This article was originally published in ALI-ABA Estate Planning Course Materials Journal, December 2011
1. For the past several years the worldwide business press has been full of stories about potentially thousands of U.S. taxpayers who may have undeclared accounts all over the world. Through a variety of mechanisms, the U.S. government has obtained information about American account holders and their assets from jurisdictions previously thought nearly impenetrable. Many developments are public; others are occurring in quiet conference rooms in Washington, D.C., and elsewhere and may never become fully known to the public.
2. Recent developments portend the gradual erosion of the traditional concept of bank secrecy and increased transparency among nations regarding financial information. In large part, a consensus has emerged that disclosure of heretofore secret bank data is now routinely warranted not just to protect against more heinous crimes, such as terrorism, narcotics, money laundering, and financial fraud, but more simply to promote the tax and fiscal interests of a given nation.
3. This article discusses methods of enforcement, incentives, and deterrence being used by the U.S. government to bring U.S. taxpayers into compliance, to prosecute alleged wrongdoers located both in and outside the United States, and to penetrate long-standing protections for bank information maintained in many countries outside the United States.
B. Criminal And Civil Exposure In Undeclared Account Cases
1. A variety of reporting requirements exist for U.S. citizens and residents, including individuals, corporations, partnerships, trusts, and estates, involving foreign accounts and other foreign holdings. The willful failure to comply with these requirements can be prosecuted as criminal offenses under U.S. law and subject the persons involved to substantial civil money penalties. Non-willful conduct can result in the assessment of tax, interest, and penalties. The statute of limitations for criminal tax offenses is six years. The statutes of limitations on civil penalties vary by the specific penalty involved, but the most serious of the civil penalties either have a six-year, or no, statute of limitations.
a. Income Tax
i. U.S. taxpayers are required to report and pay tax on their worldwide income. This includes reporting investment income earned on financial accounts located outside the United States. U.S. tax reporting also requires taxpayers to disclose the existence of any foreign accounts on the individual's U.S. tax return. Schedule B of Form 1040, and other tax forms, requires filers to check a box answering whether they have signature authority or a financial interest in any foreign accounts and if so to list the names of the countries where the account(s) are held.
ii. Criminal penalties exist for willful failure to report income and willful filing of a false return. In addition, the IRS may assess tax, interest, and penalties equal to as much as 75 percent of any tax understatement for civil fraud and lesser percentages for incorrect filings.
b. Foreign Bank Account Reporting
i. U.S. law also requires filing a separate information return, a TD F 90-22.1, Report of Foreign Bank and Finance Accounts, known as an FBAR, by June 30 following each calendar year. This form is not filed with the tax return but is sent to a separate IRS service center in Detroit. There are no extensions to this deadline.
ii. A non-willful failure to file an FBAR can be penalized up to $10,000, but a willful failure to file can result in a civil penalty of as much as 50 percent of the value of the foreign account, with no cap for each violation, per year. 31 U.S.C. §5321(a)(5). Thus a taxpayer with a substantial undeclared foreign account may face the prospect of a civil penalty for a multiyear, willful failure to file the FBAR that would not just exhaust the balance of the entire account but may result in the taxpayer having to pay additional funds.
iii. The statute of limitations on FBAR penalties is six years. The IRS has the burden of proving willfulness and must engage in special judicial proceedings to collect the penalty if imposed. So, in ordinary times, a practitioner should be able to negotiate it downward, or away altogether, especially in the case of inherited accounts or where other factors exist indicating a taxpayer was unaware of the FBAR filing requirement or otherwise acted with reasonable cause. As noted below, the IRS has a new 2011 voluntary disclosure initiative. IRS agents have no discretion to lower penalty amounts below those set forth in program guidance.
iv. The penalty for failing to file the FBAR can apply to anyone who violates, or causes any violation of, the filing requirement. 31 U.S.C. §5321(a)(5). Recently U.S. government officials have stated they believe the FBAR penalty can be assessed and collected against third parties who aid and assist U.S. taxpayers in their failure to declare accounts. The willfulness penalty is 50 percent of the highest account balance for each of the six years open under the statute of limitations. If the United States could prove a bank's participation in a series of FBAR violations for hundreds of account holders, the potential penalty exposure could be staggering.
c. Other Reporting Obligations
i. Many undeclared accounts were set up through nominee entities, such as trusts or foundations (Stiftungs in Liechtenstein) or companies in which the account holder or a nominee held the shares. A taxpayer's relationship with such entities is generally required to be reported on U.S. tax filings. Foreign gifts or bequests, and distributions from and relationships with foreign trusts, are reportable on Form 3520. One's ownership of a foreign company is generally reportable on Form 5471.
