The Cloak of Invisibility for Foreign Accounts Is Rapidly Unraveling: IRS and Foreign Banks Are Clamping Down on U.S. Tax Evasion

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A global push for enhanced financial transparency means that United States owners of foreign [1] accounts and assets will not be able to remain invisible forever. New rules and enhanced enforcement of existing rules will soon force account holders to comply with U.S. disclosure requirements or face significant consequences from both the Internal Revenue Service (“IRS”) and foreign banks.

Foreign Bank and Financial Accounts Reports (“FBARs”), information reporting and withholding rules under the Foreign Account Tax Compliance Act (“FATCA”), and conditions of a U.S.-Switzerland program focused on tax evasion will make it virtually impossible for U.S. account holders to hide foreign accounts from the IRS and impose stringent conditions to keep foreign accounts open. While there still are remedies available, time is running short for noncompliant account holders to avoid large IRS civil or criminal penalties and closure of foreign accounts by the banks.

This alert describes U.S. disclosure requirements and conditions imposed by foreign banks on their U.S. clients in order to avoid their own penalties. It also provides details about the IRS Offshore Voluntary Disclosure Program (“OVDP”), which offers a chance for U.S. taxpayers who have not complied with FBAR reporting rules or have failed to report income associated with foreign financial accounts to come forward and remedy those failures in exchange for reduced penalties and general protection from IRS criminal penalties.

Overview of FBAR and Penalties
In general, any U.S. person having a financial interest in, or signatory or other authority over, a bank, securities, or other type of financial account in a foreign country with a value greater than $10,000 must file an FBAR by June 30 of the following year. For purposes of this filing, a U.S. person includes individuals and entities. Final Treasury regulations provide more details regarding the scope of FBAR reporting requirements. [2]

The requirement to file an FBAR is authorized by the Bank Secrecy Act, and they must be filed electronically with the U.S. Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”). Although the IRS is responsible for FBAR compliance, FBARs are not income tax forms nor are they filed with a tax return. An FBAR includes information about a taxpayer’s foreign account, including where it is held, account number, maximum account value and income earned on the account. Upon receipt by FinCEN, FBAR data is entered into the Bank Secrecy Act financial database for use by law enforcement agencies.

The statutory penalties for failure to comply with the FBAR rules can be severe. A non-willful violation carries a civil penalty up to $10,000 for each violation. Willful failure to file a timely or accurate FBAR, or to retain records of the account, may result in civil penalties up to the greater of $100,000 or 50 percent of the amount in the account at the time of the violation, and criminal penalties up to $250,000 or five years in prison, or both.

Overview of FATCA
FATCA introduced largely duplicative, but even more expansive, financial disclosure requirements beginning in 2011.  In addition to foreign accounts, U.S. taxpayers must disclose directly to the IRS details of foreign assets held for investment. Individuals must file Form 8938 with their tax returns to report foreign financial accounts and assets with an aggregate fair market value exceeding either $50,000 on the last day of the taxable year or $75,000 at any time during the taxable year for single filers, and $100,000 on the last day of the taxable year or $150,000 at any time during the year for joint filers. Form 8938 is only required for individuals who have U.S. income tax return filing requirements. Generally, failure to file Form 8938 will result in a $10,000 penalty. After 90 days, the penalty increases in increments of $10,000 for each 30-day period the penalty failure continues, up to a maximum penalty amount of $60,000.

FATCA also imposed new due diligence and information reporting requirements on foreign financial institutions (“FFIs”), which will result in disclosure of U.S. accounts to the IRS. FFIs must enter into a binding agreement with the IRS to identify their U.S. account holders and file an annual report regarding those accounts with the IRS, or else face a 30-percent withholding tax on most types of U.S.-source income. The annual report will include the name of the account holder, as well as the account number, the balance in the account, and certain information regarding the activity in the account during the year. Account holders who fail to provide enough information so the institution knows whether they are a U.S. person will face closure or blocked access to their accounts.

Although FATCA once was criticized as an onerous extraterritorial imposition by the U.S. government on foreign financial institutions, in recent months the European Commission and the Organization for Economic Cooperation and Development have joined forces to develop similar regimes throughout the world, creating a new “worldwide web” of disclosure and transparency.

