Undisclosed Foreign Bank Accounts

On July 17, 2008, UBS A.G., the giant Swiss bank, announced its cooperation with the Department of Justice (DOJ) and the IRS and its identification to the authorities of U.S. clients who use undeclared foreign accounts and thus may have committed tax fraud by concealing income. This came on the heels of the guilty plea to conspiracy to commit tax fraud by a former UBS employee who alleges that it was the bank's practice to help U.S. clients conceal foreign assets through the use of nominee entities. The former employee has agreed to cooperate with the government as part of his plea, and a DOJ lawyer informed the court accepting the guilty plea that the cooperation was expected to help the government “nationwide.”

A Senate report alleges that UBS has maintained about 19,000 undeclared accounts for its U.S. clients, and that these undeclared accounts contain up to $18 billion in total assets. The report also attacks LGT Group, a Liechtenstein bank. IRS Commissioner Douglas Shulman has declared publicly that overseas income represents a national tax enforcement priority. Thus, tax enforcement authorities appear poised to root out details of offshore accounts held by many individuals in a rapidly expanding and aggressive investigation.

Maintaining a Foreign Account

Maintaining a foreign financial account is not inherently illegal. Rather, it is the manner in which a taxpayer uses an overseas account which can result in tax code violations. U.S. citizens and resident aliens must report income from all sources, whether earned inside or outside of the United States. This requirement extends to any interest and dividends received through assets held in an off-shore account. Further, anyone filing a U.S. individual income tax return must disclose on that return any financial interest in, or signatory authority over, any foreign accounts with an aggregate value of $10,000. In addition, there is a separate Foreign Bank Account Form TD F 90-22, which also must be filed by individuals, corporations, partnerships, estates and trusts with a financial interest in, or signatory authority over, foreign accounts with a value in excess of $10,000.

Many foreign banks (including UBS) have entered into a “Qualified Intermediary Agreement” (QIA) with the IRS. Under a QIA, foreign banks agree to identify U.S. clients who hold U.S. investments or received U.S-source income in their foreign accounts. Foreign banks also agree to issue Forms 1099 to U.S. clients for U.S.-source income paid into their accounts, if the clients agree to be identified. If the clients do not consent to be identified, the bank then agrees to bar the client from holding any U.S. investments in the account, and to withhold and pay over to the IRS a 28% tax on any U.S.-source payments. Income earned on non-U.S. investments is similarly subject to reporting and withholding if their purchase or sale occurred through a communication involving the U.S. Ultimately, however, a taxpayer still must report on his own tax return any foreign accounts collectively worth over $10,000.

The IRS Voluntary Disclosure Program

Given the current environment, any U.S. citizen or resident alien who has held an undisclosed overseas account faces difficult choices. One option is to do nothing, and address any scrutiny if and when it comes. Another option is to come forward and attempt to take advantage of the IRS voluntary disclosure program. Any decision must be made in consultation with counsel. Although every case is unique, the option of coming forward quickly should be given serious consideration.

The voluntary disclosure program of the IRS is set forth in Internal Revenue Manual (IRM) 9.5.3.3.1.2.1. It addresses the issue of criminal prosecution; it does not pertain to civil tax issues. Under the program, the decision of a taxpayer to come forward and cooperate with the IRS in correcting his tax liability “may result in prosecution not being recommended.” The cooperation must be truthful, timely, and complete. A disclosure is “timely” if it is made before the government already knows about the taxpayer's non-compliance or has begun to investigate the taxpayer. Disclosure also must occur before the government has received information, or has begun a related investigation focusing on a third-party, which is “directly related” to the taxpayer's own “specific liability.” The IRS retains ultimate discretion, and taxpayers should not assume that disclosure ' even honest, timely, and complete ' will preclude a referral for criminal prosecution.

The program is most vulnerable to subjective interpretations when the IRS, although not previously focused on the disclosing taxpayer, may nonetheless deem itself, after a disclosure, to have already possessed information, or to have begun an investigation of a third-party, which “directly” related to the disclosed “specific liability.” The danger here is that the IRS will overestimate its own ability, after the fact, to have appreciated investigative leads and acted effectively on them.

