Options remain for US taxpayers with undisclosed accounts

With the threat of exposure looming over the heads US taxpayers with undisclosed accounts, particularly in light of the Swiss bank voluntary disclosure programme and other recent efforts by the US authorities to combat tax evasion, the need to regularise has never been more urgent.

By way of background, US taxpayers are subject to US tax on a worldwide basis. This includes US citizens (regardless of where they reside or whether they hold dual citizenship or a valid US passport), US ‘green card’ holders (regardless of where they actually reside) and individuals who spend a ‘substantial’ number of days in the US.

US taxpayers must report and pay tax on income and gains from any non – US bank account or securities account and, in many cases, income earned by, and distributions received from, offshore companies, trusts, foundations and other structures. A US taxpayer is also required to file a report (‘Foreign Bank Account Report’, or ‘FBAR’) with the US Treasury disclosing foreign bank accounts with aggregate dollar values in excess of $10,000 and must file a separate form if he has substantial interests in non – US securities.

A US taxpayer who fails to meet any of these tax or reporting obligations is liable for the tax due, interest, and penalties. If the US authorities find that the failure to meet these obligations was intentional, a taxpayer could face criminal penalties, which may include confiscatory monetary penalties that can wipe – out the undisclosed accounts and even prison time. In the face of this potential exposure, US taxpayers with undisclosed accounts must consider their disclosure options and the best approach to rectify failures to meet these obligations.

The ‘Offshore Voluntary Disclosure Programme’ (the ‘OVDP’) allows US taxpayers to come forward, disclose details of the undisclosed accounts and income, and settle the unpaid tax, interest and penalties in exchange for receiving conditional protection against criminal prosecution and possibly lower applicable penalties. Currently, the penalties include a payment of 27.5% of the highest value of the taxpayer’s relevant offshore assets over the prior eight years (the penalty rate has increased over the course of the OVDP).

An important prerequisite for qualifying for the OVDP is that the taxpayer must come forward to the IRS before it initiates an investigation of the taxpayer. Once an investigation has begun, it is too late to initiate an OVDP application.

The first step in the OVDP is for the taxpayer to send his identifying information to the IRS for ‘preclearance’ to confirm that the taxpayer is not presently under audit or already subject to a criminal investigation. Once confirmed, the taxpayer must submit a standardised statement to the IRS disclosing the unreported accounts and the circumstances of opening and maintaining them, the highest value of the accounts over the past eight years, and other account identifying information. The taxpayer must then submit to the IRS amended tax returns reporting all of the taxpayer’s income, including any previously omitted income, and would pay the applicable taxes, interest and penalties. If the taxpayer’s voluntary disclosure process is timely, complete and truthful and the taxpayer co – operates with the IRS, then the IRS will not recommend criminal prosecution to the US Department of Justice and will waive other monetary penalties that may otherwise apply (including a penalty of 50% of the value of an unreported account for each year the account was not reported on the FBAR).

The IRS has announced a separate procedure (referred to as the ‘streamlined process’) for certain non – residents of the United States (including dual citizens) who have not filed US income tax and information returns to come into compliance, which generally requires fewer back filings and presents the potential for reduced (or no) penalties.

Another disclosure method a taxpayer may consider is the so – called ‘quiet disclosure’ method where the taxpayer rectifies his failure to meet his US tax and reporting obligations by simply filing new or amended tax returns and information returns with payment of the taxes due and interest and the hope that the IRS does not respond with an imposition of high penalties and criminal prosecution. While this informal method is used by taxpayers and known to the IRS, the IRS has stated that it may select and audit quietly – filed amended returns. With this method there is no protection against criminal prosecution, and the IRS could attempt to assert higher monetary penalties than the 27.5% penalty accompanying the OVDP.

Determining the best approach is a fact – intensive exercise, and it is often the case that the best solution for a taxpayer is not the most palatable. But with the approach of the Foreign Account Tax Compliance Act (FATCA), which will require financial institutions to collect information about their account holders and automatically transmit information on US account holders to the US government, and the new Swiss bank voluntary disclosure programme introduced last month, designed to facilitate the disclosure of US taxpayers with undisclosed accounts, the option of remaining in the shadows is coming to a close.

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