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Richard S. Lehman, P.A. www.LehmanTaxLaw.

com

Americans With Foreign Bank Deposits And Unreported Income –


A Stay Out Of Jail Card From The I.R.S.

The most recent headlines include a controversy between the United


Bank of Switzerland and the Swiss government versus the Internal Revenue
Service of the United States. The U.S. is seeking the names of
approximately 50,000 Americans with offshore bank accounts at U.B.S.

The headlines are a result of very strong efforts by the United States in
recent years to stop the use of “tax havens” where Americans were
depositing unreported income that had not been taxed and were doing
so with anonymity and impurity.

Those efforts have started to bear fruit for the U.S. tax collectors. Since
knowingly not reporting income on your Federal income tax return is a
crime, many U.S. individuals were put in a hard place with important
choices to make about taxes.

The Internal Revenue Service has very intelligently made that choice
easier.

On March 23, the Internal Revenue Service came up with a six month
“Amnesty Program” to allow U.S. taxpayers with unreported income to
disclose their foreign bank accounts without fear of any criminal tax
penalties. The price is to pay the income tax, the interest on the income
tax and two specific penalties on unreported income and foreign bank
accounts for the years 2003 through 2008. The Amnesty Program
terminates six months after its March 23, 2009 announcement, on
September 23, 2009.

This Article will discuss the I.R.S. Amnesty Program, its requirements, pitfalls
and its procedures.

The I.R.S. Amnesty Program for foreign bank deposits is a modification of a


long standing I.R.S. Voluntary Disclosure Policy that for decades has
provided for a waiver of criminal charges against a taxpayer that has
“Voluntarily Disclosed” all of his or her unreported income to I.R.S. and met
several other required standards.

This long standing policy governing Voluntary Disclosures has its


weaknesses from a taxpayer standpoint, the most crucial of which was
that the I.R.S. honored their policy but has always taken the position that
there were no guarantees of Amnesty. Furthermore, the numerous civil

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tax penalties that might result from the disclosures of previously untaxed
income remained uncertain.

The Amnesty program seems to add more certainty to the ordinary


Voluntary Disclosure policy in both of these areas. The Amnesty Program
appears to grant amnesty from both civil and criminal tax charges, for a
taxpayer’s previous undisclosed and unreported taxable income, so long
as the taxpayer meets the following Amnesty Program requirements and
meets all of the requirements of the general Voluntary Disclosure policy.

The I.R.S. manual spells out the principal requirements of the Voluntary
Disclosure which must be truthful, timely and complete. This occurs under
the following circumstances

1. The undisclosed income has not come from an illegal source.

2. The taxpayer shows a willingness to cooperate (and in fact


does cooperate) with the I.R.S. in determining his or her
correct tax liability; and

3. The taxpayer makes good faith arrangements with the I.R.S.


to pay in full, the tax, interest and any penalties determined
by the I.R.S. to be applicable.

4. The disclosure must be timely which means it must be


received before:

(a) The I.R.S. has initiated a civil examination or criminal


investigation of the taxpayer, or has notified the
taxpayer that it intends to commence such an
examination or investigation.

(b) The IR.S. has received information from a third party


(e.g., informant, other governmental agency or the
media) alerting the I.R.S. to the specific taxpayer’s
noncompliance.

(c) The IR.S. has initiated a civil examination or criminal


investigation which is directly related to the specific
liability of the taxpayer; or

(d) The I.R.S. has acquired information directly related to


the specific liability of the taxpayer from a criminal

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enforcement action (e.g. search warrant, grand jury


subpoena)

The Amnesty Program

It is first important to see what requirements have been added to the


general Voluntary Disclosure rules to meet the Amnesty Program.

Under the Amnesty Program, the taxpayer’s voluntary disclosure will be


forwarded to the local Criminal Investigation Office that will determine if
the disclosure is voluntary and has been truthful, timely, complete and is
therefore eligible for the Amnesty Program.

Assuming eligibility for the Amnesty Program, first the taxpayer must file
amended income tax returns and Treasury Department Forms TD F 90-22.1,
Report of Foreign Bank and Financial Accounts (“FBARs”), for each of the
prior six years (or for each year since the foreign bank account(s) in
question were opened), whichever is less.

The cost of Amnesty is calculated based upon the disclosures in the


Amended Returns of 2003 through 2008. The taxpayer will be responsible
for:

A. Unpaid income taxes for each of the last six years.

B. Interest calculated on the unpaid taxes.

C. An accuracy-related penalty of 20% or delinquency penalty


of 25% on all income tax liability for the six year period.

D. A penalty equal to 20% of the highest value of each


undisclosed bank account during the six year reporting
period. This can be reduced to 5% for certain bank deposits
that represented income that was previously reported to the
U.S.

