Is the IRS Poised To Prosecute Tax-Evaders?

By Attorney Morris N. Robinson, CPA, LLM
February 10, 2012

Executive Summary
 
Is the IRS gearing-up for a crackdown on tax-evaders who have not accurately reported their foreign-source income and their foreign bank and brokerage accounts? The evidence for a coming crackdown seems unmistakable.  This article “connects the dots” and provides an analysis of recent events.  This article also demonstrates how our tax boutique has the experience to help taxpayers minimize their taxes and penalties and avoid criminal prosecution.
 
Breaking News
 
The IRS is moving quickly to obtain the names of Americans who maintain Offshore bank and brokerage accounts.
 
·         On February 2, 2012, Wegelin & Co., Switzerland’s oldest private bank, was indicted by the Justice Department for allegedly conspiring with U.S. taxpayers and others to hide more than $1.2 billion in secret bank accounts.[1]  At least nine other Swiss banks, including Credit Suisse and Basler Kantonalbank, have been pressured by the IRS to release the names and contact information of their American customers and related tax and banking professionals.
 
·         On February 6, 2012, the private Swiss Bank, Julius Baer Group, announced that it may face possibly significant financial penalties for allegedly helping some of their American clients evade United States income taxes and FBAR filings.[2]
 
·         On February 8, 2012, the New York Times reported that France, Germany, Italy, Spain and Britain agreed to support the United States efforts to identify offshore accounts held by Americans.[3]
 
·         On February 10, 2012, the New York Times published an editorial entitled “The Fight Against Tax Evasion” approving of the pressure the United States is placing on Switzerland and its banks to release the names of potential American tax-evaders.  The editorial concludes: “If Switzerland stonewalls, the Justice Department can indict banks that benefit from tax evasion and seize their assets in the United States, moves that could put them out of business.  At some point, the Swiss government will find that result a lot more costly than handing over information on American tax cheats.”[4]
 
On January 9, 2012, the IRS announced the 2012 Offshore Voluntary Disclosure Program (2012 OVDP), which will allow most taxpayers to come forward and avoid criminal prosecution for failure to report foreign-source income and foreign bank and brokerage accounts.[5] This announcement comes less than one year after the second voluntary disclosure initiative (the 2011 OVDI) was announced on February 8, 2011, and less than three years after the first voluntary disclosure initiative (the 2009 OVDP) was announced on March 23, 2009.  This latest disclosure program appears to be connected with the vigorous IRS efforts to obtain the names of tax-evading Americans.
 
News Analysis
 
Congress has starved the IRS by refusing to appropriate sufficient funds for full enforcement of the income tax laws.[6] As a result, the IRS is stretched thin. The IRS assigned about 1,000 audit and collection personnel nationwide to review the submissions of the 33,000 taxpayers who have already come forward under the previous 2009 OVDP and the 2011 OVDI.  This small number, however, represents about 10 percent of the IRS’s available auditors and collection officers. Therefore, the believable threat of criminal prosecution may be the only practical method the IRS has for achieving full voluntary compliance with United States tax and bank secrecy laws.  

The prosecution of Americans – which has already resulted in convictions and prison sentences – may intensify as soon as IRS has the information it needs to bring new indictments.  We believe that the IRS will soon have the information needed to prosecute tax-evading Americans. There are two sources for this reasonable belief.

·         The IRS believes it will soon have the information needed to prosecute tax-evading Americans through the new Foreign Account Tax Compliance Act (“FATCA”).[7]  This law requires foreign bank and brokerage companies to report to the IRS the foreign income of United States citizens and residents beginning with the 2011 taxable year.  Indeed, as noted above, earlier this week France, Germany, Italy, Spain and Britain in effect agreed to support the IRS’ FATCA efforts.[8]
 
·         The IRS expects that foreign banks and brokerage companies will follow the lead of UBS AG, which in 2010 disclosed the contact information of over 4,450 American of its customers with account balances of 1 million Swiss Francs (about $1 million) or more. We believe the recently-announced 2012 OVDP also may help convince juries to convict tax evaders.  Prosecutors can be expected to tell juries that willfulness – a key element in criminal prosecutions – can be inferred from a taxpayer’s refusal to take advantage of three separate well-publicized opportunities to come forward without the risk of criminal prosecution.
Therefore, those who are not fully compliant with the United States tax and bank secrecy laws should consider coming forward as soon as possible under the 2012 OVDP.  If a foreign bank provides information on a taxpayer to the IRS before that person makes a voluntary disclosure, that person will be ineligible to participate in the 2012 and its protection from criminal prosecution.
 