The program provides competing examples of voluntary and not voluntary disclosures. A disclosure will be considered voluntary if it concerns “omitted income facilitated through a widely promoted scheme regarding which the IRS has begun a civil compliance project and already obtained information which might lead to an examination of the taxpayer; however, the IRS has not yet commenced an examination or investigation of the taxpayer or notified the taxpayer of its intent to do so.” Accordingly, taxpayers with undisclosed foreign assets held through companies not already under investigation may have a good claim that their disclosure is timely, even if the general manner of the taxpayer's non-disclosure is under scrutiny.

On the other hand, IRM 9.5.3.3.1.2.1 states that a disclosure will be considered not voluntary if it concerns “a disclosure made by a taxpayer, who is not currently under examination or investigation, of omitted constructive dividends received from a corporation which is currently under examination.” The IRS therefore appears to interpret an investigation of a third-party entity which holds the actual specific assets that a taxpayer has omitted as a matter “directly related” to the taxpayer's own “specific liability,” and therefore not susceptible to “voluntary” disclosure. It remains unclear whether the IRS will insist in actual practice that the undisclosed but relatively limited assets of a single taxpayer, contained within the total holdings of a large company already under investigation, are ineligible for the program. This will depend on whether the government will acknowledge that, as a practical matter, it cannot successfully pursue every client of a large company, and whether the government seeks to encourage continued voluntary disclosures.

Voluntary Disclosure: Pros and Cons

Assuming that a taxpayer's foreign account has produced an undisclosed tax liability, and/or has not been disclosed properly on his tax returns, a taxpayer may hesitate when contemplating voluntary disclosure. The obvious downside is that disclosure places the taxpayer squarely on the government's radar screen. On the other hand, a decision to “roll the dice” and not come forward can be quite risky. If the prior non-compliance is significant, then the chances of entirely eluding government scrutiny are lower, and the reasons to perform immediate damage control are enhanced.

If the problems associated with an account or return are limited ' for example, there were few taxable events which occurred while the money was held overseas, the amount of money is small, or a failure to disclose an account resulted from poor advice from a professional ' then the taxpayer should be better positioned to clear matters with the IRS civilly and with a relative degree of efficiency. However, a decision not to disclose an account which later is discovered will undermine one of the taxpayer's most effective arguments ' that he was operating in good faith ' and may make otherwise marginal non-compliance appear more serious than it would have appeared in the context of voluntary disclosure.

Similarly, a taxpayer who currently has an undisclosed account faces a difficult dilemma, because he also must worry about the future. The ability to claim good-faith reliance upon the advice of professional may degenerate as time goes on. Whatever a taxpayer could claim as to the reasons for his prior conduct, the continued maintenance of such undisclosed accounts may become increasingly harder to justify. Prior but unwitting violations of the tax code may morph into current and knowing ones. Efforts to remove assets from accounts may draw attention, and perhaps constitute new violations. Finally, the taxpayer still will have to file accurate returns for future tax years, and will be responsible for disclosing foreign accounts.

Bear in mind that the IRS itself does not make the ultimate decisions regarding whether or not to prosecute. Charging decisions are made by prosecutors working at the relevant U.S. Attorney's Office, in conjunction with prosecutors working at the Criminal Enforcement Section of the DOJ's Tax Division, who must review and approve all proposed criminal tax prosecutions. Thus, when the prior lack of compliance has been particularly significant, counsel might consider first approaching the local U.S. Attorney's Office for a meeting, so that counsel may lay out, without disclosing the client's identity, the relevant facts, and hopefully obtain feedback as to whether non-prosecution is a possible outcome. This may begin a dialog with the people directly involved in final charging decisions, and who may prefer the advantages of a speedy, guaranteed civil resolution over a lengthy, less certain and resource-intensive criminal process.

Peter D. Hardy ([email protected]) is a partner at Post & Schell, P.C., where he works in its Philadelphia office in its national White Collar Defense, Compliance and Risk Management Group. He was previously an Assistant United States Attorney in the Eastern District of Pennsylvania and a trial lawyer for the Department of Justice's Tax Division.

