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1. What is Voluntary Disclosure?

A voluntary disclosure is an admission to the IRS that a taxpayer failed to properly report an item of income on his or her tax return or failed to disclose a required item on a reporting form. The IRS has a Voluntary Disclosure program, which admits taxpayers who meet certain criteria and who follow a set of specific instructions. A voluntary disclosure will not automatically guarantee immunity from prosecution; however, a timely voluntary disclosure may result in prosecution not being recommended.

There are two methods for conducting a Voluntary Disclosure matter: (i) a "Noisy Voluntary," whereby a attorney approaches the IRS Criminal Investigations Division ("CI") on a taxpayer's behalf to negotiate a waiver of prosecution prior to filing amended (or unfiled) income tax returns and the FBARs; and (ii) a "Quiet Voluntary," wherein a taxpayer, or his representative, directly files unfiled or amended income tax returns and FBAR reports with the IRS and Treasury without contacting them beforehand.

A voluntary disclosure must be truthful, timely and complete, and the taxpayer must demonstrate a willingness to cooperate (and must in fact cooperate) with the IRS in determining the correct tax liability. The taxpayer must make good faith arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable. Voluntary disclosures are not available to all taxpayers, including those with illegal source income (Al Capone need not apply), but may be a viable option for the vast majority of taxpayers with unreported income or unreported foreign accounts, for example.

The Voluntary Disclosure program, in its current iteration, requires the disclosure to be timely, that is received before:

A. The IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation.

B. The IRS has received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the specific taxpayer's noncompliance.

C. The IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer.

D. The IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena).

2. Can you tell us a little about its history?

Between 1946 and 1952, the Treasury Department had a formal policy of not recommending prosecution in the case of any taxpayer who fully disclosed their fraud to the IRS before the beginning of any civil or criminal investigation. This was abandoned in the early 1950s only to resurface as an informal policy and later a formal policy. The last few years in this practice have been very exciting.
After the news pertaining to LGT and UBS began to be widespread, many people began to understand that they needed to report money held offshore to the US government. An influx of voluntary disclosures prompted a new program often called an ‘amnesty', announced in March 2009, and effective through September 23, 2009 that provides a special penalty framework.

Soon after, a FAQ was released that answered several issues that practitioners had run into again and again, for example, must a person with signatory authority only over a foreign account go through a formal voluntary proceeding?

3. What sort of deals were offered traditionally?

The deals taxpayers received varied. Some practitioners attempted to ‘forum shop' to get the best deal for their client. Taxpayers who submitted returns directly could often expect to pay taxes, penalties (typically 25%) and interest on that sum to the date of filing. They would also typically pay any automatically generated penalty for reporting forms (note, the FBAR form did not appear to generate such an automatic penalty). A taxpayer who went through the noisy voluntary process could expect to pay taxes, penalties (typically 20% negligence) and interest on that sum to the date of filing. A negotiation could be had with respect to other penalties.

4. Who is it designed to interest and why?

Voluntary Disclosure was typically used for non-filers and for individuals with unreported, legal source income.

Although the taxpayer would pay tax on the unreported income at the marginal rate applicable to their income and a negligence (or accuracy) penalty equal to 20% (or 25%) of the tax underpayment, together with interest on the unpaid tax and penalty, at rates announced periodically which are based on long term Treasury bond rates, the taxpayer would avoid being penalized for willfully evading tax, or the payment thereof, which is a felony subject to a fine of not more than $100,000, imprisonment of not more than 5 years, or both, together with the costs of prosecution.

5. Why has the Government fostered a program of leniency for delinquent taxpayers?

The IRS issued an amnesty program to run from March 23, 2009 through September 23, 2009, in response to a high degree of noncompliance with respect to unreported foreign accounts and to address uncertainty and forum shopping that arose because of the deal-making of each office. It provides a set deal for all taxpayers. Additionally, it is good to increase compliance and close the tax gap in a time of recession.

