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This IRS Amnesty Program terminates on September 23, 2009. Schedule a confidential appointment with Richard S. Lehman, P.A.
today to discuss your individual situation.]
Richard S. Lehman, P.A.2600 N. Military Trail, Suite 270
Boca Raton, Florida 33431
Telephone: (561) 368-1113
Facsimile: (561) 998-9557
The most recent headlines include a controversy between the United Bank of Switzerland and the Swiss government versus the Internal Revenue Service of the United States. The U.S. is seeking the names of approximately 50,000 Americans with offshore bank accounts at U.B.S.
The headlines are a result of very strong efforts by the United States in recent years to stop the use of “tax havens” where Americans were depositing unreported income that had not been taxed and were doing so with anonymity and impurity.
Those efforts have started to bear fruit for the U.S. tax collectors. Since knowingly not reporting income on your Federal income tax return is a crime, many U.S. individuals were put in a hard place with important choices to make about taxes.
The Internal Revenue Service has very intelligently made that choice easier.
On March 23, the Internal Revenue Service came up with a six month “Amnesty Program” to allow U.S. taxpayers with unreported income to disclose their foreign bank accounts without fear of any criminal tax penalties. The price is to pay the income tax, the interest on the income tax and two specific penalties on unreported income and foreign bank accounts for the years 2003 through 2008. The Amnesty Program terminates six months after its March 23, 2009 announcement, on September 23, 2009.
This Article will discuss the I.R.S. Amnesty Program, its requirements, pitfalls and its procedures.
The I.R.S. Amnesty Program for foreign bank deposits is a modification of a long standing I.R.S. Voluntary Disclosure Policy that for decades has provided for a waiver of criminal charges against a taxpayer that has “Voluntarily Disclosed” all of his or her unreported income to I.R.S. and met several other required standards.
This long standing policy governing Voluntary Disclosures has its weaknesses from a taxpayer standpoint, the most crucial of which was that the I.R.S. honored their policy but has always taken the position that there were no guarantees of Amnesty. Furthermore, the numerous civil tax penalties that might result from the disclosures of previously untaxed income remained uncertain.
The Amnesty program seems to add more certainty to the ordinary Voluntary Disclosure policy in both of these areas. The Amnesty Program appears to grant amnesty from both civil and criminal tax charges, for a taxpayer’s previous undisclosed and unreported taxable income, so long as the taxpayer meets the following Amnesty Program requirements and meets all of the requirements of the general Voluntary Disclosure policy.
The I.R.S. manual spells out the principal requirements of the Voluntary Disclosure which must be truthful, timely and complete. This occurs under the following circumstances
- The undisclosed income has not come from an illegal source.
- The taxpayer shows a willingness to cooperate (and in fact does cooperate) with the I.R.S. in determining his or her correct tax liability; and
- The taxpayer makes good faith arrangements with the I.R.S. to pay in full, the tax, interest and any penalties determined by the I.R.S. to be applicable.
- The disclosure must be timely which means it must be received before:
(a) The I.R.S. 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 IR.S. has received information from a third party (e.g., informant, other governmental agency or the media) alerting the I.R.S. to the specific taxpayer’s noncompliance.
(c) The IR.S. has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or
(d) The I.R.S. has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g. search warrant, grand jury subpoena)
The Amnesty ProgramIt is first important to see what requirements have been added to the general Voluntary Disclosure rules to meet the Amnesty Program.
Under the Amnesty Program, the taxpayer’s voluntary disclosure will be forwarded to the local Criminal Investigation Office that will determine if the disclosure is voluntary and has been truthful, timely, complete and is therefore eligible for the Amnesty Program.
Assuming eligibility for the Amnesty Program, first the taxpayer
must file amended income tax returns and Treasury Department Forms TD F 90-22.1, Report of Foreign Bank and Financial Accounts (“FBARs”), for each of the prior six years (or for each year since the foreign bank account(s) in question were opened),
whichever is less. The cost of Amnesty is calculated based upon the disclosures in the Amended Returns of 2003 through 2008. The taxpayer will be responsible for:
A. Unpaid income taxes for each of the last six years.
B. Interest calculated on the unpaid taxes.
C. An accuracy-related penalty of 20% or delinquency penalty of 25% on all income tax liability for the six year period.
D. A penalty equal to 20% of the highest value of each undisclosed bank account during the six year reporting period. This can be reduced to 5% for certain bank deposits that represented income that was previously reported to the U.S.