Those who choose to come forward will want a tax attorney to represent them before the Internal Revenue Service and, in some cases, will want a white collar criminal lawyer to represent them before the Department of Justice.
 
How We Can Help
 
M. Robinson & Company is a tax-law boutique that provides experienced tax representation.  We have worked with taxpayers who participated in the 2009 OVDP and the 2011 OVDI and have strong experience in successfully mitigating, or abating completely, income tax-related and FBAR penalties.
 
Our Experience with Penalty Mitigation and Abatement

Taxpayers in the 2012 OVDP will be assessed interest, income tax-related penalties, and a so-called “miscellaneous penalty.”  The income tax-related penalties consist of a 25 percent failure-to-file penalty, a 20 percent negligence penalty, and 25 percent failure-to-pay penalty.  Each of these penalties is based on the unreported or unpaid income taxes.  Interest is then assessed on the above-described taxes and penalties. The so-called “miscellaneous penalty” is in addition to these penalties. The “miscellaneous penalty” is computed by multiplying the “penalty rate” by the “penalty base.”

·        The “penalty rate”under the 2012 OVDP can vary between 5 percent in special circumstances[9] to 12.5 percent where there are no special circumstances and the “penalty base” does not exceed $75,000, to 27.5 percent where there are no special circumstances and the “penalty base” exceeds $75,000.
 
·         The “penalty base”generally includes unreported financial accounts and property purchased with unreported foreign-source income.  It is the highest amount of unreported assets held by the taxpayer during the years of underreporting beginning with 2003.

Under the OVDP penalty scheme, there is little room for penalty mitigation.  Under the regular statutory penalty scheme, however, penalties can be mitigated or completely abated where noncompliance is due to “reasonable cause” and is not “willful.  Therefore, we have advised our clients to “opt out” of the OVDI penalty scheme when we believe our clients the above-listed mitigation criteria.  “Opt-out” decisions allow taxpayers to retain their protection from criminal prosecution while potentially reducing or completely abating their penalties.

An “opt-out” decision always requires careful thought because an “opt-out” decision could result in a greater penalty.  Specifically, a taxpayer who willfully fails to report foreign financial accounts on an FBAR,[10] may receive a civil penalty equal to the greater of $100,000 or 50 percent of his or her unreported foreign account balances.  This penalty applies cumulatively to each year of non-compliance, resulting in the effective confiscation of willfully-unreported financial assets. This penalty may be substantially greater than the so-called OVDP “miscellaneous penalty.” Hence, the need for caution.

Ultimately, the IRS wants taxpayers to conform to (and no longer ignore) the intricate tax laws governing the reporting of foreign-source income, foreign financial accounts, and foreign financial activity.  We, therefore, begin our penalty mitigation efforts by assisting our clients prepare thoughtful and accurate income tax returns and FBARs.

Our Experience with Income Tax Return Preparation
 
In the process of representing our clients, we have acquired considerable experience with the preparation of United States income tax returns that accurately report foreign income.  Our expertise includes:
 
         1.      Using the United States Foreign Tax Credit Effectively.The United States foreign tax credit reduces the United States tax liability on foreign-source
                  income for foreign income taxes paid or accrued on the same “basket” (category) of foreign-source income.  This dollar-for-dollar credit is subject to
                  a complex series of rules. These include:
 
                               a.       Allocating Foreign-Source Income to “Income Baskets.” Foreign-source income must be allocated into different “baskets,” such as      
                                        “passive  income” and “general category income.”  This includes the allocation of foreign-source capital gains into “passive income” and
                                        “general category income.”
 
                               b.      Alternative Minimum Foreign Tax Credit. Just as there is a foreign tax credit for regular income tax purposes, there is also a separate 
                                        foreign tax credit for alternative minimum tax purposes.  The alternative minimum foreign tax credit has its own set of carrybacks and
                                        carryforwards.
 