For taxpayers who qualify, the amnesty requires a payment of six years' worth of back taxes on income associated with the undisclosed foreign assets, a 20% to 25% negligence/accuracy penalty on these taxes, and interest on both amounts from the date of the original return (when the tax should have been paid) until the date of payment plus an additional ‘20% of Highest Value Penalty' (i.e., a penalty of 20% of the total offshore account balances for the year of the past six in which such balances were at their highest).
In certain circumstances, ‘20% of Highest Value Penalty' can be reduced to a ‘5% of Highest Value Penalty'. This would require that the taxpayer (i) did not open or cause to be opened the Foreign Accounts, (ii) did not form or cause to be formed the CFC; (iii) has not touched the Foreign Accounts (no deposits or withdrawals) since they controlled the Foreign Accounts; and (iv) that the funds in the Foreign Assets have not escaped U.S. taxation.

This is not leniency for all taxpayers, because (in some cases) the IRS would have had to prove that the taxpayer willingly failed to file the FBAR in order to get such a high penalty.

6. Was it a ‘get out of jail free card'?

Yes, and no. As a part of the proceeding, the Criminal Investigations unit of the IRS will agree not to recommend prosecution. This can be revoked in certain circumstances, for example if the disclosure is found not to be complete or if the taxpayer does not fully cooperate with the investigation.

7. What has changed recently?

An increased focus on offshore banking. The IRS had very few weapons to deal with offshore accounts before, but now their arsenal is hefty. Interviews with taxpayers as part of a voluntary compliance including an offshore account can help the government identify individuals selling offshore structures for example. Other government agencies with in US and other governments abroad are sharing more information with the IRS every day.

8. Why has this change happened?

It is due to the attention that the IRS is paying to the problem and applying real force to generate a solution.

9. Is there no longer a ‘get out of jail free card'?

It certainly isn't free and if people wait too long, the amnesty will terminate. As the IRS identifies more individuals as banks disclose more information to them, taxpayers run the risk of being identified and thus foreclosed from making a voluntary disclosure the longer they wait.

10. What are the provisions most likely to create difficult?

1. The 20% of highest balance penalty. In the current economic crisis, many account holders have seen their account values plummet. To the extent that the tax, penalties and interest come close to or exceed the current value of the account, taxpayers may be very reluctant to disclose the account under the amnesty.

2. The IRS likely will require a taxpayer with a foreign account to undergo an interview. Many people are very uncomfortable with this idea. The IRS has always had this right under the prior program, but it exercised it far less frequently.

11. Is this a program that people might refuse? Why?

Yes, we have seen people who, upon receiving a projection of the numbers involved, have said thank you very much but no thanks, and left our office. The 20% of highest balance penalty can be a very bitter pill to swallow.

Also, because a taxpayer is likely to be interviewed by the Criminal Investigations unit of the IRS, certain taxpayers refuse to go forward in order to avoid the interview. A number of those with foreign accounts in Switzerland are Holocaust survivors, who, as is understandable, have a disinclination to go through this intimidating process.

12. What is the difference between a ‘quiet' and a ‘noisy' disclosure?

As mentioned above, there are two methods for conducting a Voluntary Disclosure matter: (i) a ‘Noisy Voluntary', whereby an attorney approaches the IRS Criminal Investigations Division (‘CI') on a taxpayer's behalf to negotiate a waiver of prosecution prior to filing amended (or unfiled) income tax returns and the FBARs; and (ii) a ‘Quiet Voluntary', wherein a taxpayer, or his representative, directly files unfiled or amended income tax returns and FBAR reports with the IRS and Treasury without contacting them beforehand.

Quiet voluntaries are frowned upon by the IRS. A quiet disclosure leaves the taxpayer open to being examined and potentially criminally prosecuted for all years. Whereas after a noisy disclosure, the taxpayer can be certain that their case is over.

However, a quiet voluntary may be the only choice for a taxpayer who does not qualify for a noisy voluntary disclosure.

13. What other things must be considered in deciding how to go forward?

(a) Cost - ‘noisy' voluntary disclosures cost significantly more that a ‘quiet' voluntary disclosure in terms of legal fees.
(b) Risk - ‘noisy' voluntary disclosures are significantly less risky that a ‘quiet' voluntary.
(c) Qualification - Not all taxpayer's qualify for a ‘noisy' disclosure. Furthermore, some taxpayers who have merely neglected to file an FBAR, for example, while reporting all of the income on their tax returns, have a special program to allow them to file back FBARs with no penalty.

14. What are the procedures that need to be followed?

(a) Your name and social security number is disclosed to the IRS;
(b) Criminal Investigations verifies that you qualify for a voluntary disclosure (i.e. you are not currently under audit etc.);
(c) You are interviewed by Criminal Investigations;
(d) Your tax returns and FBARs (prepared by an accountant and reviewed by your attorney) are sent by Criminal Investigations to Philadelphia for processing; and
(e) You receive a closing letter from the IRS.

