February 28, 2011 –
IRS Announces 2011 Offshore Voluntary Disclosure Initiative

This week the U.S. government announced a new offshore voluntary disclosure initiative (“2011 OVDI”). Under this 2011 OVDI, taxpayers who voluntarily come forward and report their previously undisclosed foreign accounts and assets by August 31, 2011 will be excused from criminal prosecution.

Will the 2011 OVDI Succeed?

IRS Commissioner Shulman said in announcing the 2011 OVDI, “As we continue to amass more information and pursue more people internationally, the risk to individuals hiding assets offshore is increasing. This new effort gives those hiding money in foreign accounts a tough, fair way to resolve their tax problems once and for all. And it gives people a chance to come in before we find them.”

However, Martin R. Press of Gunster, widely quoted in the business media in connection with the predecessor Offshore Voluntary Disclosure Program that ended in 2009, expressed skepticism that the 2011 OVDI would attract many taxpayers who, since 2003, had significant unreported income.  Martin R. Press told USA Today, with respect to the 2011 OVDI, “Current tax evaders are not coming in, because it’s too costly, and they’re risk-takers.”

2011 OVDI

Under the 2011 OVDI, taxpayers are required to pay a penalty of 25% on the largest aggregate balance in the accounts in any single year between 2003 through 2010. For this purpose, the aggregate account balance must generally include the value of assets in undisclosed foreign entities and the value of assets that were either acquired with improperly untaxed funds or produced improperly untaxed income. For example, if the taxpayer, whether before or after 2003, used unreported foreign income to buy land and artwork that was located abroad, and that land and art work was owned between 2003 and 2010, that land and artwork must be included in the aggregate account balance.

If, in each of the years 2003 through 2010, the largest aggregate account balance is less than $75,000, the penalty is reduced to 12.5% of the largest account balance. The penalty can be reduced to 5% in only very narrow cases, such as where the taxpayer inherited foreign accounts, withdrew no more than $1,000 from those inherited accounts between 2003 through 2010, and did not direct the investment of those accounts.

In addition to paying the 25% penalty (or, if applicable, the 12.5% or 5% penalty), taxpayers participating in the 2011 OVDI must reveal all of their previously undisclosed foreign accounts and income. If they had unreported income since 2003, they must submit amended returns covering 2003 through 2010, pay all income taxes and interest due on those 2003 through 2010 returns (with income taxes on passive foreign investment company (PFIC) income optionally computed on a simplified basis), and pay a 20% penalty on the 2003 through 2010 income tax due.

The 2011 OVDI is similar to a previous voluntary disclosure program that ended in 2009 and accepted 15,000 taxpayers.  However, the 2009 program generally required the taxpayer to pay a penalty of 20% on the largest aggregate balance in the foreign accounts, rather than the 25% in the 2011 OVDI.

IRS Investigative Activity

Last year, as part of a deferred prosecution agreement, the U.S. government caused UBS to turn over the names of thousands of U.S. taxpayers with secret offshore accounts. However, the U.S. government has said that it is not stopping with UBS. Instead, they are now focusing on banks, advisers and promoters from around the world.

Last month, Rick Raven, the IRS Deputy Chief for Criminal Investigations, reported that IRS Criminal Investigations Chief Victor Song was on a tour to visit law enforcement officials in India, the Middle East and Hong Kong as part of the IRS’s continuing crackdown on offshore accounts. It is expected that there will be major prosecutions arising from HSBC accounts. Vaibhav Dahake was charged on January 26 in New Jersey for conspiracy with bankers to hide bank accounts located in India and the British Virgin Islands.

Prosecutions

The Department of Justice has recently successfully prosecuted individuals with undisclosed offshore accounts. For example, this month, two South Florida real estate developers received 10 year prison terms for filing false tax returns. The IRS alleged the defendants used shell corporations in the Bahamas, the British Virgin Islands, Panama, Liechtenstein, and Switzerland to seek to conceal their assets and income from the IRS.

Possible sources of IRS leads for future prosecutions include: civil audits of a taxpayer’s tax returns; informers; whistleblowers seeking awards; disgruntled bank employees, information from summonses of U.S. and foreign financial institutions, data supplied by foreign countries, and information provided by taxpayers who entered the 2009 program. For example, in January, the former chief operating officer of Julius Baer’s Cayman Island Branch released to Wikileaks data on 2,000 cross-border bank accounts he believed were involved in tax evasion.

New Laws Designed to Catch Those Hiding Assets

The IRS will soon have new enforcement tools with respect to accounts of U.S. taxpayers in foreign jurisdictions. Beginning in 2011, U.S. individual taxpayers who hold financial assets exceeding $50,000 in the aggregate must report these assets on their Forms 1040 filed in early 2012. Reportable financial assets include financial accounts in foreign countries; any interest in an entity formed in a foreign country; and any financial instrument or contract held for investment.  These new reporting requirements are in addition to the current requirement that taxpayers file a “Report of Foreign Bank and Financial Accounts” (commonly referred to as an “FBAR” report) with the Treasury Department to disclose their foreign accounts. There are significant penalties for failing to report.

Beginning in 2013, foreign financial institutions that hold U.S. securities portfolios must, as a practical matter, in order to avoid burdensome U.S. withholding on that portfolio, enter into a written agreement with the IRS. The agreement will require the foreign financial institution to perform due diligence to determine indirect or direct U.S. owners, and to report to the IRS.