                               c.       Carrybacks and Carryforwards. We understand how to account for foreign tax credit carrybacks and carryforwards for both the regular
                                         foreign tax credit and the alternative minimum foreign tax credit.
 
                               d.      Accruing Foreign Income Taxes. We can offset “present” United States income taxes against “accrued” foreign income taxes where the
                                        foreign income taxes will be paid to a foreign government in a later year.
 
                               e.      Interaction with Foreign Earned Income Exclusion. We understand the interaction of the foreign tax credit and the United States limited
                                        exclusion on foreign earned income.
 
                               f.       Foreign Tax Credit on PFIC Income. The PFIC rules do not change the character of income, such as “general category” income or
                                        “passive” income.  Rather, the PFIC rules affect only when the income is recognized; whether the gain or loss is ordinary or long-term    
                                         capital gain and the rate of tax on the ordinary income.  Thus, the foreign taxes paid or accrued on foreign-source income may offset the
                                         United States income taxes arising from the identical “basket” of income – even if that income is PFIC income.
 
          2.      Reporting PFIC Income.  PFIC income is income generated by foreign mutual funds, called passive foreign investment companies (PFICs).  Unlike
                   income from United States mutual funds, income from foreign mutual funds must generally be “marked-to-market” on an annual basis.  These
                   “mark-to-market” adjustments can affect the timing of gain or loss and in some cases the character of the gain or loss as ordinary or long-term
                   capital gain.  We are able to report the income from foreign mutual funds accurately along with the foreign tax credit on PFIC income as described
                   above.
 
          3.      Using Income Tax Treaties.  United States income taxation of foreign income is subject to the treaties the United States ratified with foreign
                   countries.  We understand and apply these treaties when representing voluntary disclosure clients and, for example, have used income tax treaties
                   to exclude from income the earnings of sizable foreign retirement accounts.
 
          4.     Tax Accounting Using Foreign Functional Currencies. We are familiar with the special tax-accounting rules taxpayers must follow when they have
                   interests in businesses that use a currency other than the United States dollar as their functional currency.  Our experience with functional
                  currencies includes (1) reporting installment sales; (2) computing rental income and expense; (3) depreciating residential and business real estate;
                  and (4) calculating tax basis (tax cost).
 
          5.     Avoiding Tax on Repatriation of Certain Funds under Section 1031. The devaluation of the United States dollar against foreign currencies typically
                  results in the recognition of gain for United States income tax purposes when the foreign currencies are exchanged for United States dollars.  These
                  gains can sometimes be postponed under section 1031 where the underlying assets were held for investment both before and after the currency
                  exchange and both the dollar and the foreign currency were functional currencies.
 
          6.     Tax Accounting for Foreign Investments. Special tax-accounting rules apply to the taxation of interest income from foreign bonds, gain or loss on
                  the sale of foreign bullion, etc.
 
          7.      Using the Foreign Earned Income Exclusion. This allows for the partial exclusion of income earned abroad under certain circumstances.
 
Our Experience with FBAR Preparation (Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts)
 
We have considerable experience preparing complex FBARs where a United States person (typically a United States citizen or green card holder) has signature authority over a foreign bank or brokerage account owned by his or her employer and/or jointly with another member of his or her family.
 
Our Experience with Complex Foreign Information Return Preparation
 
We are experienced in preparing of a number of different information returns, which if not done correctly and filed timely can result in significant penalties to the taxpayer.  This includes:
 
         1.      Reporting Foreign Gifts – Form 3520.  Gifts in excess of $100,000 are reported on Form 3520.
 
         2.      Reporting Foreign Trusts – Form 3520.  Beneficiaries report the distributions they receive from foreign trusts using Form 3520.
 
         3.      Reporting Transfers to Foreign Corporations – Form 926.  Transferors must report the transfer of money and property to foreign corporations using
                  Form 926.
 
         4.      Reporting the Activities of Foreign Corporations – Forms 5471/5472.   The shareholders of foreign corporations must report the activities of their
                  foreign corporation using Form 5471 and, in some cases, Form 5472.
 
Contact Us
 
Please contact us if we can be of assistance.  We never charge for a confidential initial phone consultation with a potential new client and/or his or her legal and accounting advisors.
 
-End of Article-