15. Are there deadlines?

Yes. The ‘amnesty' expires on September 23, 2009. The 2008 FBARs are due June 30, 2009, and if you tax returns are on extension for 2008, they need to be filed by October 15.

16. What about people outside the United States? Who should be concerned?

Any US citizen, resident or green card holder should be concerned. Also non-US individuals who do business in the US regularly.

17. What are the procedures for people who did not realize they were US citizens?

First an analysis of their individual situation should be done. Assuming they were living in Europe, for example, and paying tax there, they may owe little or no US tax. If they owe no tax, it is a simple matter to file the back FBARs under the current amnesty. Because there is no argument for reasonable cause under the amnesty, and if they owe tax, they face the same decision as people living in the US, although they may tend to decide to choose the quiet method more frequently because they may feel the risk is worth it.

18. There are a number of obligations under the US tax code that are not strictly fiscal in nature. What are they?

See below.

19. What if you violate them? What are the penalties?

• FBAR - foreign bank account report (TD F 90-22.1), which is required to be filed by all US citizens and residents, green card holders, and ‘persons' (a term of art that includes entities) ‘in and doing business in' the US who have a financial interest in or signature authority over financial accounts in foreign countries exceeding $10,000 in the aggregate. The FBAR form is separate from any tax returns that must be filed and is due by 30 June of each year (extensions are not available).
  - Negligent failure to file the FBAR form for foreign accounts (due each June for the prior calendar year) can trigger a penalty of $10,000 for each failure.
  - Willful violation of the FBAR reporting requirement can result in a civil penalty equal to the greater of $100,000 or 50% of the account balance at the time of the offense. Willful violations are not subject to the reasonable cause exception.
  - If failure to file the FBAR is deemed to be a criminal violation, the penalty can include a fine of up to $250,000, imprisonment for up to five years, or both. If the failure to file is deemed to be part of a criminal activity (i.e., it occurs during the violation of another law or is part of an illegal activity involving more than $100,000 in a 12 month period), the maximum fine increases to $500,000 and the possibility of imprisonment increases to up to ten years.
  - Each unreported bank account and each calendar year constitutes a separate violation, so with multiple accounts unreported for several years, you could face literally dozens of separate penalties - each of which could potentially trigger the maximum fine.
• Failing to file Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Taxpayers must also report various transactions involving foreign trusts, including creation of a foreign trust by a United States person, transfers of property from a United States person to a foreign trust and receipt of distributions from foreign trusts under section 6048. This return also reports the receipt of gifts from foreign entities under Section 6039F. The penalty for failing to file each one of these information returns, or for filing an incomplete return, is 35% of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25% of the gift. The penalty may be excused if reasonable cause for failure to report can be established.
• Failing to file Form 3520-A, Information Return of Foreign Trust With a U.S. Owner. Taxpayers must also report ownership interests in foreign trusts, by United States persons with various interests in and powers over those trusts under section 6048(b). The penalty for failing to file each one of these information returns or for filing an incomplete return, is five percent of the gross value of trust assets determined to be owned by the United States person.
• Failing to file Form 5471, Information Return of U.S. Person with Respect to Certain Foreign Corporations. Certain United States persons who are officers, directors or shareholders in certain foreign corporations (including International Business Corporations) are required to report information under sections 6035, 6038, and 6046. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
• Failing to file Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. Taxpayers may be required to report transactions between a 25 percent foreign-owned domestic corporation or a foreign corporation engaged in a trade or business in the United States and a related party as required by sections 6038A and 6038C. The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
• Failing to file Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation. Taxpayers are required to report transfers of property to foreign corporations and other information under section 6038B. The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.

20. What other measures should people be thinking about?

(a) Restructuring assets to simplify their reporting in future years.
(b) After fully completing their voluntary disclosure (and NOT before), transferring funds into a US bank and out of any ‘sham' structures set up by the bank.
(c) For any new foreign accounts established, making sure any individual you indicate has signatory authority is aware of their reporting obligation.
(d) Because once your total foreign accounts are over $10,000, each account must be reported, ensure that any new account you establish - however small - is reported.
(e) Order your bank statements for the prior year well in advance of your filing deadlines.