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U.S. Government’s Crackdown on Offshore Tax Evasion - Options for Non-Compliant Taxpayers


For the past four years, the U.S. government has waged an unprecedented global campaign to crack down on the use of secret, offshore bank accounts by U.S. taxpayers to evade taxes. While there is nothing illegal about maintaining accounts in foreign countries, U.S. taxpayers are required annually to disclose their offshore accounts to the Internal Revenue Service on a form entitled “Report of Foreign Bank and Financial Accounts”—commonly known as the “FBAR” form—and to report all income generated by those holdings on their personal income tax returns.

The failure to report foreign accounts can subject a taxpayer to hefty civil penalties and, in the case of willful conduct, criminal prosecution. Since 2009, over 35,000 U.S. taxpayers have come forward under special IRS voluntary disclosure programs to reveal that they have  unreported bank accounts in countries such as Switzerland, India, Israel, and many others. The government nonetheless believes that many  more taxpayers still maintain unreported foreign accounts, and is aggressively seeking to discover such individuals and punish them with civil penalties and, in some instances, criminal charges.At the same time, the Internal Revenue Service has implemented several initiatives which offer non-compliant taxpayers the opportunity to return to compliance and avoid the possibility of criminal charges.

The UBS Deferred Prosecution Agreement and Its Aftermath

The Internal Revenue Service and Justice Department initially trained their sights on UBS AG, Switzerland’s largest bank. After UBS banker Bradley Birkenfeld provided information to the IRS on his bank’s practice of aiding U.S. taxpayers in hiding funds in numbered bank accounts (and eventually received a $104 million whistleblower reward), UBS admitted that it helped U.S. citizens hide money using undisclosed accounts, offshore corporations, family foundations, and other mechanisms designed to conceal the true identity of account holders. The U.S. also discovered that the sheer number of accounts held by Americans was staggering: in court filings, the Justice Department estimated that over 52,000 Americans held accounts at UBS alone.

UBS avoided criminal prosecution in the U.S. by paying $780 million in fines and penalties to the U.S. government and by agreeing to turn over the names of U.S. customers of the bank that were suspected of committing tax fraud. Under enormous diplomatic pressure from the U.S. government which ensued, Swiss legislators subsequently voted to weaken the country’s historic bank secrecy laws, paving the way for UBS to hand
over the names of thousands of additional its U.S. depositors to the U.S. authorities. This result prompted the Justice Department to proclaim on its web site that “fabled Swiss bank secrecy” had been dealt “a devastating blow.”

Justice Department attorneys and IRS agents combed through mountains of information handed over by UBS, commenced more than 150 criminal
investigations of account holders, and eventually brought criminal charges against the most egregious tax evaders. To date, nearly 50 Americans holding accounts at UBS and other Swiss banks have faced criminal charges, along with dozens of “enablers”—such as bankers, attorneys, and financial advisors—who assisted account holders in hiding assets offshore.

The government’s crackdown on offshore tax avoidance and evasion did not end with UBS; at least 10 banks in Switzerland, Israel, and India are
currently under criminal investigation for allegedly aiding and abetting tax fraud by U.S. depositors. Switzerland’s oldest bank, Wegelin Co., was indicted in federal court in New York, had its correspondent bank accounts in the U.S. seized, and eventually pleaded guilty and paid fines and penalties in excess of $70 million. Most recently, several account holders at Israeli banks have been charged with, and pleaded guilty to, concealing foreign accounts. It is widely expected that additional foreign banks will either cut deals with the U.S. or face criminal charges for their roles in helping Americans evade taxes and more names from banks all over the world will be turned over to the IRS.

Obligation to Report Foreign Bank Accounts and Certain Foreign Assets

As noted above, there is nothing improper about a U.S. taxpayer maintaining a bank account in a foreign country, even in so-called “bank secrecy” countries such as Switzerland, the Cayman Islands, and Singapore. Anyone having such an account is required to report on his or her personal income tax return all income (interest, dividends, and capital gains) earned in that account and answer “yes” to a question on Schedule B of the return which asks whether you have a foreign bank account. Account holders are also required annually to file a form called “Report of Foreign Bank and Financial Accounts” (commonly known as the FBAR form) with the Treasury Department on June 30 of each year.The failure to file the FBAR form and to report income from a foreign account can subject the account holder (and spouse, if a joint tax return is filed) to criminal charges, including tax evasion, as well as substantial civil penalties. U.S. taxpayers with foreign assets over certain dollar thresholds are also required to file a new Form 8938, entitled “Statement of Foreign Financial Assets,” with their income tax returns.  Civil and criminal penalties also apply to the failure to file
this form, and the failure to file extends indefinitely the civil statute of limitations to assess taxes for the tax return that failed to report the foreign assets.

