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Taxpayers with bank or other financial accounts offshore should be reminded that they are required to file Form TD F 90-22.1 (“Report of Foreign Bank and Financial Accounts”) by June 30 of this year for the 2008 calendar year. Failure to comply with this requirement could result in meaningful sanctions.

The Internal Revenue Service has stepped up enforcement efforts against taxpayers hiding assets offshore or earning unreported income overseas. Highly publicized cases against UBS highlight these enforcement efforts. It is not uncommon for taxpayers to fail to comply with offshore asset reporting guidelines, often because taxpayers simply are not aware of the myriad of disclosure requirements. As part of these efforts, the IRS recently announced two significant changes with respect to these reporting requirements: (i) a new voluntary disclosure initiative; and (ii) redesigned Form 926 for overseas asset transfers.

New IRS Offshore Account Voluntary Disclosure Initiative

Taxpayers are expected to comply with a number of offshore reporting requirements. Among these requirements is the filing by June 30 for the prior year of Form TD F 90-22.1, commonly known as the “FBAR.” Note that this due date is different than the due date applicable for a taxpayer’s U.S. Federal Income Tax Return. The FBAR also is sent to a different address than the taxpayer’s return (i.e., the FBAR is required to be filed with the IRS Service Center in Detroit). The FBAR is in addition to reporting the existence of the foreign account and the income therefrom on the taxpayer’s U.S. Federal Income Tax Return for the year. The FBAR is required to be filed by any U.S. taxpayer that has a financial interest in, or signatory authority over, financial accounts in a foreign country with an aggregate value exceeding $10,000 at any time during the tax year. Importantly (and often overlooked), a U.S. person has a financial interest in (and, therefore, a reporting obligation for) accounts of a (i) corporation in which the U.S. person owns directly or indirectly more than 50 percent of the total value or vote; (ii) partnership in which the U.S. person has a greater than 50 percent profits or capital interest; or (iii) trust in which the U.S. person has a present beneficial interest, directly or indirectly, in more than 50 percent of the assets or from which such person receives more than 50 percent of the income. Taxpayers that fail to file the FBAR may be subject to significant civil and criminal penalties.

Other potentially applicable reporting obligations in connection with offshore accounts include, for example, Form 926 (“Return by a U.S. Transferor of Property to a Foreign Corporation”), Form 5471 (“Information Return of U.S. Persons with Respect to Certain Foreign Corporations”), Form 3520 (“Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts”), and Form 8865 (“Return of U.S. Persons with Respect to Certain Foreign Partnerships”). There are additional penalties for failing to file these forms. Many taxpayers simply are not aware of all of the reporting requirements associated with ownership of foreign assets, but this does not excuse the failure to file.

The IRS has recently launched an aggressive campaign to address non-compliant taxpayers. More than 3,000 additional agents are being hired by the IRS for the increased enforcement efforts. Some of these efforts have been highlighted in the mass media through coverage of cases such as UBS. Some countries that have had strict bank secrecy laws preventing enforcement have begun to indicate a willingness to share information with U.S. enforcement agents. All of these developments result in heightened risks for taxpayers that are not currently complying with U.S. tax laws.

On March 26, 2009, the IRS announced a new initiative to encourage voluntary disclosure by taxpayers of offshore accounts. The voluntary compliance initiative was effective on March 23, 2009, and will remain in effect for six months (i.e., until September 23, 2009). Taxpayers making voluntary disclosures of offshore non-compliance can avoid many penalties, such as the account balance FBAR non-disclosure penalty provisions and other provisions pertaining to various information returns described above. Under the voluntary disclosure guidelines, the IRS will look back six years. The following guidelines apply to taxpayers voluntarily disclosing:

• Taxpayers must pay taxes, interest, and an accuracy or delinquency penalty for all years.
• Criminal penalties generally will not be applied.
• In lieu of all other penalties, taxpayers also will be assessed a penalty equal to 20 percent of the amount in foreign bank accounts and entities in the year with the highest aggregate account/asset value.

The special 20 percent penalty will be reduced to 5 percent if:

• the taxpayer did not open or cause any accounts to be opened or entities formed;
• there has been no activity in any account or entity during the period the account was controlled by the taxpayer; and
• all applicable U.S. taxes have been paid on the funds in the accounts or entities.

