Undeclared Foreign Accounts— Voluntary Disclosures And FBARs After The IRS Settlement Initiative

This article was originally published in Journal of Tax Practice & Procedure

Background

For the past two years, the worldwide business press has been full of stories about potentially thousands of U.S. taxpayers who may have undeclared accounts in Switzerland, Liechtenstein and other foreign countries. Secret foreign bank accounts are no longer the stuff of Hollywood, and the law practice of criminal tax has moved from the legal trades to the front pages of major newspapers. Developments have been fast and furious.

In late 2007 and early 2008, details began to emerge about the guilty plea of a wealthy Los Angeles– area real estate developer, who in turn cooperated against his Swiss UBS private banker. The banker was later arrested, and he cooperated with authorities by providing his client list as well as documents reflecting a decade long set of marketing practices by UBS aimed at encouraging U.S. account holders to commit tax fraud.1

Meanwhile, in February 2008, it was disclosed that a former employee of LGT Truehand, a trust company affiliated with LGT Bank in Liechtenstein, had stolen customer data and provided it to tax authorities throughout the EU, and to the IRS as well under a newly enacted "whistleblower" provision.2

In July 2008, a U.S. Federal District Court authorized the IRS to serve a "John Doe" administrative summons on UBS seeking the production of the records of all accounts that it maintained during the period 2002–2007 for U.S. customers who instructed the bank not to disclose their identities to the IRS. Around the same time, the IRS served a request for assistance under the Swiss-U.S. Treaty on Double Taxation for records of accounts in which a "blocking entity" had been inserted between the account's beneficial owner and the account assets; such a practice was designed to evade rules on withholding where U.S. securities were held in the account.3

The U.S. Senate Permanent Subcommittee on Investigations held hearings in the summer of 2008 relating to LGT and UBS, exposing the uses of foreign accounts to hide assets from the IRS. Representatives from UBS testified before the Subcommittee about their willingness to cooperate with the American investigations and about changes in their banking practices.4

After the hearings, UBS began to notify its American clients with undeclared accounts that their private banking arrangement would be terminated unless the clients agreed to convert their accounts to "declared" status.5

In late September 2008, the IRS posted on its Web site a new version of Treasury Form 90-22.1 (Foreign Bank Account Report), known as the "FBAR," with more detailed and explicit instructions, expanding the reporting requirements in a number of material ways. Much of the attention in this area is prompted by the extraordinarily tough civil penalties imposed for the willful failure to file this form.

In October 2008, the IRS proposed tougher rules for the Qualified Intermediary (QI) program, including requirements that QI financial institutions must provide early notification of material failure of internal controls, must improve evaluation of risk of circumvention of U.S. taxation by U.S. persons and must agree to audit oversight by a U.S. auditor.

Other matters relating to the UBS investigation followed quickly:

In early November, a senior UBS bank official was indicted on one count of criminal conspiracy. This appears to be a direct result of the cooperation of the UBS private banker who pled guilty and cooperated. In January 2009, a U.S. District Judge declared that the bank official was officially a fugitive from justice.6 The IRS and the Justice Department, along with the Manhattan District Attorney's Office, apparently obtained information on approximately 70 U.S. account holders who engaged in wire transfers between their U.S.-based UBS accounts and Swiss based accounts at that same institution.7 In February 2009, the U.S. Department of Justice and UBS entered into a Deferred Prosecution Agreement, whereby UBS agreed to pay the United States $780 million to resolve all criminal, and most civil, issues arising from the bank's role in facilitating U.S. tax evasion. Other terms of the UBS deferred prosecution agreement included the extraordinary disclosure of the identities of approximately 250 to 300 account holders to the Justice Department, as well as production of voluminous records of their accounts.8 As of this writing, the Justice Department had obtained guilty pleas from seven UBS account holders whose names were apparently provided either by the cooperating private banker or by the Swiss Federal Tax Authority pursuant to the Deferred Prosecution Agreement. The Justice Department has also said that perhaps as many as 150 other account holders are under criminal investigation.9 The IRS settled the John Doe summons case with UBS in August 2009, agreeing to a timetable whereby UBS would respond, through the Swiss government, to a new treaty request identifying certain types of accounts that would be disclosed. Notices from UBS have gone out to thousands of American account holders informing them that their account information may be disclosed.10 The Justice Department has charged additional Swiss bankers, financial advisors and lawyers alleging, among other things, a conspiracy to help Americans commit tax fraud, bribery of Swiss government officials, and other offenses.11 Further, the press has reported, and the government has confirmed, that other persons affiliated with banks in "secrecy" jurisdictions throughout the world have stolen customer data and may be approaching the IRS and other law enforcement agencies seeking whistleblower rewards. Indeed, in December 2009, it was reported that data had been stolen from HSBC's private banking group in Geneva and provided to certain tax authorities.12

