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Deadline for Voluntary Tax Disclosures is Fast Approaching - September 23rd

Article

Corporate & Finance Alert

September 8, 2009

By: Peter J. UlrichMichael J. DelTergo

Update: On September 21st, the IRS announced that it was extending the deadline for the Program to October 15, 2009. The IRS also announced that there would be no further extensions.

In the last few weeks there have been numerous press reports regarding the settlement reached between UBS, the Swiss banking giant, and the United States with respect to the U.S. Government’s litigation to force UBS to disclose the identities of U.S. account holders. On August 19, the Department of Justice announced that it had reached an agreement with respect to that litigation under which the Internal Revenue Service (“IRS”) will receive 4,450 names of U.S. taxpayers with accounts at UBS.

The nature and timing of the settlement with UBS highlights the need for U.S. taxpayers with undisclosed accounts at UBS or other foreign banks, or undisclosed interests in foreign corporations, hedge funds, and other investment vehicles, to seriously consider the IRS’ voluntary disclosure program (the “Program”) with respect to interests in foreign accounts or other entities prior to its termination on September 23, 2009.

The IRS Voluntary Disclosure Program Application Process

On March 26 and May 6, 2009, the IRS published a series of memoranda and other materials regarding the Program. The materials clarified the application of its existing voluntary disclosure practice to taxpayers with undisclosed foreign accounts. The IRS has reported record disclosures under the Program, in part because of the wide publicity regarding the UBS litigation.

In late July, the IRS released a form for taxpayers to follow when they make a voluntary disclosure. The IRS issued this form to streamline the voluntary disclosure process and to collect information that will permit the IRS to track down intermediaries and other agents of financial institutions that promoted offshore accounts and assisted taxpayers in setting them up.

Some of the questions are as expected: the form requests personal information regarding the taxpayer; the unreported earnings from the accounts and their highest aggregate value for the years 2003-2008; and information regarding the source of funds and the initial purpose for establishing the offshore account (e.g., Holocaust compensation or restitution, inherited account, account established prior to World War II, tax non-compliance purposes, etc.) These questions elicit information that is used by the IRS to determine if the taxpayer is eligible for the Program, and if so, whether the taxpayer qualifies for reduced penalties, and are consistent with the information requested in the March 26 Program release, and the subsequent May 6, 2009 release of FAQs about the Program. Those releases advise taxpayers to submit a letter with the foregoing information to the Criminal Investigation Division (“CI”), which will initially evaluate if the taxpayer qualifies for the Program and then either refer the matter to the Philadelphia Offshore Identification Unit for civil processing, or in egregious cases, retain the matter in CI for further investigation.

Additional questions, which have been asked by CI after taxpayers make their initial disclosure, but that had previously not been officially disclosed by the IRS, ask the taxpayer for information about his or her interactions with the financial institution holding the account, and with any other individual or entity that may have had a role in establishing or managing the account. The questions ask the taxpayer to explain and provide the details, including names of participants, locations and dates of all face-to-face meetings, and any other communications that the taxpayer had regarding the accounts or assets with the financial institutions or any independent investment managers or intermediaries.

Implications of Information Gathered by IRS and Current UBS Events

The fact that the IRS is raising the latter line of questions with thousands of taxpayers applying under the Program has important implications to taxpayers who are still on the fence about participating. The numerous responses from taxpayers will assist the IRS and the Department of Justice to locate, investigate, and prosecute the financial institutions and their employees, and also any independent advisors and investment managers that were involved in the promotion of tax evasion transactions. This information is not otherwise reportable on the Report of Foreign Bank and Financial Accounts, or “FBAR.”

Consequently, taxpayers who are relying on foreign bank secrecy laws to protect them, may still be discovered if their U.S. based financial advisors or investment managers are identified by other taxpayers and they in turn are pressured or forced to reveal information to the Department of Justice. And of course, U.S. taxpayers with accounts at UBS are clearly at risk right now. Since any taxpayer that is investigated or questioned by the IRS prior to making an application to the Program cannot take advantage of the Program, this makes it all the more imperative that taxpayers considering disclosure under the Program act quickly.

Tax, Interest and Civil Penalties Imposed Under the Program

Of course, obtaining protection from criminal prosecution under the Program has a price, but this price is much lower than the combination of civil penalties (including the 75% civil fraud penalty assessed on underpayments) that might otherwise apply, separate from any criminal penalties. Under the Program, the taxpayer will be liable for any unpaid income taxes and interest on the unpaid tax liabilities for the last six years (2003 through 2008). If the IRS concludes that the disclosure was voluntary and that the taxpayer has cooperated fully with the IRS, the taxpayer will be subject to the following penalties: (i) either an accuracy-related (20%) or delinquency (25%) penalty, depending on whether prior income tax returns were filed, on the income tax liability for all six years; and, (ii) in lieu of all other penalties, a penalty equal to 20% of the account’s or entity’s highest value during the prior six-year period. With respect to this latter 20% penalty on the account’s value, this amount will be reduced to 5% if: (a) the taxpayer did not open the account; (b) there was no activity in the account during the period in which the account was controlled by the taxpayer; and (c) the funds deposited to the account were previously subject to U.S. taxation (meaning that only account earnings were not taxed).

U.S. beneficiaries of undisclosed foreign accounts or owners of interests in undisclosed foreign entities need to seriously consider applying under the IRS’ voluntary disclosure program before the September 23, 2009 deadline.