While tens of thousands of taxpayers have entered the offshore voluntary disclosure process many more have not. The reasons for not filing voluntary disclosures are not important, what is important is what happens if a taxpayer receives an audit notice. Some audits will be triggered by information reported to the IRS from foreign financial institutions responding to requests from the U.S. government and some will be for other reasons. The reason may influence the initial document request but ultimately the risk on examination are serious. The risks range from civil assessment and penalties to criminal referral and possible prosecution. How the taxpayer responds during the audit is therefore critical.
First, it is important to recognize that if the taxpayer has unreported foreign financial accounts a decision to come forward early in the audit process is important to potential penalty mitigation. Second, because of the potential for criminal referral taxpayers must be aware that their conversations with accountants may not be privileged. Third, past information provided to the accountant may be subject to production (such as client information organizers) by way of Grand Jury subpoena. Taxpayers should also expect that their accountant will be interviewd by the agent. Fourth, the accountant can be compelled to testify. Fifth, because of the “required records doctrine” taxpayers can be compelled to testify in Grand Jury proceeding without benefit of Fifth Amendment protections against self-incrimination. The parade of horrible outcomes could be devastating if the wrong approach is taken early in the audit process.
If there is non-willful conduct in failing to file a Report of Foreign Bank Account (FBAR), then the taxpayer should consider coming forward to the agent at the beginning of the audit process and offering up the information necessary to establish FBAR compliance and reporting of previously unreported income. A reasonable cause explanation should also be considered and if established may result in no FBAR penalty. More complex approaches are necessary if the failure to file FBAR’s was knowing and intentional (“willful”). At that point the taxpayer still needs to produce records in response to Information Document Requests (IDR’s) submitted by the Revenue Agent (auditor). Coming forward may still be warranted, but under no circumstances should the taxpayer attempt to hide information, or conceal account records, for doing so can result in a criminal referral and charges of “obstruction”. Some hope that they will simply not be discovered.
As to the hope for non-discovery, many taxpayers will find themselves receiving letters from their offshore financial institutions requiring proof of FBAR compliance. Taxpayers must assume that failure to respond will or responding falsely will not help. The information will be turned over to the IRS. The fact that a taxpayer has not yet received a letter from their foreign financial institutions should not be interpreted as a safe from information turnover. Some foreign financial institutions will cooperate with the IRS under undisclosed agreements. Ultimately the account information will be released by offshore financial institutions to the IRS for all U.S. taxpayers.
The important point to remember is that upon receipt of an audit notice, a taxpayer with undisclosed foreign financial accountants needs to develop an audit strategy in a privileged context, with skilled counsel in order to avoid what could be very serious, lengthy and expensive tax and FBAR litigation.