New IRS Voluntary Disclosure Program on the Horizon for U.S. Persons with Undisclosed Foreign Financial Accounts

January 27, 2011

The Internal Revenue Service (IRS) is set to announce soon a new reduced-penalty voluntary disclosure program for U.S. owners of previously undisclosed foreign financial accounts – and with it, the best opportunity for such persons to come forward may again be at-hand.

Background

According to recent remarks made by IRS Deputy Commissioner Stephen Miller, the new program will build on the first reduced-penalty offshore voluntary disclosure program that ended in October 2009 and yielded approximately 15,000 taxpayer disclosures. Deputy Commissioner Miller indicated that taxpayers who did not qualify for the first voluntary disclosure program would be eligible for the settlement terms of the new program.

The 2009 reduced penalty voluntary disclosure program permitted taxpayers to effectively avoid criminal prosecution, if they disclosed all of their previously undisclosed foreign financial accounts and agreed to: (1) pay all unpaid taxes (and interest with respect thereto) going back six years; (2) pay an accuracy or delinquency penalty on the overdue tax for each of the six years; and (3) in lieu of all other penalties that may apply, pay a penalty equal to 20% of the highest aggregate balance held in the account during the six-year period.

In contrast, in the absence of such a reduced-penalty voluntary disclosure program, a U.S. person’s non-willful violation of the requirement to disclose his interest in an applicable foreign financial account could result in a civil penalty up to $10,000. A willful violation could result in a civil penalty equal to the greater of $100,000 or 50% of the balance in the account at the time of the violation. These penalties are in addition to any criminal penalties, including fines and imprisonment that could apply.

Although it is relatively certain that the terms of the new voluntary disclosure program will not be as favorable as the terms of the first program, we expect that, given the IRS’s stated goal of getting more U.S. taxpayers in compliance, the reduced-penalty framework of any new voluntary disclosure program will still be significantly more favorable for many taxpayers than the penalties and uncertainty such taxpayers would face in the absence of coming forward under such a program.

Who Must File an FBAR?

Any U.S. person, whether residing in the United States or abroad, who has a financial interest in or signature authority over any financial account in a foreign country must file a Report of Foreign Bank and Financial Accounts (FBAR) disclosing their interest in such accounts, if the aggregate value of these accounts exceeds $10,000. The FBAR is due by June 30 of the year following the year that the account holder meets the $10,000 threshold.

There is no extension for filing the FBAR. Accordingly, if you are a U.S. person with such an interest or signature authority over a foreign financial account and you have not previously filed an FBAR with respect to such account, you should strongly consider taking advantage of the voluntary disclosure process now, before the IRS finds you first.

Filing a Voluntary Disclosure

According to long-standing IRS procedure, a voluntary disclosure occurs when: (1) the taxpayer makes a communication with the IRS that is truthful, timely and complete; (2) the taxpayer shows a willingness to cooperate (and does in fact cooperate) with the IRS in determining his correct tax liability; and (3) the taxpayer makes good faith arrangements with the IRS to pay in full the tax, interest, and any penalties determined by the IRS to be applicable.

In general, a letter from an attorney which encloses complete and amended tax returns from a client which reports legal source income omitted from the original returns and which offers to pay the tax, interest, and any penalties determined by the IRS to be applicable in full and which meets the timeliness standard, constitutes a voluntary disclosure for these purposes.

It is important to note that a communication will not be considered timely – and thus the terms of any voluntary disclosure program will not be available – if the voluntary disclosure is received by the IRS after: (1) the IRS has initiated a civil examination or criminal investigation of the taxpayer, and the IRS has notified the taxpayer that it intends to initiate a civil examination or criminal investigation of the taxpayer; (2) the IRS has received information from a third party alerting the IRS to the specific taxpayer’s noncompliance; (3) the IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or (4) the IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action. In short, for these reasons, time is of the essence when making a voluntary disclosure submission to the IRS.

Given the high stakes involved and the amount of time it can take to obtain the foreign financial records necessary to make a voluntary disclosure, U.S. taxpayers who would like to honor their overdue FBAR filing obligations should get started now. We have assisted numerous individuals and companies in complying with their FBAR obligations and the tax and information reporting requirements associated therewith.

Please do not hesitate to contact any of us or any member of the McGuireWoods Tax Controversy Team if you would like additional information on your options for reporting a previously undisclosed foreign financial account.

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