Thursday, August 27, 2009

U.S. taxpayers with foreign accounts have relied on foreign bankers' assurance that they would never divulge their customers' secrets. However, based on recent events, it is naive to hope that their Swiss accounts will remain private and the whole thing will just blow over. A U.S. federal judge declared that all of UBS's assets in the U.S. will be seized if his disclosure Order described is not followed. Under a settlement announcement last week (details of which are not yet provided), the Swiss government will apparently not stand in the way of the court-ordered disclosure.

Until September 23, 2009, taxpayers with unreported income in foreign bank accounts can take advantage of a March 2009 IRS settlement offer. In exchange for full disclosure and payment of all back taxes, interest, and penalties, the IRS agrees that it will go back only a limited number of years for audit, the level of penalties will be lower than would otherwise exist, and criminal prosecution will not occur.

The IRS contends that, as of 2004, UBS held 52,000 accounts containing a $14.8 billion total asset value. Although the IRS reports that the level of self-reporting under this amnesty program is above the almost non-existent amended reporting before the amnesty program, the number of taxpayers accepting amnesty so far is a small percentage of those that the IRS contends have this tax problem.

The Court Orders UBS to Give its Customer Data to the IRS, and the Swiss Government Backs Down

The Americans whose information UBS has not yet turned over should realize that there is little possibility that their past reporting will remain secret. The government's "Memorandum of Law In Support Of Petition to Enforce "John Doe" Summons" details the results of the government investigation, most of which cannot be meaningfully disputed based on UBS's deferred prosecution agreement (see chronology below for details). Here is a sample of the government's view of the wrongdoing:

"UBS's own documents and admission of guilt in the related criminal case – prove that for years UBS regularly sent private bankers into the United States, and used phone, fax and e-mails from Switzerland to communicate with American clients in the United States, to help American taxpayers evade their obligations to report and pay taxes on all income, and to declare all offshore bank accounts.

The Internal Revenue Service is investigating as many as 52,000 unknown U.S. taxpayers who flouted their obligations to their government, by refusing to disclose their secret accounts at UBS AG, one of the largest banks in Switzerland. The IRS seeks the identities of those account holders (and other account information) from a Swiss bank that regularly conducted business in secret within the United States, and systematically violated U.S. law.

UBS regularly sent its private bankers into the United States to solicit business from and maintain business with U.S. citizens and residents. Those UBS private bankers made thousands of client solicitations and contacts within the United States. Those contacts earned UBS AG more than $100 million in fees. At the same time, that business cost the U.S. Treasury hundreds of millions of dollars in unpaid taxes. UBS AG ended this practice only after the Tax Division of the Department of Justice learned of its conduct, and contacted UBS. Until its activities were discovered, UBS – on U.S. soil – regularly violated U.S. law, and actively helped its U.S. customers violate U.S. law….

"In light of its admitted illegal conduct within the United States, UBS's argument defies all notions of common sense and fair play. In essence, UBS argues that it may come into the United States, violate the laws of the United States with impunity for seven years, and help thousands of its U.S. customers violate the laws of the United States – evading hundreds of millions of dollars in U.S. income taxes in the process. And as long as it maintains the records of its wrongdoing – and the identities of its lawbreaking U.S. customers – in Switzerland, UBS argues that the IRS is powerless to obtain those records. This proposition not only defies the law, it defies logic and common sense as well."

In a July 7, 2009 Order, the Court denied UBS the disclosure protection that UBS sought. On the same day, the Swiss government objected to the government's efforts to enforce the summons, asserting that UBS would be unable to comply with the summons without breaking Swiss law. The Swiss government brief concluded:

"The government of Switzerland will use its legal authority to ensure that the bank cannot be pressured to transmit the information illegally, including if necessary by issuing an order taking effective control of the data at UBS that is the subject of the summons and expressly prohibiting UBS from attempting to comply."

On July 31, 2009, the parties reported to the Court that the Swiss and U.S. governments reached an agreement on major issues involving disclosure. Remaining issues are expected to be resolved before an August 10 evidentiary hearing that the Court rescheduled in response to the settlement progress. The parties and governments have not yet released further details at that time.

