A little known and sometimes extremely troublesome reporting requirement exists for United States persons who own foreign bank accounts in various countries around the world. To the extent that such accounts exceed the aggregate value of $10,000.00 US Dollars at any time during a year, taxpayers have an obligation to both disclose the existence of the account on their income tax returns as well as file a separate report with the United States Treasury concerning the existence of the account. These reports, known as FBAR reports, are required to be filed on or before June 30th of each year and are filed separate and apart from a tax return which a taxpayer might otherwise prepare with respect to any such accounts. In addition, for the first time this year, the report is required to be filed electronically and the form on which the report is filed has changed substantially.
This FBAR requirement has actually been part of the law for decades; however, until the terrorist attack of September 11, 2001, there was essentially no enforcement regime connected with failure to report foreign bank accounts. In the wake of 9/11 and as part of a concerted effort to increase tax reporting and compliance, decrease income tax evasion, and attack the perceived dual problems of international money laundering and funding for terrorist activities, a penalty regime was enacted which has been described by a number of commentators as “draconian”.
In the case of foreign bank accounts, the penalty is 50% of the outstanding highest balance in value of a foreign account at any time during the year in which an individual fails to report. This penalty, where an account has persisted for a number of years and has gone unreported (whether inadvertently or otherwise), can accumulate to several times the value of the account, as the potential penalty can be as high as several hundred percent. As a consequence, the penalty was considered to be confiscatory by a number of commentators.
The context for the penalty being as high as it is was, of course, the sweeping series of reporting requirements which were put in place over the last several decades with respect to foreign controlled corporations, foreign trusts, gifts from foreign sources, and other international activities which now form a complex web of reporting and tax compliance for U.S. persons that have interests, businesses, or assets overseas.
Some commentators observed that the penalty regime was sufficiently draconian that it actually discouraged compliance, and in 2008 the Internal Revenue Service inaugurated a program designed to raise revenue both through the penalty regime and payment of taxes previously unpaid and which allowed tax payers to get into compliance under a substantially reduced penalty regime. This program, known as the Offshore Voluntary Disclosure Program, permitted taxpayers to file the FBAR reports previously unfiled while presenting original or amended tax returns that determine their entire tax liability. In conjunction with the payment of any unpaid tax with interest and penalties thereon, the program provides for a reduced penalty regime. The program, in its current iteration, provides the penalty is no greater than 27.5% of the highest account balance during the entire period of offshore disclosure.
The Offshore Disclosure Program provides for a look-back over eight years with respect to activities of a taxpayer and enables a taxpayer to get into compliance without having the account being entirely confiscated. In some instances where it is clear that the failure was inadvertent and that little or no income tax evasion may be present, there are facts and circumstances which can permit a taxpayer to qualify for a reduced penalty regime.
However, it is important to realize that while the Offshore Voluntary Disclosure Program affords an opportunity for many taxpayers to get into compliance, it has risks and in some cases may not be the appropriate solution. First, as one of the conditions of the Offshore Voluntary Disclosure Program, a taxpayer must agree to extend the statute of limitations to cover the eight year reporting period for the program and must amend any and all tax returns to add at a minimum a number of correctly answered questions concerning offshore accounts and assets as well as reporting any income which was previously unreported and paying taxes with interest and penalties thereon.
In cases where the conduct involved is not inadvertent, the Offshore Voluntary Disclosure Program puts tax payers in the position of making a series of difficult decisions which, from the taxpayers perspective may involve both a great deal of risk and tremendous expense. It is important to observe, however, that a failure to comply leaves the taxpayer in the no-win position of waiting to be discovered and facing potential criminal exposure, as well as extremely draconian penalties, if they elect not to comply after they learn the rules and have thorough understanding of them.
As is probably apparent from this article, we have handled a number of these matters, and the decision making process of how to enter the program and the specifics of what will need to be done in order to either qualify for the Offshore Voluntary Disclosure Program (or in those rare cases opt out of the program) requires a very fine detailed analysis of both the tax activities of a taxpayer and the potential exposure to the penalty. We would be happy to discuss these matters with you, and we urge any and all taxpayers who receive a copy of this newsletter, to take appropriate action in their case to deal with these issues.