Overview of Program for Swiss Banks
On August 29, 2013, the United States and Switzerland announced the “Program for Swiss Banks,” allowing Swiss banks to cooperate with the Department of Justice’s ongoing investigations of the use of foreign bank accounts to commit tax evasion by disclosing U.S. accounts. To avoid prosecution, Swiss banks were required to provide information regarding U.S. accounts to the U.S. government, including the total number of such accounts held by the bank, the maximum value of each account, the number of U.S. persons or entities affiliated with the account, the name of the relationship manager, and other details by December 31, 2013.  Additional details of each account can be provided to the IRS upon request, including the name of the account holder. Participating Swiss banks are subject to penalties on the aggregate balances of such accounts unless U.S. persons have certified the accounts have been disclosed to the IRS.  Swiss banks actively sought such certifications to minimize penalties and, in many cases, froze or closed accounts in the absence of the required certification.

Banks outside Switzerland also are taking steps to ensure that their clients are complying with U.S. tax law, either through internal reviews of customer account information or by requiring clients to certify their compliance. For instance, the United Kingdom and Switzerland signed a similar agreement that went into force on January 1, 2013. Under the agreement, a UK taxpayer with financial assets in Switzerland has the choice of paying (1) a onetime payment based on a formula calculated according to capital and income/gains of an account, the length of time that the account was held, and the rate of balance increase over the relevant period, plus applicable withholding or (2) authorizing disclosure to the United Kingdom. We should expect similar initiatives to emerge in several other countries in the near future.

Overview of the IRS Offshore Voluntary Disclosure Program
In 2009, after a series of high-profile plea agreements and prosecutions, the IRS offered a voluntary disclosure program for those who had not complied with FBAR reporting rules or failed to report income associated with foreign financial accounts. In exchange for disclosing account and income information, participants may benefit from reduced penalties and general protection from criminal investigation. Acceptance into the program is not automatic; if the IRS already is aware of accounts through other means, participation will be denied. While the program has been available sporadically since 2009, in January 2012 the IRS reopened the OVDP, cautioning that the terms of the program could change or end at any time. 

Under the OVDP, taxpayers accepted into the program must pay (1) an FBAR penalty, which is 27.5 percent of the highest annual aggregate balances in the undisclosed accounts over the past eight years; (2) the tax owed on the undisclosed income from the accounts over the eight-year period; (3) a 20-percent penalty based on the additional tax owed; and (4) interest on the additional tax and 20-percent penalty. 

The combination of the U.S.-Switzerland program, FATCA reporting requirements and publicity regarding the prosecutions associated with U.S. tax evasion has resulted in thousands of taxpayers entering the IRS OVDP.

Uncharted Terrain: Virtual Currency Concerns
As the IRS continues its aggressive offshore reporting and tax compliance initiatives, new questions are beginning to emerge about the taxation, character and reporting obligations of virtual currencies. Virtual currencies are online payment systems that function as real currencies, only without the full faith and credit of a central government. Certain virtual currencies, called “cryptocurrencies,” operate on a free-floating exchange and are accepted as a legal form of tender in several countries. Questions include whether virtual currencies are financial accounts or financial assets subject to FATCA and FBAR reporting; whether income from virtual currencies is ordinary or capital in nature; how such income is measured; when and where it is taxed; and who is responsible for collecting and remitting the tax. The IRS has stated it is considering these issues but has not provided guidance or answers to any of these questions. The U.S. Government Accountability Office recently issued a report [3] criticizing the IRS for not addressing these tax compliance risks.

This uncertainty and lack of guidance makes it almost impossible for owners of virtual currency to know how to meet their disclosure and filing obligations in order to comply with the law.

Do Not Rely on the Cloak of Invisibility: What You Should Do Now
If you have a foreign financial account or asset that you have not disclosed, you are facing substantial and increasing risk of detection that could lead to civil or criminal penalties, not to mention possible lack of access to funds held in foreign accounts. Immediate action is recommended to determine how to remedy and mitigate any noncompliance before IRS enforcement, FATCA information reporting, disclosures through the Switzerland program, and other international cooperative efforts make it nearly impossible to hide foreign accounts and avoid stiff consequences.

Notes:
[1] Throughout this article, the term “foreign” means “non-U.S.” (e.g., bank accounts held outside the United States, or persons that are not defined as U.S. persons under 26 U.S.C. Section 7701(a)(30)).

[2] See Amendment to the Bank Secrecy Act Regulations - Reports of Foreign Financial Accounts, 76 FR 10234 (Feb. 24, 2011).

[3] Gov’t Accountability Office, GAO-13-516, Virtual Economies and Currencies: Additional IRS Guidance Could Reduce Tax Compliance Risks (2013).

 

Topics:  Banks, Disclosure Requirements, FATCA, Foreign Banks, IRS, OVDP, Tax Evasion

Published In: Criminal Law Updates, Finance & Banking Updates, International Trade Updates, Tax Updates

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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