Americans, pay your taxes on time and avoid prosecution

At the end of March 2009, the US tax authorities, Internal Revenue Service (IRS), announced a six-month voluntary disclosure programme (VDP) to Americans who come forward and pay back taxes due on unreported offshore account holdings.

The VDP offers lower penalties and the possibility of escaping criminal prosecution, provided the offshore funds originated from legal sources.

The IRS has had a voluntary disclosure practice for many years, but many taxpayers were reluctant to use it. This was due to uncertainty about the degree of liability for potentially severe civil penalties, the harshness of which could result in back taxes, interest and penalties exceeding the value of the entire offshore account.

As the US now struggles with rising deficits and public anger over financial bailouts, President Obama and Congress have focused on reducing tax evasion through the use of overseas accounts or entities as a significant step to ease the country's financial stresses.

The IRS' newly announced VDP will bring both more tax dollars to the needy Treasury and more delinquent taxpayers back into the filing system.

The IRS has stated that the number of Americans who have disclosed foreign accounts has already more than doubled this fiscal year over 2007-08.

The VDP was developed at a time when the US Department of Justice (DOJ) was nearing success in its battle with UBS over the Swiss bank's role in encouraging tax evasion by Americans with offshore accounts.

As part of its settlement allowing it to avoid criminal prosecution, UBS admitted to abetting tax evasion, paid US$780 million (Dh2.8 billion) in fines, and released information about Americans owning over 250 offshore accounts.

The bank continues to fight an IRS subpoena seeking information disclosure on over 50,000 other offshore accounts.

In order to resolve cases in an organised manner and to make exposure to civil penalties more predictable, the IRS has centralised the civil processing of offshore voluntary disclosures and offers a uniform penalty structure for taxpayers who voluntarily come forward.

While some Americans who enter the VDP are likely to provide information about the bankers, lawyers and accountants who assisted them in setting up the offshore plan, such cooperation is not a requirement.

Anyone already under criminal investigation for tax evasion is not eligible. The programme enables non-compliant taxpayers to resolve their tax liabilities and minimise their chances of criminal prosecution.

When a taxpayer "truthfully, timely, and completely" complies with all provisions of the VDP, the IRS will not recommend criminal prosecution to the DOJ.

Many individuals who maintain undisclosed offshore accounts are now seeking advice on how they can cure failures to report before they are contacted by the IRS, the DOJ or some other US governmental agency.

Whatever the reason for the creation and maintenance of such an unreported foreign account, it is now possible to be "cleansed" under the VDP and clear all legal obligations once and for all.

Any action should be taken with extreme caution and only after a full and complete analysis of all pertinent facts. It must be remembered that the making of a voluntary disclosure is not a guarantee of any kind. Instead, it is only a mitigating circumstance that the IRS will take into account in deciding whether to recommend criminal prosecution.

Under the VDP, owners who voluntarily disclose foreign accounts would pay:

o Back taxes and interest for a minimum of six years;

o Depending on whether a return was filed, either a 20 per cent or a 25 per cent accuracy-related penalty on the tax owed for each year.

o An additional 20 per cent penalty in lieu of certain other penalties, imposed on the highest aggregate value at any point during the last six years for the offshore foreign accounts.

An example, as below, is provided in an IRS guidance release issued in early May: Assume the taxpayer has the following amounts in a foreign account over a period of six years (see table).

The example does not provide for compounded interest, and assumes the taxpayer is in the 35 per cent tax bracket, files a return but does not include the foreign account or the interest income on the return, and the maximum applicable penalties are imposed.

If the taxpayer comes forward and voluntary disclosure is accepted by the IRS, they face this potential scenario:

They would pay $386,000 plus interest which includes:

o Tax of $105,000 (six years at $17,500) plus interest,

o An accuracy-related penalty of $21,000 (ie, $105,000 x 20 per cent), and

o An additional penalty, in lieu of certain other potential penalties that may apply, of $260,000 (i.e., $1,300,000 x 20 per cent).

If the same taxpayer didn't come forward and the IRS discovered the offshore account, the person faces up to $2,306,000 in tax, accuracy-related penalty, and other penalties.

In addition, the taxpayer would also be liable for interest and possible additional penalties, as well as possible criminal prosecution. The IRS' approved penalty framework is effective only for a six month period. After that time, the IRS will re-evaluate the program and decide whether, or how, to continue it in the future.

Taxpayers are advised not to wait until the end of the six-month time frame since there is no guarantee that they will still be eligible or that the current penalty terms will be available.

The IRS has stepped up its enforcement efforts, including the use of so-called John Doe summonses, to identify taxpayers using offshore accounts and entities to avoid tax and thus, the likelihood of getting caught is increased.

- The author is a Dubai-based American attorney specialising in US and international taxation planning as well as international commercial transactions.

She can be reached at vjeker@eim.ae.

The information provided does not constitute tax or legal advice and is of a general nature only. The opinion expressed here are the author's and do not necessarily reflect the views of Gulf News.