These guidelines, like the Voluntary Compliance guidelines also need


some further explanation. However, it should be pointed out that the I.R.S.
has supplied helpful guidance in the form of a series of questions and
answers that can be located on the I.R.S. website at I.R.S.gov under the
words “offshore bank deposits – Amnesty”.

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An example of the calculation for the cost of the Amnesty Program


described above is found at Question and Answer No. 12 of the I.R.S.
publication which reads as follows:

Q.12. How does the penalty framework work? Can you give us an
example?

A12. Assume the taxpayer has the following amounts in a foreign


account over a period of six years. Although the amount on
deposit may have been in the account for many years, it is
assumed for purposes of the example that it is not unreported
income in 2003.

Amount of Interest Account


Year Deposit Income Balance

2003 $1,000,000 $50,000 $1,050,000

2004 $50,000 $1,100,000

2005 $50,000 $1,150,000

2006 $50,000 $1,200,000

2007 $50,000 $1,250,000

2008 $50,000 $1,300,000

(NOTE) This example does not provide for compounded interest,


and assumes the taxpayer is in the 35 percent 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 has their voluntary disclosure


accepted by the IRS, they face this potential scenario:

They would pay $386,000 plus interest. This includes

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

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

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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%)

The I.R.S. Questions and Answers publication is very helpful to answer


many of the questions that will arise under these policies. To mention a
few:

1. Can a Taxpayer qualify for the Amnesty Program if he or she


no longer has the ability to pay?

Q27. If I don’t have the ability to pay can I still participate in the IRS’s
Voluntary Disclosure Practice?

A27. Yes. The March 23, 2009 guidance requires the taxpayer to fully pay
all taxes and interest for all years covered, and the Voluntary Disclosure
penalty, as well as all other unpaid, previously assessed liabilities, when the
signed closing agreement is returned to the Service. However, it is
possible for a taxpayer who is unable to make full payment at that time to
submit a request that includes other payment arrangements acceptance
to the IRS.

The burden will be on the taxpayer to establish inability to pay, to the


satisfaction of the IRS, based on full disclosure of all assets and income
sources, domestic and offshore, under the taxpayer’s control. Assuming
that the IRS determines that the inability to fully pay is genuine, the
taxpayer must work but other financial arrangements, acceptable to the
IRS to resolve all outstanding liabilities, in order to be entitled to the
penalty relief set forth in the March 23, 2009 guidance.

2. What assets may be subject to the Amnesty Program?

The answer to the question of what asset may be subject to the Amnesty
Program actually required two Questions and Answers, not one. The I.R.S.
issued one set of Questions and Answers in May and recently updated
those Questions and Answers on June 24th. It seems the May Questions
and Answers on this subject needed clarification in the form of a second
question in June which is Question and Answer NO. 37.

The two answers make it clear that the assets that may be subject to the
20% penalty include more than just bank deposits. They include tangible
assets such as real estate or art, intangible assets such as patents or stocks
or other interests in a business.

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Question 37 clarified that there was no 20% penalty for non income
producing assets that had no reporting obligation to disclose their
existence at this point. The tax on gain in any of these assets should be
paid to the U.S. when the gain is realized.

Q20. Does the twenty percent penalty apply to entities? Does the
twenty percent penalty apply only to cash and securities held in foreign
accounts or entities or to tangible and intangible assets as well?

A20. The twenty percent penalty applies to entities. The twenty percent
penalty applies to all assets (or at least the taxpayer’s share) held by
foreign entities (e.g., trusts and corporation) for which the taxpayer was
required to file the information returns, as well as all foreign assets (e.g.
financial accounts, tangible assets such as real estate or art and
intangible assets such as patents or stock or other interests in a U.S.
business) held or controlled by the taxpayer.

Q37. Re: Q & A 20. A taxpayer owns valuable land and artwork located
in a foreign jurisdiction. This property produces no income and there were
no reporting requirements regarding this property. Must the taxpayer
report the land and artwork and pay a 20 percent penalty?

A.37 Q&A 20 related to income producing property for which no income


was reported. Under those circumstances, no distinction is made
between assets held directly and assets held through an entity in
computing the 20 percent offshore penalty. However, if the taxpayer
owns non income producing property in the taxpayer’s own name, there
has been no U.S. taxable event and no reporting obligation to disclose.
The taxpayer will be required to report any current income from the
property or gain from its sale or other disposition at such time in the future
as the income is realized. Because there has as yet been no tax
noncompliance, the 20 percent offshore penalty would not apply to
those assets. If the foreign assets were held in the name of an entity such
as a trust or corporation, there would have been an information return
filing obligation that may need to be disclosed. See Q&A 42.

3. How does a Taxpayer treat unreported income earned prior


to 2003?