The voluntary disclosure initiative does not apply to those taxpayers currently under criminal investigation. The initiative appears to leave open this voluntary disclosure option even for taxpayers who may be on lists obtained by the IRS from foreign banks so long as those taxpayers are not already facing a criminal investigation. Consequently, for those taxpayers fearing a criminal investigation, it may be ideal to disclose as soon as possible.

Voluntary disclosure generally requires contacting the Special Agent in charge of the local IRS Criminal Investigation Division and providing amended returns and any delinquent reports and forms. It may be beneficial for the disclosing taxpayer to have his or her tax attorney work with his or her accountant in preparing the necessary disclosure documents and amended returns. In order to make the disclosure, taxpayers should send a letter to the nearest Special Agent in Charge, IRS Criminal Investigation, with all identifying information, including name, address, tax identification number, passport number, and date of birth. The letter should include an explanation of any previously unreported or underreported income or incorrectly claimed deductions or credits related to the undisclosed foreign accounts or entities, including the reasons for the errors or omissions. If the taxpayer is represented, a power of attorney should also be included.

Some taxpayers may find themselves in unique circumstances due to the variety of reporting requirements. In some cases, taxpayers may have filed all of the required forms except for the FBAR and have otherwise reported and paid tax on income overseas. In these cases, the IRS has indicated that penalties will not be applied if those taxpayers voluntarily disclose the failure to file FBARs. Also, in some cases taxpayers have filed amended returns and are paying related tax and interest for previously unreported income without otherwise notifying the criminal investigations unit of the IRS (so-called “quiet disclosures”). These taxpayers are eligible for the voluntary disclosure program but must resubmit all previously submitted amended returns.

The IRS will assess all taxes and interest due going back six years, or the earliest year within that six year period in which the account was opened or acquired or an entity was formed. The IRS will then assess either a 20 percent accuracy penalty or a 25 percent delinquency penalty on tax amounts due for each of the six filed years and no reasonable cause exception is allowed. Finally, the IRS will impose either the 20 percent or 5 percent penalty on the highest aggregate balance in the foreign accounts depending on the circumstances.

The IRS has explained that the program may be reevaluated at the end of the six-month period, but that the IRS believes six months is sufficient time to close out a number of voluntary disclosures, to evaluate the experience, and to receive feedback from the practitioner community. The IRS has also stressed that taxpayers who wait until the end of the six-month period may risk being disqualified because the IRS has also stepped up efforts to identify taxpayers hiding assets offshore and continues to receive information from whistleblowers and other taxpayers who have voluntarily disclosed. Consequently, a taxpayer’s likelihood of coming under investigation increases the longer a taxpayer waits to disclose; once under investigation, the taxpayer is no longer eligible for voluntary disclosure.

Redesigned Form 926

For the 2009 tax year, the IRS has released a substantially redesigned Form 926. A U.S. citizen or resident, domestic corporation, or domestic estate or trust must file Form 926 to report certain transfers of property to a foreign corporation. The form generally must be filed by a taxpayer that transfers property, regardless of whether that property is appreciated, or cash in excess of $100,000 in a 12-month period.

The new Form 926 requires significantly more information than the previous version (designed in December of 2005). The following information is now required:

• Certain basis reporting by taxpayers that transfer stock or securities or assets used in a trade or business that are excepted from current U.S. tax on the overseas transfer;
• Reporting of gain by partners transferring partnership assets overseas;
• Specific details with respect to the date of the transfer, the property transferred, the fair market value and the cost or other basis in the property and the gain recognized in the transfer;
• The taxpayer’s interest in the foreign corporation before and after the transfer;
• Certain other information related to foreign tax credits and foreign currency gain or loss; and
• Whether cash was the only property transferred.

In addition, there are reporting requirements relating to transfers of foreign goodwill or other intangible assets. With respect to all of the new reporting requirements, the new form requires detailed information to ensure compliance with certain reorganization provisions that allow U.S. taxpayers to avoid recognizing current tax on gains realized with respect to the transfer of assets overseas. U.S. taxpayers should be sensitive to these reporting requirements when engaging in any transactions with or involving foreign corporations given the broad range of assets, including cash, stocks, bonds or other securities, intangibles, and other property that may result in reporting requirements. Form 926 is due with the taxpayer’s U.S. Federal Income Tax Return (April 15 for individual taxpayers).

We hope you find this information helpful. If you have any questions, please contact , , or your regular Baker Hostetler contact.

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