(1) Forms 3520 And 3520-A
(A) If a U.S. transferor of property to a foreign trust, or a U.S. recipient of a distribution from such a trust, fails to timely file a Form 3520 to report these transactions, the IRS may impose a penalty equal to 35 percent of the gross value of the property transferred to or received from the trust.
(B) If a U.S. donee fails to timely file a Form 3520 to report the receipt of a large foreign gift, or files the form incorrectly or incompletely, such donee may be subject to a penalty equal to five percent, not to exceed 25 percent, of the value of the gift or bequest received in the relevant year.
(C) If a foreign grantor trust fails to timely file a Form 3520-A, or fails to furnish all of the required information, the U.S. owner may be subject to a penalty equal to five percent of the gross value of the portion of the trust's assets treated as owned by the U.S. person at the close of the taxable year.
(D) The failure to timely file a complete and correct Form 3520 or Form 3520-A may result in an additional penalty of $10,000 per 30-day period for failing to comply within 90 days of notification by the IRS that the information return has not been filed. The total penalty for failure to report a trust transfer, however, cannot exceed the amount of the property transferred. (
2) Form 5471. Depending on the type of foreign corporation involved, and the company's relationship to the U.S. shareholder, varying penalties may be imposed for failure to file a Form 5471. Generally the penalty is $10,000 per failure to file, but additional penalties can be imposed if the form is not filed after notice by the IRS.
(A) These penalties generally have a reasonable cause exception, meaning if a taxpayer can demonstrate that his or her failure to file the form was due to reasonable cause, the penalty can be abated in its entirety. Reasonable cause can include, for example, advice from a practitioner on which the taxpayer had relied or a simple lack of knowledge on the taxpayer's part of the filing requirement.
(B) In cases where there has been a failure to file such forms, however, there is no statute of limitations. So in theory the IRS can reach back many years should it choose to impose civil penalties in these cases.
(C) In both IRS voluntary disclosure programs (discussed below), the IRS generally permitted participants to disregard purely nominee entities and avoid filing these additional forms, so long as the entities were dissolved by the time the case was resolved.
d. The U.S. government has implemented and followed a number of procedures aimed at discovering American taxpayers with undeclared accounts and acting against them. The current and expanding information disclosure regime includes a combination of the following disclosure methods to obtain information about foreign financial accounts, whether in secrecy jurisdictions or otherwise:
i. Whistleblowers and informants.
ii. Criminal investigations of financial institutions and account holders.
iii. Civil summons processes.
iv. Requests under tax treaty or mutual information exchange agreements.
v. Voluntary disclosure by thousands of Americans seeking to avoid criminal prosecution and obtain reduced civil penalties and their continuing tax compliance.
vi. Foreign Account Tax Compliance Act and related legislative and regulatory developments.
e. These investigative tools provide the U.S. tax enforcement establishment with a template for continuing to pursue offshore accounts and making international tax compliance a major focus of its investigative push. This climate strongly suggests that any American taxpayer who has not complied with the rules on reporting foreign accounts should take advantage of the IRS's voluntary disclosure policy or consider alternative methods of coming into compliance.
C. Informants And Whistleblowers
1. Recent Developments
a. The United States has obtained information about a number of foreign banks and their activities involving American account holders from informants or whistleblowers. Details of the information reported by Igor Olenicoff, Bradley Birkenfeld, Heinrich Kieber, Rudolf Elmer, and other unidentified cooperators, informants, and whistleblowers have been reported at length in the press. This information has led to investigations of multiple foreign financial institutions and to audits or prosecution of probably hundreds of U.S. persons.
b. In some of these cases, the individual providing the secret information to the authorities has broken one or more laws of their home country, but that is not an obstacle preventing use of the information and investigation of the leads provided to U.S. authorities, unless one could show the U.S. government affirmatively participated in the unlawful conduct.
