VIEW IN PDF: Tax News & Comment — August 2011
Approximately one million U.S. taxpayers have at least one financial account located in a foreign country. Many have not reported their offshore accounts to the IRS, a violation with possible civil and criminal penalties. UBS, Switzerland’s largest bank and the manager of private wealth for many Americans, is currently under investigation by the Department of Justice for not reporting interest and dividends earned by U.S. taxpayers.
The implementation of foreign account (FBAR) reporting requirements are provided for under the Bank Secrecy Act, enacted in 1970. The legislation was intended to assist U.S. investigators in preventing offshore tax evasion and in tracing funds used for illicit purposes, such as the laundering of drug money. Actual reporting of foreign accounts and the filing of FBARs has been required since 1972, but the rule was largely ignored by taxpayers and rarely enforced by the IRS until recently.
FBAR regulations were recently amended and became effective March 28, 2011. The amended regulations applies to all foreign financial accounts maintained in the year 2010. 31 C.F.R. § 1010.350 now provides that “each United States person having a financial interest in, or signature or other authority over, a bank, securities, or other financial account in a foreign country” must file a Foreign Bank and Financial Accounts Report (FBAR).
A “United States person” includes U.S. citizens and residents, and domestic corporations, partnerships, estates, and trusts. Having “signature authority” over a foreign financial account means that the person can control the disposition of money in the account by sending a signed document to, or orally communicating with, the institution maintaining the account.
31 C.F.R. § 1010.306(c) provides that an FBAR must be filed if the aggregate value of all foreign financial accounts is more than $10,000 at any time during the calendar year. To illustrate, if a U.S. person owns several small financial accounts in various countries, that person will be required to file an FBAR if the value of all the accounts exceeds $10,000 at any time during the calendar year. There are some exceptions to the FBAR filing requirement, such as if the offshore financial account is owned by a government entity or if the person is a trust beneficiary.
31 C.F.R. § 1010.306(c) provides that the FBAR must be filed by June 30 for foreign financial accounts exceeding $10,000 during the previous calendar year on Treasury Form TD F90-22.1. The FBAR is not filed with income tax returns, but must be reported on income tax returns by checking the appropriate box on Schedule B of Form 1040, which requires the taxpayer to disclose the existence of a foreign bank account. Notice 2011-54 provides that persons having signatory authority over, but no financial interest in, a foreign financial account in 2009 or earlier calendar years are required to file FBARS by November 1, 2011.
Extensions given by the IRS for income tax returns are not applicable to the FBAR filing deadline. FBAR reporting is an effective tool for the IRS, because the Treasury need show only that the taxpayer maintained an unreported overseas account, not whether the taxpayer actually earned any income from the account.
Due to increased efforts by the IRS to penalize U.S. taxpayers with undisclosed offshore accounts, and in an attempt to persuade those taxpayers into reporting those accounts, the IRS initiated the 2011 Offshore Voluntary Disclosure Initiative (“OVDI”) on February 8, 2011. The OVDI is the second program of its kind. The first voluntary disclosure program, the 2009 Offshore Voluntary Disclosure Program (“OVDP”), terminated on October 15, 2009 with approximately 15,000 voluntary disclosures.
Procedure for OVDI Participation
The OVDI allows taxpayers with undisclosed foreign accounts to report their accounts and to come into compliance with the U.S. tax system without risking later detection by the IRS. Taxpayers with undisclosed offshore accounts could face the imposition of high penalties and the possibility of criminal prosecution if the accounts are later discovered by the IRS. Taxpayers who willfully fail to file FBARs face criminal penalties of up to $500,000 or fifty percent (50%) of the account balance and imprisonment of up to ten years, and civil penalties of up to$100,000 or fifty percent (50%) of the account balance.
The lifespan of the OVDI program is short. The OVDI program is available to taxpayers only through August 31, 2011. The program requires that participants pay a penalty of twenty-five percent (25%) of the highest account balance between 2003 and 2010, but provides exceptions that could reduce the penalty to five percent (5%) or twelve-and-a-half percent (12.5%).
Participants must also file all original and amended tax returns and pay back taxes and interest, as well as accuracy-related and/or delinquency penalties. Initially, the IRS required that all forms and payments be submitted by August 31, 2011. However, on June 2, 2011, the IRS revised the program to allow a 90-day extension if the requesting taxpayer demonstrates a “good faith attempt” to meet the August 31 deadline. If making such a request, the taxpayer must include a list of those items which are missing, an explanation for why they are still outstanding, and a description of the efforts made to secure them.
To participate in the program, a taxpayer has the option of submitting a “pre-clearance request” to the IRS Criminal Investigation Lead Development Center. The submission must be made by fax to (215) 861-3050, and must include the taxpayer’s name, date of birth, social security number and address and, if the taxpayer is represented by an attorney or accountant, an executed power of attorney.
The IRS Criminal Investigation office will notify the taxpayer or the taxpayer’s representative via fax whether the taxpayer has been cleared to make a voluntary disclosure using the Voluntary Offshore Disclosure Letter. Taxpayers or representatives with questions may contact either their local IRS Criminal Investigations office or the Washington office at (215) 861-3759. If cleared by IRS Criminal Investigations, the taxpayer will have 30 days in which to submit an “Offshore Voluntary Disclosure Letter.”