On July 17, 2008, UBS A.G., the giant Swiss bank, announced its cooperation with the Department of Justice (DOJ) and the IRS and its identification to the authorities of U.S. clients who use undeclared foreign accounts and thus may have committed tax fraud by concealing income. This came on the heels of the guilty plea to conspiracy to commit tax fraud by a former UBS employee who alleges that it was the bank's practice to help U.S. clients conceal foreign assets through the use of nominee entities. The former employee has agreed to cooperate with the government as part of his plea, and a DOJ lawyer informed the court accepting the guilty plea that the cooperation was expected to help the government “nationwide.”

A Senate report alleges that UBS has maintained about 19,000 undeclared accounts for its U.S. clients, and that these undeclared accounts contain up to $18 billion in total assets. The report also attacks LGT Group, a Liechtenstein bank. IRS Commissioner Douglas Shulman has declared publicly that overseas income represents a national tax enforcement priority. Thus, tax enforcement authorities appear poised to root out details of offshore accounts held by many individuals in a rapidly expanding and aggressive investigation.

Maintaining a Foreign Account

Maintaining a foreign financial account is not inherently illegal. Rather, it is the manner in which a taxpayer uses an overseas account which can result in tax code violations. U.S. citizens and resident aliens must report income from all sources, whether earned inside or outside of the United States. This requirement extends to any interest and dividends received through assets held in an off-shore account. Further, anyone filing a U.S. individual income tax return must disclose on that return any financial interest in, or signatory authority over, any foreign accounts with an aggregate value of $10,000. In addition, there is a separate Foreign Bank Account Form TD F 90-22, which also must be filed by individuals, corporations, partnerships, estates and trusts with a financial interest in, or signatory authority over, foreign accounts with a value in excess of $10,000.

Many foreign banks (including UBS) have entered into a “Qualified Intermediary Agreement” (QIA) with the IRS. Under a QIA, foreign banks agree to identify U.S. clients who hold U.S. investments or received U.S-source income in their foreign accounts. Foreign banks also agree to issue Forms 1099 to U.S. clients for U.S.-source income paid into their accounts, if the clients agree to be identified. If the clients do not consent to be identified, the bank then agrees to bar the client from holding any U.S. investments in the account, and to withhold and pay over to the IRS a 28% tax on any U.S.-source payments. Income earned on non-U.S. investments is similarly subject to reporting and withholding if their purchase or sale occurred through a communication involving the U.S. Ultimately, however, a taxpayer still must report on his own tax return any foreign accounts collectively worth over $10,000.

The IRS Voluntary Disclosure Program

Given the current environment, any U.S. citizen or resident alien who has held an undisclosed overseas account faces difficult choices. One option is to do nothing, and address any scrutiny if and when it comes. Another option is to come forward and attempt to take advantage of the IRS voluntary disclosure program. Any decision must be made in consultation with counsel. Although every case is unique, the option of coming forward quickly should be given serious consideration.

The voluntary disclosure program of the IRS is set forth in Internal Revenue Manual (IRM) 9.5.3.3.1.2.1. It addresses the issue of criminal prosecution; it does not pertain to civil tax issues. Under the program, the decision of a taxpayer to come forward and cooperate with the IRS in correcting his tax liability “may result in prosecution not being recommended.” The cooperation must be truthful, timely, and complete. A disclosure is “timely” if it is made before the government already knows about the taxpayer's non-compliance or has begun to investigate the taxpayer. Disclosure also must occur before the government has received information, or has begun a related investigation focusing on a third-party, which is “directly related” to the taxpayer's own “specific liability.” The IRS retains ultimate discretion, and taxpayers should not assume that disclosure ' even honest, timely, and complete ' will preclude a referral for criminal prosecution.

The program is most vulnerable to subjective interpretations when the IRS, although not previously focused on the disclosing taxpayer, may nonetheless deem itself, after a disclosure, to have already possessed information, or to have begun an investigation of a third-party, which “directly” related to the disclosed “specific liability.” The danger here is that the IRS will overestimate its own ability, after the fact, to have appreciated investigative leads and acted effectively on them.

