Kristin Konschnik of Withers discusses the ramifications of the US Internal Revenue Service’s recently announced updated guidance for the 2011 Offshore Voluntary Disclosure Initiative.

Kristin Konschnik of Withers discusses the ramifications of the US Internal Revenue Service’s recently announced updated guidance for the 2011 Offshore Voluntary Disclosure Initiative.

The Offshore Voluntary Disclosure Initiative (2011 OVDI) is the second formal IRS amnesty programme aimed at US taxpayers with unreported offshore income and assets. The IRS has also announced that it intends to move against “one or more banks” in the next month as part of its crackdown on offshore tax evasion.

The current atmosphere of compliance in the US prompted by the UBS investigation, among other things, has given the IRS multiple tools to ensure that wealthy US citizens comply with their US federal tax and reporting obligations. These methods include:

·        The new Offshore Voluntary Disclosure Initiative announced in February 2011

·        The taxpayer Foreign Bank Account Reporting (FBAR) requirement

·        A separate taxpayer reporting obligation for foreign financial assets

·        The Foreign Account Tax Compliance Act (FATCA), requiring foreign financial institutions to report their US clients to the IRS

·        The recently organised IRS Global High Wealth unit, focused on auditing the complex structures of high net worth individuals and families

Inescapable obligations

The starting premise is that US citizens and permanent residents (greencard holders) are subject to US tax and reporting obligations with respect to their worldwide income, even if they live outside the US. Furthermore, US citizenship is automatically granted to anyone born in the US and to many people born outside the US to one US citizen parent (in either case, regardless of whether they have a US passport).

The various measures at the IRS’ disposal (not to mention the volume of information the IRS may obtain – or has obtained – from potential whistleblowers, disgruntled bank employees and prior voluntary disclosures) will put increasing pressure on non-compliant US citizens and greencard holders, who should “come clean” as soon as possible.

Who is in the IRS’ sights?

The 2011 OVDI is aimed primarily at US taxpayers with unreported offshore income and assets. Eligible taxpayers who choose to participate in the 2011 OVDI must submit all back tax and information returns for tax years 2003 through 2010 and pay all taxes, interest, accuracy and delinquency penalties by 31 August 2011, although a 90-day extension may be granted in certain circumstances under new guidance.

The taxpayer must also pay a 25 per cent “in lieu of” penalty on the total value of all unreported foreign bank accounts and entities, determined by reference to the year in which the value of these accounts and entities was the highest in the period between 2003 and 2010; total value also could include the value of the taxpayer’s “non-financial assets,” such as their house, if purchased with unreported income.

Under newly-published guidance, a reduced penalty of 5 per cent could apply to certain individuals living outside of the US who have complied with their tax obligations in the country of residence; furthermore, the penalty base under this exception may exclude non-financial assets. A taxpayer also may choose to become compliant by filing “quietly” instead of participating in the 2011 OVDI, although the IRS has stated that they do not view “quiet disclosures” as valid voluntary disclosures.

Yet more reporting requirements

The FBAR is another IRS information-gathering mechanism and a focus of the 2011 OVDI.

US taxpayers must report all of their foreign financial accounts on an FBAR if those accounts exceed $10,000 in the aggregate. Substantial civil penalties apply for failure to file an FBAR: for non-wilful failures, $10,000 per account per year, and for wilful failures, 50 per cent of the highest account balance or $100,000, whichever is greater, per account per year. Criminal penalties also may apply for wilful failures. In addition, legislation enacted in 2010 as part of the HIRE Act requires US taxpayers to report certain “foreign financial assets,” including non-US deposit or custodial accounts, stocks and securities of foreign issuers and interests in foreign entities, if the value of these assets exceeds $50,000 in the aggregate. Substantial penalties may apply if a taxpayer fails to make the required disclosure.

The regulatory burden on institutions

Furthermore, under FATCA, foreign financial institutions such as banks that invest directly or indirectly in the US will be required to identify and ultimately disclose their US account holders to the IRS effective from 1 January 2013. The onerous nature of these requirements may cause some foreign banks to decline US account holders, making it more difficult for wealthy US citizens living abroad to maintain bank accounts where they live. Presumably, the IRS will look to match taxpayer and bank reporting to identify any non-compliance.

Finally, the IRS recently created a new Global High Wealth unit,  the purpose of which is increasing the compliance of high wealth individuals and families, and understanding the complex structures they use, including trusts, private foundations, partnerships and other legal structures.

The IRS anticipates that a GHW unit review will start with a high net worth individual’s tax return but branch out to returns of other family members, retirement plans and related private foundations and business entities. While the GHW unit is relatively new, the IRS views it as a permanent addition to the IRS audit functions.

Given the range of tools available to the IRS to “ferret out” non-compliant US taxpayers, wealthy US citizens who are non-compliant should “come clean” as soon as possible or they may find it increasingly more difficult to do so without substantial cost and, potentially, criminal exposure.