The taxpayer opt to bypass the pre-clearance request phase, and submit an Offshore Voluntary Disclosure Letter without obtaining pre-clearance from the IRS. A taxpayer opting out of pre-clearance would be required to mail the Offshore Voluntary Disclosure Letter to the IRS at the following address:
Internal Revenue Service
ATTN: Offshore Voluntary
Philadelphia Lead Development
600 Arch Street, Room 6406
Philadelphia, PA 19106
The Offshore Voluntary Disclosure Letter requires the taxpayer to list the aggregate value of all offshore accounts for the period from 2003 through 2010 and the total unreported income from offshore accounts for the same period. Once the letter has been reviewed by the IRS, the taxpayer will receive notice as to whether the disclosure has been preliminarily accepted or declined. If the disclosure is preliminarily accepted, the taxpayer must submit all required forms and payment by the August 31 deadline to the following address:
Internal Revenue Service
3651 S. I H 35 Stop 4301 AUSC
Austin, TX 78741
ATTN: 2011 Offshore Voluntary Disclosure Initiative
As noted, a taxpayer may request a 90-day extension of the August 31st deadline to complete a submission under OVDI. To qualify for the extension, the taxpayer must demonstrate a good faith attempt to comply fully before August 31st. The good faith attempt to comply must include the properly completed and signed agreements to extend the period of time to assess tax (including tax penalties) and to assess FBAR penalties.
Opting Out of OVDI Program
Taxpayers who have chosen to participate in the OVDI are also given the option to “opt-out” of the program, an irrevocable decision which could lead to the taxpayer owing more than he or she would owe under the OVDI. By choosing to opt out, the taxpayer is electing to instead undergo a standard audit by the IRS. Such a decision is advantageous in a limited number of cases. A taxpayer might choose to opt out if, given the facts of the case, the penalties imposed under the OVDI appear too severe.
A taxpayer who violated the FBAR reporting requirements may fare better by opting out of the program if the violation was not willful or if the violation was based on the written advice of an independent legal advisor. The maximum penalty if the violation was not willful is $10,000 for each non-willful violation and no penalty is imposed if the violation was based on the written advice of an independent legal advisor. In either case, the maximum penalties imposed would likely be less than the twenty-five percent (25%) mandatory penalty imposed under the OVDI.
Opting out of OVDI is not be without risk, because an argument that the violation lacked intent is one which if lost, could result in the taxpayer facing criminal penalties. The IRS takes the position that the willfulness requirement is satisfied if the taxpayer makes a “conscious effort” to avoid awareness of FBAR reporting. Form 1040, Schedule B refers to instructions which mention FBARs. Although the IRS is of the view that a person with foreign accounts should read the instructions, the fact that a taxpayer checked the wrong box, or no box, on Schedule B could be insufficient by itself to establish that the FBAR violation was attributable to willfulness. However, this is not an area in which risks should be taken.
To opt out of OVDI, the taxpayer must provide a written statement of intent. The written statement is reviewed by a centralized review committee which decides whether to grant the withdrawal or assign the case for other treatment. In making its decision, the committee considers whether the OVDI penalties will be too severe given the facts of the case.
[Rebecca K. Richards contributed in the research and drafting of this article.]
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The IRS has issued final regulations that provide a five-month extension to file partnership, estate and fiduciary tax returns. TD 9531. The final regulations for the most part adopt temporary regulations promulgated in 2008. The rationale for a shorter extension period for these entities as opposed to the six-month extension available for individuals is that many taxpayers require Schedule K-1 forms from these entities in preparing their returns.
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Following several years of increases, the IRS Spring 2011 Statistics of Income Bulletin notes a 3.5 percent drop in the number of returns filed by individual with $200,000 or more of AGI for tax year 2008. In 2008, 4.3 million individual returns reported income of $200,000 or more. The two largest deductions taken by those taxpayers were for taxes paid and mortgage interest. Returns of 3.9 million higher income taxpayers reported charitable deductions; and 1.5 million claimed the foreign tax credit.
Among individuals with $200,000 or more of AGI in 2008, (i) 3.8 million taxpayers reported salary and wage income of $1.2 trillion; (ii) 1.3 million taxpayers reported income from partnerships and S corporations of $446 billion; (iii) 1.3 million taxpayers reported capital gains of $417 billion; and (iv) 3.2 million taxpayers reported dividend income of $125 billion.
The Report noted that donors filed 234,714 Form 709 gift tax returns for tax year 2008. Children accounted for 48.9 percent of all gifts, grandchildren accounted for 24.7 percent, and gifts to other relatives accounted for 10.4 percent. Gifts to charities accounted for less than one percent of all gifts made in 2008.
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The IRS has announced final regulations that provide automatic five-month extensions to file most partnership, estate and trust returns. The purpose of the regulations is to better coordinate the filing requirements of those returns with individual taxpayers on extended six-month deadlines who require Schedule K-1s in order to file T.D. 9531.
IRC Code Section 6045(g), enacted in 2008, requires brokers to report the adjusted basis and character of gain from sales of a “covered” security, which includes stocks, debt and other financial instruments. The requirements apply to stock acquired in 2011, but do not apply to dividend reinvestment plans and regulated investment companies until 2012. Notice 2011-56 allows taxpayers to revoke the broker’s default method for basis reporting retroactively.
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On June 29, 2011, The 2011 mid-year report of National Taxpayer Advocate Nina E. Olson released on June 29, 2011, praised a recently announced IRS policy change making lien withdrawals more available to taxpayers in certain cases. However, the report expressed concern about the IRS practice of automatically filing tax liens based on a dollar amount rather than considering the taxpayer’s financial situation. The Advocate believes that before filing a tax lien, the IRS should
balance the need to protect the government’s interests in the taxpayer’s assets with a corresponding concern for the financial harm the lien will create for that taxpayer.
The report states that if the IRS has determined a taxpayer is suffering an economic hardship or possesses no significant assets, the filing of a lien is unlikely to further tax collection but will further damage a taxpayer’s credit rating.
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