The program provides competing examples of voluntary and not voluntary disclosures. A disclosure will be considered voluntary if it concerns “omitted income facilitated through a widely promoted scheme regarding which the IRS has begun a civil compliance project and already obtained information which might lead to an examination of the taxpayer; however, the IRS has not yet commenced an examination or investigation of the taxpayer or notified the taxpayer of its intent to do so.” Accordingly, taxpayers with undisclosed foreign assets held through companies not already under investigation may have a good claim that their disclosure is timely, even if the general manner of the taxpayer's non-disclosure is under scrutiny.

On the other hand, IRM 9.5.3.3.1.2.1 states that a disclosure will be considered not voluntary if it concerns “a disclosure made by a taxpayer, who is not currently under examination or investigation, of omitted constructive dividends received from a corporation which is currently under examination.” The IRS therefore appears to interpret an investigation of a third-party entity which holds the actual specific assets that a taxpayer has omitted as a matter “directly related” to the taxpayer's own “specific liability,” and therefore not susceptible to “voluntary” disclosure. It remains unclear whether the IRS will insist in actual practice that the undisclosed but relatively limited assets of a single taxpayer, contained within the total holdings of a large company already under investigation, are ineligible for the program. This will depend on whether the government will acknowledge that, as a practical matter, it cannot successfully pursue every client of a large company, and whether the government seeks to encourage continued voluntary disclosures.

Voluntary Disclosure: Pros and Cons

Assuming that a taxpayer's foreign account has produced an undisclosed tax liability, and/or has not been disclosed properly on his tax returns, a taxpayer may hesitate when contemplating voluntary disclosure. The obvious downside is that disclosure places the taxpayer squarely on the government's radar screen. On the other hand, a decision to “roll the dice” and not come forward can be quite risky. If the prior non-compliance is significant, then the chances of entirely eluding government scrutiny are lower, and the reasons to perform immediate damage control are enhanced.

If the problems associated with an account or return are limited ' for example, there were few taxable events which occurred while the money was held overseas, the amount of money is small, or a failure to disclose an account resulted from poor advice from a professional ' then the taxpayer should be better positioned to clear matters with the IRS civilly and with a relative degree of efficiency. However, a decision not to disclose an account which later is discovered will undermine one of the taxpayer's most effective arguments ' that he was operating in good faith ' and may make otherwise marginal non-compliance appear more serious than it would have appeared in the context of voluntary disclosure.

Similarly, a taxpayer who currently has an undisclosed account faces a difficult dilemma, because he also must worry about the future. The ability to claim good-faith reliance upon the advice of professional may degenerate as time goes on. Whatever a taxpayer could claim as to the reasons for his prior conduct, the continued maintenance of such undisclosed accounts may become increasingly harder to justify. Prior but unwitting violations of the tax code may morph into current and knowing ones. Efforts to remove assets from accounts may draw attention, and perhaps constitute new violations. Finally, the taxpayer still will have to file accurate returns for future tax years, and will be responsible for disclosing foreign accounts.

Bear in mind that the IRS itself does not make the ultimate decisions regarding whether or not to prosecute. Charging decisions are made by prosecutors working at the relevant U.S. Attorney's Office, in conjunction with prosecutors working at the Criminal Enforcement Section of the DOJ's Tax Division, who must review and approve all proposed criminal tax prosecutions. Thus, when the prior lack of compliance has been particularly significant, counsel might consider first approaching the local U.S. Attorney's Office for a meeting, so that counsel may lay out, without disclosing the client's identity, the relevant facts, and hopefully obtain feedback as to whether non-prosecution is a possible outcome. This may begin a dialog with the people directly involved in final charging decisions, and who may prefer the advantages of a speedy, guaranteed civil resolution over a lengthy, less certain and resource-intensive criminal process.

Peter D. Hardy ([email protected]) is a partner at Post & Schell, P.C., where he works in its Philadelphia office in its national White Collar Defense, Compliance and Risk Management Group. He was previously an Assistant United States Attorney in the Eastern District of Pennsylvania and a trial lawyer for the Department of Justice's Tax Division.