These guidelines, like the Voluntary Compliance guidelines also need some further explanation. However, it should be pointed out that the I.R.S. has supplied helpful guidance in the form of a series of questions and answers that can be located on the
I.R.S. website at I.R.S.gov under the words “offshore bank deposits – Amnesty”.
An example of the calculation for the cost of the Amnesty Program described above is found at Question and Answer No. 12 of the I.R.S. publication which reads as follows:
Q.12. How does the penalty framework work? Can you give us an example?
A12. Assume the taxpayer has the following amounts in a foreign account over a period of six years. Although the amount on deposit may have been in the account for many years, it is assumed for purposes of the example that it is not unreported income in 2003.
Amount of Interest Account
Year Deposit Income Balance
2003 $1,000,000 $50,000 $1,050,000
2004 $50,000 $1,100,000
2005 $50,000 $1,150,000
2006 $50,000 $1,200,000
2007 $50,000 $1,250,000
2008 $50,000 $1,300,000
(NOTE) This example does not provide for compounded interest, and assumes the taxpayer is in the 35 percent tax bracket, files a return but does not include the foreign account or the interest income on the return, and the maximum applicable penalties are imposed).
If the taxpayer comes forward and has their voluntary disclosure accepted by the IRS, they face this potential scenario:
They would pay $386,000 plus interest. This includes
- Tax of $105,000 (six years at $17,500) plus interest
- An accuracy-related penalty of $21,000 (i.e., $105,000 x 20%, and
- An additional penalty in lieu of the FBAR and other potential penalties that may apply, of $260,000
(i.e., $1,300,000 x 20%)
The I.R.S. Questions and Answers publication is very helpful to answer many of the questions that will arise under these policies. To mention a few:
1. Can a Taxpayer qualify for the Amnesty Program if he or she no longer has the ability to pay?
Q27. If I don’t have the ability to pay can I still participate in the IRS’s Voluntary Disclosure Practice?
A27. Yes. The March 23, 2009 guidance requires the taxpayer to fully pay all taxes and interest for all years covered, and the Voluntary Disclosure penalty, as well as all other unpaid, previously assessed liabilities, when the signed closing agreement is returned to the Service. However, it is possible for a taxpayer who is unable to make full payment at that time to submit a request that includes other payment arrangements acceptance to the IRS.
The burden will be on the taxpayer to establish inability to pay, to the satisfaction of the IRS, based on full disclosure of all assets and income sources, domestic and offshore, under the taxpayer’s control. Assuming that the IRS determines that the inability to fully pay is genuine, the taxpayer must work but other financial arrangements, acceptable to the IRS to resolve all outstanding liabilities, in order to be entitled to the penalty relief set forth in the March 23, 2009 guidance.
2. What assets may be subject to the Amnesty Program?
The answer to the question of what asset may be subject to the Amnesty Program actually required two Questions and Answers, not one. The I.R.S. issued one set of Questions and Answers in May and recently updated those Questions and Answers on June 24th. It seems the May Questions and Answers on this subject needed clarification in the form of a second question in June which is Question and Answer NO. 37.
The two answers make it clear that the assets that may be subject to the 20% penalty include more than just bank deposits. They include tangible assets such as real estate or art, intangible assets such as patents or stocks or other interests in a business.
Question 37 clarified that there was no 20% penalty for non income producing assets that had no reporting obligation to disclose their existence at this point. The tax on gain in any of these assets should be paid to the U.S. when the gain is realized.
Q20. Does the twenty percent penalty apply to entities? Does the twenty percent penalty apply only to cash and securities held in foreign accounts or entities or to tangible and intangible assets as well?
A20. The twenty percent penalty applies to entities. The twenty percent penalty applies to all assets (or at least the taxpayer’s share) held by foreign entities (e.g., trusts and corporation) for which the taxpayer was required to file the information returns, as well as all foreign assets (e.g. financial accounts, tangible assets such as real estate or art and intangible assets such as patents or stock or other interests in a U.S. business) held or controlled by the taxpayer.
Q37. Re: Q & A 20. A taxpayer owns valuable land and artwork located in a foreign jurisdiction. This property produces no income and there were no reporting requirements regarding this property. Must the taxpayer report the land and artwork and pay a 20 percent penalty?