2. IRS Whistleblower Office
a. For many years the IRS had a somewhat informal program of encouraging informants and paying rewards, but the system was cumbersome and not productive. In 2006 the U.S. Congress passed legislation creating within the IRS a whistleblower office whose mission is to solicit information from informants and supervise the process of paying rewards for valuable data.
b. The whistleblower office is authorized to pay significant rewards for specific information leading to a determination that another party has an unpaid tax liability. The law provides for two types of awards. For cases where the amounts involved exceed US$2 million, the IRS may pay 15–30 percent of amounts collected. In other cases, rewards may equal 15 percent of such amounts. Informants who disagree with their reward amount may appeal to the U.S. Tax Court for more money.
c. Whistleblower claims are reviewed by specialists in the whistleblower office and, if deemed worthy of investigative work, are sent to agents in the field for further development. All information provided by whistleblowers is screened by the IRS Criminal Investigation Division, which has new offices in Beijing, Panama, and Sydney, and other offices and attaches worldwide. It is not a coincidence that in the IRS national office building in Washington, D.C., the whistleblower office is right next door to the offices of the Chief of the Criminal Investigation Division.
d. A legal industry has emerged in the United States to encourage informants to come forward, with practitioners entering into contingent fee agreements with their clients to share in reward amounts. A U.S. lawyer disclosed on April 8, 2011, that his client had received the first reward paid by the whistleblower office, for US$4.5 million for exposing underreporting and underpayment of tax at a U.S. financial services company.
a. In nearly every complex financial criminal investigation, U.S. prosecutors rely on cooperating witnesses to help make a case for prosecution. Where an individual is caught up in an unlawful scheme, often the only way such a person can obtain lenient treatment from prosecutors and under federal sentencing guidelines is to cooperate against those around, and above, him or her in a corporate hierarchy.
b. Thus, in the arena of foreign bank–related cases, the standard playbook for U.S. prosecutors is to pursue lower-level employees at financial institutions and obtain their cooperation in exchange for no, or reduced, criminal charges and lenience in sentencing. This may be occurring in the 2011 arrest and indictment of various foreign bankers, including bankers at Credit Suisse in Switzerland. It is likely that other such cases are moving behind the scenes. Anytime there is publicity about an arrest or indictment of one bank employee, one can expect that the lawyer for that person will advise his or her client about the benefits of cooperating against higher-ups.
D. Disclosures From Criminal Investigations Of Financial Institutions
1. Corporations doing business in America are treated as artificial persons. They can sue and be sued, and they can be indicted, as an entity, for criminal offenses. Under principles of respondeat superior, a corporate entity is responsible for the conduct of its employees. Where one or more individual employees engage in unlawful conduct in connection with their employment, their actions may be deemed actions of their employer, subjecting the employer itself to criminal sanctions.
2. Thus whenever the U.S. Justice Department (DOJ) obtains evidence of wrongdoing by one or more bankers or other employees at a corporate entity, if that conduct occurred in the scope of employment the U.S. government has a technical and legal basis to lodge criminal charges against the entity itself. This gives the United States tremendous leverage over any bank operating in the United States, where an indictment could result in significant damage to the bank's brand and reputation as well as possible regulatory consequences, including loss of licenses to operate. U.S. prosecutors make decisions about whether to indict corporate entities based on a list of public criteria, including the nature, extent, and pervasiveness of the conduct; the existence of an effective compliance program; the company's cooperation with authorities in the investigation; and potential collateral damage to innocent parties that might occur if the entity were prosecuted.
3. Options for a company to resolve a criminal investigation include i) a non-prosecution agreement, ii) a deferred prosecution agreement, iii) a plea to a criminal charge, or iv) indictment and trial.
a. A non-prosecution agreement is a contract between the United States and the involved entity whereby the United States agrees not to pursue criminal charges in exchange for certain actions by the entity. A deferred prosecution agreement (DPA) is similar, but the U.S. government files a specific criminal charge against the entity; prosecution on that charge is deferred and will ultimately be dismissed, pending the entity's performance of certain conditions. A DPA permits resolution without the government having to proceed to trial against the company, or without the company having to formally enter a guilty plea. In most DPAs the government insists on an express acknowledgement of wrongdoing.
b. UBS entered into a DPA in 2009, whereby the bank agreed to pay the United States in excess of $750 million to resolve all criminal, and most civil, issues arising from the bank's role in facilitating U.S. tax evasion. c. The U.S. government views cooperation as an essential component of any DPA. Terms of the UBS DPA included the extraordinary disclosure of the identities of approximately 250–300 account holders to the Justice Department, as well as production of voluminous records of their accounts.
i. Based on this information, the Justice Department has obtained numerous guilty pleas from and indicted other UBS account holders. The Department has said that perhaps as many as 150 other UBS account holders are under criminal investigation. The number of UBS account holders who have pled to or been charged with criminal tax offenses is now approaching 30.
ii. The Justice Department also relied on this information to charge additional Swiss bankers, financial advisers, and lawyers, alleging a conspiracy to help Americans commit tax fraud, bribery of Swiss government officials, and other offenses.
d. In January 2010 a Swiss court held this information disclosure was unlawful as a matter of Swiss law. But this ruling will not prevent the United States from using the information unless one could establish that the United States played a direct role in violating foreign law.