International pressure is growing for greater transparency as to financial accounts in various countries. The United States and Liechtenstein entered into an Information Exchange Agreement, applicable for years 2009 and beyond. The Swiss and U.S. governments signed a new Treaty protocol in September 2009. The OECD and the EU have been pressuring countries like Switzerland to be more transparent, and Switzerland was recently removed from the "gray list" of potential tax havens as a result of concrete steps taken by the Swiss to become more open. Similar pressure is being exerted on bank-secrecy jurisdictions in Asia deemed by some to be tax havens.

In March 2009, the IRS announced a "settlement initiative" aimed at encouraging Americans to come forward with voluntary disclosures about previously undeclared accounts. Any qualified U.S. taxpayer participating in this initiative would avoid criminal prosecution and pay civil penalties that, while substantial, would be well below what the U.S. tax authorities could otherwise seek to collect. The initiative expired on October 15, 2009, with 14,700 American taxpayers taking advantage of the special program.

In April 2009, the IRS served a "John Doe" summons on First Data Corporation, a processor of credit and debit card transactions, seeking information on U.S. merchants who have directed the deposit of business receipts to foreign accounts, and during the summer, settled this matter with First Data, presumably resulting in the production of additional account information.13

In the IRS settlement initiative, the IRS has obtained information on a number of additional foreign financial institutions, as well as specific bankers, financial advisors and other persons. This information will be used to formulate additional treaty requests and perhaps summonses to be served on other foreign governments and banks. Press reports over the past year have suggested that this process may already be underway.

In this swirling enforcement environment, tax practitioners continue to be approached by clients seeking advice on how to clean up their affairs before the government comes knocking at their door. The cases range across a broad factual spectrum.

In many cases involving undeclared foreign accounts, the account was opened with legal funds, sometimes even "tax paid" funds, with the account holder seeking the protection of a bank secrecy jurisdiction because of World War II, the Holocaust or other personal or family-related developments.

In some of these cases, a second or third generation of taxpayers became aware of accounts established by their parents or grandparents, and they want to clean the matter up; in other instances, elderly taxpayers wish to make voluntary disclosures so as not to burden their heirs with the problem of having a previously undeclared foreign account.

And of course in other cases, the taxpayers involved are persons who affirmatively sought to hide money from the IRS, concealed the transfer of untaxed funds into their foreign accounts, and hid their methods of withdrawal from such accounts. Irrespective of the "rawness" of the fact pattern, however, any such case is eligible for noncriminal resolution under the IRS's voluntary disclosure policy.

Regardless of the underlying reasons for the establishment of the account, most of these cases share a number of common characteristics:

A failure to report income earned on the accounts A failure to disclose the existence of the account on the individual's U.S. tax return ( There is a place to check a box answering the question whether the taxpayer has signature authority or a financial interest in a foreign account, and if so, to list the names of the countries where the account is held.) A failure to file annual FBAR forms disclosing the existence of the account Potentially, a failure to file additional IRS forms regarding a taxpayer's relationship to a foreign trust or foreign corporation, or the taxpayer's receipt of funds from foreign sources, including gifts and bequests Each of these failures, if willful, could be the basis for tax felony prosecutions...