A.37 Q&A 20 related to income producing property for which no income was reported. Under those circumstances, no distinction is made between assets held directly and assets held through an entity in computing the 20 percent offshore penalty. However, if the taxpayer owns non income producing property in the taxpayer’s own name, there has been no U.S. taxable event and no reporting obligation to disclose. The taxpayer will be required to report any current income from the property or gain from its sale or other disposition at such time in the future as the income is realized. Because there has as yet been no tax noncompliance, the 20 percent offshore penalty would not apply to those assets. If the foreign assets were held in the name of an entity such as a trust or corporation, there would have been an information return filing obligation that may need to be disclosed. See Q&A 42.
3. How does a Taxpayer treat unreported income earned prior to 2003?
Paragraph No. 3 also requires two separate Questions and Answers for clarification. Previously in this Report, Question and Answer 12 was referred to. In Answer No. 12, there is a specific point of saying
the original deposit “is not unreported income for 2003”. This answer begs the question of whether amnesty is granted for pre 2003 unreported income.
In Question 33 of the June 24th version of the Questions and Answers, the following statement is made about unreported income in a pre disclosure year (2003 – 2008). Question No. 33 appears to say that the Amnesty Program is a program that will also cover the pre amnesty years. The answer to this question continues to need clarification by the I.R.S.
Q33. If the look back period is 2003-2008, what does the taxpayer do if the taxpayer held foreign real estate, sold in 2002, and did not report the gain on his 2002 return? Does the taxpayer compute the 20 percent on the highest aggregate balance in 2003-2008? What, if anything, does IRS expect the taxpayer to do with respect to 2002?
A33. Gain realized on a foreign transaction occurring before 2003 does not need to be included as part of the voluntary disclosure. If the proceeds of the transaction were repatriated and were not offshore after January 1, 2003, they will not be included in the base for the 20 percent offshore penalty. On the other hand, if the proceeds remained offshore after January 1, 2003, and the income in the account was not reported, they will be included in the base for the penalty.
4. How to obtain records from overseas?
Q18. What should I do if I am having difficulty obtaining my records from overseas?
A18. Our experience with offshore cases in recent years is that taxpayers are successful in retrieving copies of statements and other records from foreign banks when they genuinely attempt to do so. If assistance is needed, the agent assigned to a case will work with the taxpayer in preparing a request that should be acceptable to the foreign bank.
5. What information is needed to comply with the Amnesty Program?
Q25. Besides federal income tax returns, what forms or other returns must be filed?
A25. The following forms must be filed:
- Copies of original and amended federal income tax returns for tax periods covered by the voluntary disclosure.
- Complete and accurate amended federal income tax returns (or original returns, if not previously filed) of the taxpayer for all tax years covered by the voluntary disclosure.
- An explanation of previously unreported or underreported income or incorrectly claimed deductions or credits related to undisclosed foreign accounts or undisclosed foreign entities, including the reason(s) for the error or omission.
- If the taxpayer is a decedent’s estate, or is an individual who participated in the failure to report the foreign account or foreign entity in a required gift or estate tax return, either as executor or advisor, complete and accurate amended estate or gift tax returns (original returns, if not previously filed) necessary to correct the underreporting of assets held in or transferred through undisclosed foreign accounts or foreign entities.
- Complete and accurate amended information returns required to be filed by the taxpayer, including, but not limited to, Forms 33520, 3520-A, 5471, 5472, 926 and 8865 (or originals, if not previously filed) for all tax years covered by the voluntary disclosure for which the taxpayer requests relief, and
- Complete and accurate Form TD F 90.22.1. Report of Foreign Bank and Financial Accounts, for foreign accounts maintained during calendar years covered by the voluntary disclosure.
6. What are the civil and criminal penalties a Taxpayer might face if they do not join the Amnesty Program?
Q.14 What are some of the criminal charges I might face if I don’t come in under voluntary disclosure and the IRS finds me?
Possible criminal charges related to tax returns include tax evasion (26 U.S.C. § 7206(1) and failure to file an income tax return. The failure to file an FBAR and the filing of a false FBAR are both violations that are also subject to criminal penalties,
A person convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.
What are some of the civil penalties that might apply if I don’t come in under voluntary disclosure and the IRS finds me? - A Penalty for failing to file the Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, commonly known as an “FBAR”.