4. Other Developments
a. Bank Leumi Requires Disclosure. In November 2010 Bank Leumi, Israel's largest bank, began requiring U.S. clients to declare accounts to the IRS or close their accounts. The move was used to highlight the bank's desire to comply with all legal regulatory guidelines as the United States continues to focus on prosecuting individuals and entities that promote tax evasion to U.S. taxpayers.
b. WikiLeaks Obtains Data On Offshore Accounts. On January 17, 2011, Rudolf Elmer, former chief of the Cayman office of Julius Baer, delivered account data of approximately 2,000 offshore accounts to WikiLeaks. WikiLeaks has not yet made the data public although it originally claimed the data could be available in a matter of weeks. Julius Baer has denied any wrongdoing. Mr. Elmer is now facing charges in Switzerland for violating bank secrecy laws. Neither of these facts, however, is likely to dissuade the United States from using this data if this information becomes available to them. Reports state that the data provided to WikiLeaks had been provided to tax authorities some months ago.
c. HSBC-India Prosecutions. On January 26, 2011, U.S. prosecutors indicted a naturalized U.S. citizen from India on charges arising from his account relationship with an international bank, which several published reports state is HSBC Holdings PLC, from 2001 until around 2010. The indictment describes in detail the alleged activities between the account holder and five unnamed co-conspirators, all of whom were account managers at the international bank either in the United State or India. The indictment alleges the bank managers helped the account holder conceal assets through foreign corporations, discouraged him from repatriating funds, offered to assist him in moving his money, and that the managers tailored this scheme specifically to U.S. citizens of Indian descent. Since January, the Department of Justice has charged or obtained guilty pleas from other HSBCIndia account holders.
d. Actions Against Credit Suisse Bankers. After the arrest of one former UBS banker now working at Credit Suisse, and the indictment of an alleged co-conspirator, U.S. prosecutors in Alexandria, Virginia, charged four other Credit Suisse bankers with aiding and abetting U.S. citizens in evading taxes. The four bankers, all current or prior wealth advisers with Credit Suisse, are alleged to have assisted in the creation of thousands of offshore accounts with a combined value of $3 billion. The indictment also alleges the bankers encouraged Americans to transfer assets to smaller banks in Hong Kong and Tel Aviv and to avoid participation in the 2009 voluntary disclosure initiative. Credit Suisse was not included in the indictment and maintains that it is fully compliant with banking regulations.
e. Follow-Up Interviews–2009 Voluntary Disclosure Initiative. The IRS Criminal Investigation Division, in some cases working with U.S. Attorney's Offices or the DOJ Tax Division, has been engaged in significant follow-up activity regarding information obtained from the 2009 IRS Offshore Voluntary Disclosure Program. Criminal investigators are contacting persons who made disclosures in the 2009 program to obtained detailed information about their banks, bankers, financial advisers, foreign lawyers, and any other persons who may have facilitated their use of an undeclared foreign account. A number of well-known foreign financial institutions appear to be the subject of these inquiries, as well as certain advisers and other third parties who appear to have had a number of U.S. clients with undeclared foreign accounts.
5. The IRS and Justice Department view the template of the UBS investigation as a path toward obtaining similar information from other financial institutions. To the extent the American authorities can obtain leverage over these financial institutions, such that there is a risk that the bank itself could be indicted, the United States can attempt to pry open additional disclosures through a deferred prosecution agreement or other method. A financial institution faced with potential loss of privileges to do business in the United States is likely to find some way to comply with requests for further information. At least as concerns Switzerland, the ruling on the illegality of the disclosure pursuant to the UBS DPA, and the resolution of the UBS John Doe summons case (discussed below), make unlikely another "compelled disclosure" along the lines that occurred in the UBS DPA.
6. Various state governments are also conducting criminal investigations of their taxpayers arising from undeclared foreign accounts. The Manhattan District Attorney in New York has been active and has obtained guilty pleas and civil settlements. Other states appear to be pursuing persons who have allegedly evaded state taxes through the use of undeclared foreign accounts.
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This article is designed to give general information on the developments covered, not to serve as legal advice related to specific situations or as a legal opinion. Counsel should be consulted for legal advice.