Will the Panama Papers Lead to Criminal Charges Against U.S. Taxpayers?

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The International Consortium of Investigative Journalists (ICIJ), collaborating with German newspaper Süddeutsche Zeitung, in spring 2016 began leaking approximately 11 million internal documents obtained without permission from Panamanian law firm Mossack Fonseca by an anonymous whistleblower.  These “Panama Papers,” as they have become widely known, detail the creation over a 40-year period of hundreds of thousands of business entities and bank accounts in offshore financial centers commonly known as “tax havens.”  Many of the documents allegedly reveal the law firm helping its clients to evade taxes, sidestep financial disclosure obligations, and hide the proceeds of criminal activity through these offshore holdings.  

Scandal and innuendo have inevitably followed, ensnaring diverse notables, such as Russia’s Vladimir Putin and a now-former prime minister of Iceland, who are accused of exploiting these offshore business entities for corrupt ends.  American citizens and businesses have yet to feel the leak’s impact.  The federal government, however, has taken steps over the last few months that raise the question whether the Panama Papers may result in criminal charges under U.S. law.

Legal Purposes of Offshore Business and Banking

Generally speaking, the term “offshore business entities” refers to shell companies registered or incorporated outside the country of their owners’ residence in tax havens that offer unique benefits, such as anonymity, low taxes, and minimal regulatory oversight.  To be sure, there is nothing inherently illegal about such companies.  Offshore transactions have numerous legitimate business purposes.  For example, holding assets in another country can enable persons to minimize their taxes through means that are decidedly legal, set up businesses overseas, and buy real estate in foreign countries.  

Indeed, the U.S. government has recognized these wholly acceptable business purposes, requiring only that U.S. taxpayers declare their foreign assets through specified filings in order to prevent tax evasion and money laundering.  A U.S. taxpayer with offshore assets may be required to file a Form 114, Report of Foreign Bank and Financial Accounts (FBAR) with the U.S. Department of the Treasury or other informational returns with respect to their foreign arrangements, in addition to their usual income tax obligations.   

Civil and Criminal Liability for Failing to Report Offshore Income

On the other hand, failure to abide by these obligations can result in steep civil penalties and criminal sanctions. 

For example, despite that gifts from foreign persons are not subject to U.S. income taxation, the failure to report the receipt of the gifts that did not result from willful conduct by the U.S. taxpayer may still result in the following civil penalties:

  • A foreign trust can be subject to a penalty equal to the greater of (1) $10,000 or (2) 35% of the gross amount contributed or distributed from the trust;
  • An undisclosed gift from a foreign person can result in a 25% penalty on the gross amount of the gift;
  • Failure to file informational returns on behalf of foreign partnerships and corporations can result in a $10,000 penalty (and up to $50,000) for each entity per year; and
  • Failure to file an FBAR (Form 114), can result in an IRS penalty of $10,000 for each account per year.

Penalties and criminal sanctions stemming from the willful failure to report offshore income are even more severe.  For example, the willful FBAR civil penalty is the greater of $100,000 or 50% of the account balance per account per year.  A willful violation of not filing an FBAR can also result in a criminal penalty of $250,000, 5 years in prison, or both.  Willful failures to satisfy the IRS filing requirements may also result in criminal charges, such as tax evasion under 26 U.S.C. § 7201 or tax obstruction under 26 U.S.C. § 7212(a).  Section 7201 carries a fine of $100,000 ($500,000 in the case of a corporation) or up to five years imprisonment, or both, together with the costs of prosecution, and § 7212(a) may result in a $5,000 fine, up to three years imprisonment or both.

U.S. Taxpayers and the Panama Papers

These penalties have obvious importance to the roughly 2,400 U.S.-based clients of Mossack Fonseca that have been identified to date in the Panama Papers.  Although many of the transactions detailed in the Panama Papers that relate to these U.S.-based clients appear to have been legal, U.S. government leaders have expressed skepticism regarding offshore business entities and accounts generally.  For example, U.S. Senators Sherrod Brown and Elizabeth Warren have requested the investigation of all U.S.-related companies and individuals with ties to Mossack Fonseca, regardless of whether the companies appear to have been involved in wrongdoing.  Given this widespread viewpoint, it is likely that U.S. individuals and corporations named in the Panama Papers will attract some level of scrutiny from civil and regulatory authorities, such as the IRS. 

Some cautious U.S. taxpayers identified in the Panama Papers may choose to self-report their previously undeclared overseas income, either formally through one of the IRS’s voluntary self-disclosure programs or through a “quiet disclosure” by amending historical tax returns and paying associated taxes and interest without otherwise flagging previous reporting omissions.  U.S. taxpayers who do so should recognize first that the IRS has already publicly stated that it is monitoring amended tax returns, and it will assess whether the amendments justify enforcement actions.  As a result, careful consideration with an experienced professional should be given when determining how to correct previous errors or omissions.

Looming Danger of Government Scrutiny

The real danger is that looming behind every civil or administrative proceeding by the IRS is the possibility that evidence will be referred to law-enforcement authorities for potential investigation for criminal offenses.  The U.S. Department of Justice has already expressed a keen interest in this matter: Preet Bharara, the U.S. Attorney for the Southern District of New York, has opened a criminal investigation relating to the Panama Papers, and he has formally requested a meeting with the ICIJ in order to gather evidence.

The broad takeaway here is that U.S. taxpayers with offshore assets should be highly wary of government scrutiny, regardless of Mossack Fonseca’s involvement in the assets’ creation or the assets’ legality under current U.S. law.  Given the politically charged nature of the Panama Papers, even the investigation into a holder of an offshore account by regulators such as the IRS may lead to a more serious criminal investigation.  At a minimum, any investigation by U.S. authorities will require sharing with the government transactional data, correspondence, and explanations regarding business decisions.  In other words, government involvement will be intrusive and disruptive.  U.S. taxpayers under investigation should consider with great care how the presentation of this information will impact the course of the investigation in order to minimize exposure to criminal liability.


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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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