- A penalty for failing to file form 3520. Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts.
- A penalty for failing to file Form 3520-A. Information Return of Foreign Trust with U.S. Owner Taxpayers
- A penalty for failing to file Form 5471. Information Return of U.S. Person with Respect to Certain Foreign Corporations.
- A penalty for failing to file Form 926. Return by a U.S. Transferor of Property to a Foreign Corporation.
- A penalty for failing to file Form 8865. Return of U.S. Persons with Respect to Certain Foreign Partnerships.
- Fraud penalties
- A penalty for failing to file a tax return
- A penalty for failing to pay the amount of tax shown on the return.
- An accuracy related penalty on underpayments
There are answers to these and many other questions in the I.R.S. publication and a taxpayer is urged to read it in full. The I.R.S. certainly does its job to push the taxpayer towards compliance, since it gives another example that shows how costly it could be from a civil tax payment standpoint for the taxpayer who chooses not to use the Amnesty Program but chooses to sit and wait and hope for the best.
The reader will note that the example in Question 12 of the I.R.S. publication produced a total amount of tax, not including interest equal to
$386,000 as the cost of full compliance for an unreported deposit of $1 Million that earned $300,000 in income for the six year reporting period. The I.R.S. in Question 12 also published the cost to
the taxpayer who chooses not to comply. This time the cost would be 600% higher than the taxpayer would pay under the potential Amnesty Program
with a total of interest and penalties of $2,306,000.If the taxpayer did not come forward and the IRS discovered other offshore activities, they face up to
$2,306,000 in tax, accuracy-related penalty, and FBAR penalty. The taxpayer would also be liable for interest and possible additional penalties, and an examination could lead to criminal prosecution.
The civil liabilities potentially include:
- The tax and accuracy-related penalty, plus interest, as described above.
- FBAR penalties totaling up to $2,175,000 for willful failures to file complete and correct FBARs (2003 - $100,000, 2004 - $100,000, 2005 - $100,000, 2006 - $600,000, 2007 - $625,000 and 2008 - $600,000.
- The potential of having the fraud penalty (75 percent) apply, and
- The potential of substantial additional information return penalties if the foreign account or assets is held through a foreign entity such as a trust or corporation and required information returns were not filed.
Note that if the foreign activity started more than six years ago, the Service may also have the right to examine additional years.
Practical SolutionsThis author has found on multiple occasions that when dealing with cases such as those involved in the Amnesty Program, the taxpayer is best served by making his first few steps the right ones which include hiring the right team of counsels that include both a tax lawyer and a criminal lawyer.
These two disciplines of law working together will generally come up with the best solution. Often the tax lawyer believes that certain taxpayer disclosures and presentations will be helpful in deterring an I.R.S. criminal investigation while the criminal lawyer must always keep his eyes on the taxpayer’s Fifth Amendment rights to make sure the disclosures necessary to tell the taxpayer’s story do not violate the taxpayer’s constitutional rights and do great harm. The resulting work product of the two disciplines generally seems to have outcomes that include the best of both worlds.
There is one area in particular where much more guidance is needed from the I.R.S. to make sure that potential applicants to the Amnesty Program are not driven away for fear of the requirement that their income must be from “legal sources”. There is very little information available by way of case law, contemporary writings, I.R.S. publications and other sources that provide any parameters to the term “legal” or “illegal” sources of income for purposes of the Amnesty Program. This presents a problem since the Amnesty Program will attract taxpayers in many borderline cases, that may be unnecessary scared away.
For example, assume a taxpayer is indicted for a criminal misdemeanor involving the violation of a state law while conducting his or her business. Assume all of the charges against the taxpayer are later dismissed either immediately or after exhausting the legal process.
Query: Is this illegal income?
The handling of the question of “legal source income” needs to be treated with delicacy by taxpayer and counsel alike. This author has found on many occasions that it is extremely helpful to request that counsel meet directly with the I.R.S. criminal investigator, without discussing the taxpayer’s name, for advice on dealing with gray areas of the law.
Attorney-client privilege is one of the strongest privileges available under law.
Richard S. Lehman, P.A.2600 N. Military Trail, Suite 270
Boca Raton, Florida 33431
Telephone: (561) 368-1113
Facsimile: (561) 998-9557