The IRS's Comparison with and without Amnesty

Even with amnesty, the amounts owing are still quite painful. In a Frequently Asked Questions released by the IRS on May 6, 2009, the IRS provides the following example based on a $1 million unreported foreign account balance and $300,000 of unreported interest covering five years:

"If the taxpayer comes forward and has their voluntary disclosure accepted by the IRS, they …would pay $386,000 plus interest. This includes:

- Tax of $105,000 [assumes a 35% tax bracket] plus interest,

- An accuracy-related penalty of $21,000 (i.e., $105,000 x 20%), and

- An additional penalty, in lieu of the FBAR and other potential penalties that may apply, of $260,000 (i.e., $1,300,000 x 20%)."

In short, the taxpayer under amnesty pays the U.S. 129% of the total income that was earned. However, this is mild when compared to what the government explains will be demanded without amnesty and $300,000 of total unreported income. In short, the amounts owing will almost two times the entire account balance and accumulated unreported income:

"If the taxpayer didn't come forward and the IRS discovered their offshore activities, they face up to $2,306,000 in tax, accuracy-related penalty, and FBAR penalty. The taxpayer would also be liable for interest and possibly additional penalties, and an examination could lead to criminal prosecution.

The civil liabilities potentially include:

- The tax and accuracy-related penalty, plus interest, as described above,

- FBAR penalties totaling up to $2,175,000 for willful failures to file complete and correct FBARs (2003- $100,000, 2004 - $100,000, 2005 - $100,000, 2006 - $600,000, 2007 - $625,000 and 2008 - $650,000),

- The potential of having the fraud penalty (75 percent) apply, and

- The potential of substantial additional information return penalties if the foreign account or assets is held through a foreign entity such as a trust or corporation and required information returns were not filed.

Note that if the foreign activity started more than six years ago, the Service may also have the right to examine additional years."

If these monetary amounts were not enough, here is the IRS description of the criminal charges without the amnesty program:

"Possible criminal charges related to tax returns include

- tax evasion (26 U.S.C. § 7201),

- filing a false return (26 U.S.C. § 7206(1)) and

- failure to file an income tax return (26 U.S.C. § 7203)

- The failure to file an FBAR and the filing of a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. § 5322.

A person convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000."

Key Background Chronology

Here is some background to understand the current risks to the taxpayers with these accounts:

1. In 2001, the IRS established a Qualified Intermediary Program (QI Program) to attract foreign investors to U.S. securities. More than 7000 foreign banks participate in the program. Until October 13, 2008, the IRS allowed the banks to promise to identify clients, withhold any taxes due on U.S. securities in their account (typically 30%) and send the tax money owed to the IRS.

2. Taxpayers are required to report all income from domestic and foreign sources. In addition, U.S. taxpayers who have foreign accounts with an aggregate value of more than $10,000 at any time during the year must file a Foreign Bank and Financial Account report, Form TD F 90-22 (FBAR) with the Treasury Department by June 30 each year. A check-the-box question as part of Form 1040 requires taxpayers to answer whether they have signature authority or a financial interest in any foreign account, and that this form has been properly completed. However, the FBAR is not filed with your federal tax return. Instead, it is filed with the Department of the Treasury by June 30 of the year following each calendar year. There is no extension of time available for filing the FBAR.

3. In July 2008, The Senate's Permanent Subcommittee on Investigations issued a report concerning "Tax Haven Banks and U.S. Tax Compliance". The report contained numerous findings regarding the manner in which wealthy U.S. citizens have (illegally) used foreign trusts to avoid U.S. taxation. The report indicates the unreported tax problem is much larger than previously anticipated.

4. In February 2009, UBS settled a lawsuit by paying a $780 million fine and agreeing to a deferred prosecution agreement. UBS disclosed to the IRS approximately 300 U.S. taxpayers in connection with this deal. As part of the deferred prosecution agreement, UBS admitted that from 2000 to 2007, its Swiss private bankers helped Americans evade U.S. taxes through sham offshore companies in tax havens and submitted misleading forms to the U.S. government regarding beneficial account owners.

5. One day after this settlement, the Justice Department filed a civil suit seeking to force UBS to disclose what the IRS believes are 52,000 UBS client names of U.S. taxpayers for whom UBS did not possess an appropriate Form W-9 and did not file accurate Forms 1099.

6. In June 2009, the first of UBS's customers whose information was provided to the IRS in connection with the deferred prosecution agreement enters a criminal guilty plea. The taxpayer agrees to pay back taxes and severe penalties, and will likely serve some jail time. A similar second UBS customer pleads guilty in July 2009.

Our prior article a year ago predicted what is now happening. We continue to believe that the situation for those with unreported foreign income and accounts will continue to deteriorate.

Fulcrum Inquiry performs forensic accounting and financial investigations