Voluntary Disclosure versus Prosecution


For taxpayer’s who had direct or indirect control over offshore financial accounts which aggregated $10,000 or more in calendar year 2012 a Report of Foreign Bank or Financial Account, known as an FBAR (Form TD 90-F. 22.1) is due and must be received by the IRS at the Detroit Center by June 30, 2013. Since June 30 is a Sunday the actual due date is June 28, 2013. The failure to timely file may result in the imposition of significant penalties. The civil penalties range from zero for a “reasonable cause” based failure to timely files, (that means a lawyer wrote an opinion that the taxpayer did not have to file), to a “non-willful” penalty of $10,000 per account per year ( a simple late filing) to a “willful” penalty of the greater of $100,000 or 50 % of the highest account balance during the year. A willful failure to file is one based upon the taxpayers’ specific intent not to file or “willful neglect” in filing. The criminal penalty is the worst outcome. The criminal penalty is based upon an assertion that the the taxpayer acted “willfully” as determined by the Department of Justice resulting in prosecution where the penalty is potentially multiple years in prison plus a fine, plus the civil highest civil FBAR penalty, 50%. But what does a taxpayer do if a taxpayer has multiple unfilled years and is concerned about filing the 2012 FBAR without otherwise coming forward on past years? The risk in not filing 2012 timely is that any potential penalty reductions, such as to a non-willful or reasonable cause will be lost due to what would surely be interpreted as an intentional failure to file for 2012.

The Criminal Tax Division of the Justice Department (DOJ) has been unambiguous about its position on prosecution and FBAR penalties. The position is that if a taxpayer is identified as potentially having ownership or control of an offshore financial account prior to the taxpayer coming forward then they will be subject to prosecution, and the 50% FBAR penalty, plus the 75% civil fraud penalty on unreported income, plus interest. The rationale for the stringent approach of the DOJ is that taxpayer’s including U.S. Ex Pat’s and dual nationals have had three recent opportunities to come forward in voluntary disclosure programs. The first was in 2009, the second 2011 and the current program which began in 2012. The costs of participation have increases with each iteration of the offshore voluntary disclosure program going from 20% of the highest single year account balance in 2009 to 25% for 2011 to 27.5 % for the 2011 program.

Beginning with the 2011 income tax returns there are specific FBAR question on Schedule B of Form 1040 and there is a new Form 8938 required as part of the income tax return which requires a separate disclosure of Specified Foreign Financial Assets. Further, most foreign financial institutions are requesting proof of compliance with U.S. income tax reporting rules, including FBAR reporting, for all depositors who have U.S. identifiers on record. The actions (Notices) of the foreign financial institutions, mandated under the Foreign account Tax Compliance Act (FATCA) are treated as further evidence of “willfulness” by DOJ in filing criminal FBAR cases. The obvious conclusion is that the risk benefit analysis is seriously tilted to coming forward. But what if the accounts are held in the names of business that the taxpayer controls and the taxpayer is not in compliance with income tax rules?

The advantage of filing under the voluntary disclosure program is that the taxpayer can avoid failure to file returns for “controlled foreign corporations” controlled foreign partnerships” which run $10,000 per year per entity and also avoid separate penalties for failing to file other information return. Other information returns include Form 3520, Report of Foreign Gift, Devise , Bequest or Trust Transfer” which is required if the taxpayer receives a gift or inheritance from a foreign person which totals more than $100,000 in a calendar year or makes a transfer to an offshore trust. The penalties for failure to file Form 3520 range from 25%-35% of the Fair Market Value of the gift or inheritance.

In addition to avoiding potentially horrendous information return penalties the income tax penalty is frozen at 20% of the tax on the unreported income instead of the 75% fraud penalty assessable in the criminal tax case. The FBAR penalty is also limited to 27.5% of the highest single year account balance for the 8 years covered by the voluntary disclosure. This is in lieu of the DOJ position that the 50% penalty is assessable. In the event that the taxpayer believes that the FBAR penalty required under the voluntary disclosure is too high compared to the otherwise assessable n”non-willful” penalty the taxpayer can “opt out” of the voluntary disclosure and likely not face a risk of criminal prosecution or 50% FBAR penalty or 75% fraud penalty. The decision to “opt out” must be carefully considered, and one size does not fit all, but the “opt out” process is certainly available in proper circumstances.

Given the very recent settlement between U.S and Swiss governments, which will result in disclosure of many more names and account holder information there is an imperative for taxpayers to come forward quickly and get into compliance or risk a terrible outcome, if they do not.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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