taking informed business risks and riding out the results.  Thus you begin educating the steely-eyed executive sitting across your table.

Disclosure Facts on the Ground as Practitioners are Experiencing Them

First, you expand Client’s basic knowledge about the 2009 program.  Participants filed amended federal returns and FBARs for tax years 2003 through 2008, and paid what the IRS calculated as due.  Participants’ fears that the program was the equivalent of presenting their wrists for the criminal prosecutors’ handcuffs did not materialize.  Of the approximately 15,000 taxpayers who disclosed unreported offshore income through the 2009 program, only forty-two were criminally prosecuted.  Another 3,000 taxpayers submitted voluntary disclosures regarding their offshore accounts after the first program closed.

Partially to address those 3,000 late disclosing taxpayers, to sweep in more taxpayers such as Client, and possibly in anticipation of another UBS situation, on February 8, 2011, the IRS announced the sequel to the 2009 program, labeled OVDI.  Sure enough, in April the Government sought court authority for the IRS to request accountholder names from banks HSBC-India and Credit Lyonnais.  OVDI applies to all US taxpayers with offshore accounts greater than $10,000.  Participants must file all required paperwork and submit full payment by August 31, 2011.

There is no reward for sitting out the 2009 disclosure program.  Participants must file amended returns and FBARs for tax year 2003 through 2010; that is, eight years instead of six years under the 2009 initiative.  The additional penalty is 25% of the highest aggregate value of the undeclared foreign accounts and assets in that period.  While the program structure provides for lower penalties – for example, if the failure to report offshore income was not willful – to the IRS, these lower penalties exist on paper only.  To date, the Service’s position is that any failure to report offshore income is willful and the full 25% penalty applies.  At least one Federal Court has ruled against the Service on the question, but the Service’s position has not yet changed (United States v. Williams (2010) 2010 U.S. Dist. Lexis 90794; 2010-2 U.S. Tax. Cas. (CCH) P50,623; 106 A.F.T.R.2d (RIA) 6150.)  Under OVDI, as under the 2009 program, the Service offers more lenient civil and criminal treatment to the OVDI participants than is available outside the program.

Are You In or Are You Out?

You advise Client that her choices fall along a spectrum ranging from full disclosure and full payment to continued non-disclosure.

In completely on the Service’s terms. Client can choose to enter the program, accepting the Service’s terms.  The IRS will calculate liability and penalties according to OVDI rules.  Voluntary disclosure examiners do not have discretion to settle cases for less than what is due and owing under the program rules.  If Client can prove a genuine inability to pay in full by August 31, 2011, Client must agree to payment arrangements acceptable to the IRS.  Finally, Client must enter into a Closing Agreement on Final Determination.  That is, Client will have no right to contest the tax liability and penalties.  Here is a program quirk:  Title 31 § 5314 of the U.S. Code requires disclosure of interest in foreign bank accounts, not Title 26.  IRS collections procedures and taxpayer protections are governed by Title 26.  Client will not have recourse to the Service’s Appeals division, and the opportunity to achieve a negotiated settlement.  Under this option, Client would write a predictable and large check.  On the bright side, Client will have the peace of mind of being in tax compliance.

Disclose then opt out. If Client submits a full disclosure of amended returns and FBARs and disagrees with the application of the offshore penalty, Client may withdraw, or opt out, of the program.  The withdrawal is irrevocable.  Having opted out, the IRS is under no obligation to honor its offer of lenient criminal consideration.  In addition, the IRS may conduct a complete examination of all relevant tax years and issues – not solely Client’s failure to report her offshore income.  This may not be a concern for Client, but it will involve no small amount of your billable time.  Worst of all, the outcome will be uncertain, and the OVDI reduced penalty structure disappears.  Client’s additional civil penalty liability risk increases from 25% to 50% of the account values for each year, in combination with an array of other penalties waived by the Government in the OVDI.  Client’s potential assessment for the additional penalty alone, assuming for simplicity an average $1.5 million account balance each of the eight years, is an eye-watering $6 million.  Failing to file an FBAR subjects a taxpayer to a prison term of up to ten years and criminal penalties of up to $500,000.

The bright side for this option?  The door opens to Title 26 collections procedures and taxpayer protections, including access to Appeals officers, who have settlement authority.  However, in Client’s case, as a sophisticated business person who chose not to participate in the first offshore voluntary disclosure program and then continued non-compliance, it is unlikely there is sufficient upside to opting out to offset the risk of extreme penalties.

Come clean with a quiet disclosure. Some taxpayers are making quiet or silent disclosures.  They file amended returns and their unfiled FBARs, and pay taxes, interest, and Title 26 penalties.  The returns are submitted through the regular tax filing channels.  A silent disclosure might slip by the Service for taxpayers whose foreign account income and associated tax liabilities are relatively small.  Even this option is not for the faint of heart.  Client would be reporting additional annual foreign income of more than $100,000, which is more likely to be noticed at Fresno, given the Service’s heightened scrutiny in this area.  You hand Client the Department of Justice’s May 19, 2011 press release, crowing about the Government’s plea bargain with a New Jersey taxpayer who attempted a quiet disclosure.  The taxpayer filed amended returns and late FBARs for tax years 2003 through 2008 outside the 2009 program, belatedly admitting he owed an additional $40,624 in taxes.  Having been detected, the taxpayer must pay a civil penalty of $76,283 and faces up to five years in prison followed by three years of supervised release and a $250,000 fine.  You advise Client that quiet disclosure opens her to every possible penalty and criminal prosecution.

Out completely. Client has the option to continue nondisclosure.  If caught, Client will be subject to criminal prosecution and civil penalties.  There is no rational reason to remain out of compliance.  The Service has made it clear there will be no reward for waiting to come forward.

Piling on – Client’s California tax liability. Covering all bases, you advise Client she also has California tax liability on the unreported foreign income.  Happily, in March 2011 Governor Brown signed a law establishing a tax amnesty program that applies to individual’s and entities’ offshore financial accounts.  The program will be in effect from August 1 through October 31,  2011, dovetailing with the federal OVDI.  Participants in the State’s amnesty will avoid most penalties.  More information is available at the FTB’s website and from the FTB practitioners’ hotline.

Only the Client Can Decide.

And then you wait.  After answering questions and offering to be available for follow-up, you remind Client that she should act quickly.  If Client chooses to voluntarily disclose, Client, her CPA, and you must act without delay to assemble Client’s OVDI submission and arrange full payment by August 31.

When ready to proceed, the first step is to contact the IRS Criminal Investigation Lead Development Center for clearance for Client to participate.  Persons already under criminal review or IRS audit may not participate in the OVDI.  The IRS has provided step-by-step OVDI instructions, including template disclosure communications, penalty calculation worksheets, and fifty-three FAQ’s at www.irs.gov.  Search on “voluntary disclosure initiative.”


Carolyn M. Lee, LL.M. – Taxation, is an associate in the Taxation and Estate Planning, Probate, Trust Administration, and Trust Litigation practices at Archer Norris, PLC.  Archer Norris attorneys represent business, commercial, and public sector clients wherever clients need strategic legal counsel throughout California and beyond.  Contact Ms. Lee at cmlee@archernorris.com.

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