Options for Non-Compliant Taxpayers:  The IRS Offshore Voluntary Disclosure Program

In 2009, shortly after UBS executed its deferred prosecution agreement and the Swiss government started divulging the identities of holders of secret accounts, the IRS announced a special amnesty program for offshore bank accounts. This program was prompted by the recognition that not everyone with a Swiss bank account was a tax cheat; indeed, many Americans inherited bank accounts in Switzerland—such as from ancestors fleeing Nazi Germany —or maintained accounts in foreign countries for wholly legitimate reasons. Amnesty was only available, however, if the account holder came forward before the IRS obtained the individual’s account information; once the IRS learned of the taxpayer’s non-compliance, the voluntary disclosure program was no longer an option. Individuals who took advantage of that program were required to pay back taxes and substantial civil penalties in exchange for amnesty from criminal prosecution. This special program (which lasted for only six months) was such a huge success, with over 15,000 individuals coming forward to confess that they had unreported bank accounts, that the IRS re-opened the program in 2011 and yet again in 2012. To date, more than 35,000 individuals have taken advantage of the three IRS amnesty programs for offshore accounts, generating over $5 billion in addition revenue for the U.S. Treasury.

The current amnesty initiative offered by the IRS—called the Offshore Voluntary Disclosure Program (OVDP) —does not have a definitive end date, but the IRS has warned that the program could end at any time. Taxpayers accepted into the OVDP must file amended tax returns for an eight-year period and pay all back taxes, interest, and an accuracy-related penalty calculated at 20 percent of the taxes due. In a change from the prior program, the top-tier civil penalty has been increased from 25 percent to 27.5 percent, and this penalty is calculated based upon the highest aggregate value of the taxpayer’s foreign bank accounts during the eight-year disclosure period. The program retains the lower tier penalties of 12.5 percent and 5 percent which apply in only limited circumstances.

New Filing Compliance Procedures for U.S. Taxpayers Residing Abroad

The IRS has also announced a new program to enable U.S. taxpayers residing overseas, including dual citizens, to become compliant with their U.S. tax obligations. The IRS formulated this procedure in response to revelations that many U.S. taxpayers living abroad only recently became aware of their U.S. tax and FBAR obligations. Taxpayers who wish to take advantage of the new procedure will be required to file delinquent tax returns for the past three years and delinquent FBARs for the past six years. All submissions will be reviewed by the IRS but the intensity of review will vary according to the level of compliance risk presented by the submission. Taxpayers presenting low compliance risk will receive expedited review and the IRS will not assert penalties or pursue follow-up actions. The IRS has stated that tax returns showing little or no U.S. due will generally be considered
“low risk.”  On the other hand, submissions that present higher compliance risk are not eligible for the new procedure and will be subject to a more thorough review and possibly a full examination, which in some cases may include more than three years, and may include imposition of interest and penalties.

The Foreign Account Tax Compliance Act (FATCA)

Despite the large numbers of individuals who have participated in the various IRS amnesty programs over the past four years, it is nonetheless
widely believed that many more U.S. taxpayers holding foreign accounts in countries around the world have failed to “come in from the cold,”largely due to the belief that the U.S. government would never discover the existence of their accounts. Many of these account holders presumably believe that they are protected by the bank secrecy laws of the countries where they maintain accounts or that those jurisdictions would never willingly give up the names of account depositors. But that is all about to change, as key provisions of a controversial new U.S. law—the Foreign Account Tax Compliance Act (FATCA)—become effective starting in 2014.

The primary focus of FATCA is to identify non-compliance by U.S. taxpayers using offshore accounts. Once implemented, FATCA will require foreign financial institutions (a broadly-defined term which includes traditional banks but also encompasses a broad array of non-bank financial institutions including hedge funds) to annually disclose information about accounts held by U.S. individuals, or foreign companies in which U.S. individuals hold a substantial ownership interest. Foreign financial institutions (FFIs) which refuse to provide such information about their customers to the U.S. will face a stringent penalty: withholding of 30 percent of all U.S.-source payments of interest, dividends, and the like. FATCA essentially forces foreign banks to cooperate if they wish to have access to U.S. capital markets, and will substantially penalize banks which refuse to participate.

The arrival of FATCA signals a new era and arms the U.S. government with a powerful tool to detect offshore tax evasion. U.S. taxpayers with undeclared foreign accounts can no longer assume that they will remain undetected or protected by foreign banking secrecy laws. Taxpayers who
are non-compliant with their U.S. tax and/or FBAR obligations are well-advised to consider taking advantage of either the OVDP or the new compliance procedures for non-resident taxpayers, depending upon their circumstances. With the IRS and Justice Department continuing their unrelenting global crackdown on international tax evasion and bank secrecy laws, and full-scale implementation of FATCA on the near horizon, the risk of detection is significantly increased and the threat of criminal prosecution is real. Non-compliant taxpayers would be well advised to take advantage of the ongoing IRS offshore voluntary disclosure program before FATCA is fully implemented and the window of opportunity for amnesty has closed.

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