Paragraph No. 3 also requires two separate Questions and Answers for
clarification. Previously in this Report, Question and Answer 12 was
referred to. In Answer No. 12, there is a specific point of saying the original
deposit “is not unreported income for 2003”. This answer begs the
question of whether amnesty is granted for pre 2003 unreported income.

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In Question 33 of the June 24th version of the Questions and Answers, the
following statement is made about unreported income in a pre disclosure
year (2003 – 2008). Question No. 33 appears to say that the Amnesty
Program is a program that will also cover the pre amnesty years. The
answer to this question continues to need clarification by the I.R.S.

Q33. If the look back period is 2003-2008, what does the taxpayer do if the
taxpayer held foreign real estate, sold in 2002, and did not report the gain
on his 2002 return? Does the taxpayer compute the 20 percent on the
highest aggregate balance in 2003-2008? What, if anything, does IRS
expect the taxpayer to do with respect to 2002?

A33. Gain realized on a foreign transaction occurring before 2003 does


not need to be included as part of the voluntary disclosure. If the
proceeds of the transaction were repatriated and were not offshore after
January 1, 2003, they will not be included in the base for the 20 percent
offshore penalty. On the other hand, if the proceeds remained offshore
after January 1, 2003, and the income in the account was not reported,
they will be included in the base for the penalty.

4. How to obtain records from overseas?

Q18. What should I do if I am having difficulty obtaining my records from


overseas?

A18. Our experience with offshore cases in recent years is that taxpayers
are successful in retrieving copies of statements and other records from
foreign banks when they genuinely attempt to do so. If assistance is
needed, the agent assigned to a case will work with the taxpayer in
preparing a request that should be acceptable to the foreign bank.

5. What information is needed to comply with the Amnesty


Program?

Q25. Besides federal income tax returns, what forms or other returns must
be filed?

A25. The following forms must be filed:

Copies of original and amended federal income tax returns


for tax periods covered by the voluntary disclosure.

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Complete and accurate amended federal income tax


returns (or original returns, if not previously filed) of the taxpayer for all tax
years covered by the voluntary disclosure.

An explanation of previously unreported or underreported


income or incorrectly claimed deductions or credits related to
undisclosed foreign accounts or undisclosed foreign entities, including the
reason(s) for the error or omission.

If the taxpayer is a decedent’s estate, or is an individual who


participated in the failure to report the foreign account or foreign entity in
a required gift or estate tax return, either as executor or advisor, complete
and accurate amended estate or gift tax returns (original returns, if not
previously filed) necessary to correct the underreporting of assets held in
or transferred through undisclosed foreign accounts or foreign entities.

Complete and accurate amended information returns


required to be filed by the taxpayer, including, but not limited to, Forms
33520, 3520-A, 5471, 5472, 926 and 8865 (or originals, if not previously filed)
for all tax years covered by the voluntary disclosure for which the
taxpayer requests relief, and

Complete and accurate Form TD F 90.22.1. Report of Foreign


Bank and Financial Accounts, for foreign accounts maintained during
calendar years covered by the voluntary disclosure.

6. What are the civil and criminal penalties a Taxpayer might


face if they do not join the Amnesty Program?

Q.14 What are some of the criminal charges I might face if I don’t
come in under voluntary disclosure and the IRS finds me?

Possible criminal charges related to tax returns include tax evasion (26
U.S.C. § 7206(1) and failure to file an income tax return. The failure to file
an FBAR and the filing of a false FBAR are both violations that are also
subject to criminal penalties,

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

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to a prison term of up to ten years and criminal penalties of up to


$500,000.

What are some of the civil penalties that might apply if I don’t come in
under voluntary disclosure and the IRS finds me?

A Penalty for failing to file the Form TD F 90-22.1 (Report of


Foreign Bank and Financial Accounts, commonly known as
an “FBAR”.

A penalty for failing to file form 3520. Annual Return to Report


Transactions with Foreign Trusts and Receipt of Certain
Foreign Gifts.

A penalty for failing to file Form 3520-A. Information Return of


Foreign Trust with U.S. Owner Taxpayers

A penalty for failing to file Form 5471. Information Return of


U.S. Person with Respect to Certain Foreign Corporations.

A penalty for failing to file Form 926. Return by a U.S.


Transferor of Property to a Foreign Corporation.

A penalty for failing to file Form 8865. Return of U.S. Persons


with Respect to Certain Foreign Partnerships.

Fraud penalties

A penalty for failing to file a tax return

A penalty for failing to pay the amount of tax shown on the


return.

An accuracy related penalty on underpayments

There are answers to these and many other questions in the I.R.S.
publication and a taxpayer is urged to read it in full. The I.R.S. certainly
does its job to push the taxpayer towards compliance, since it gives
another example that shows how costly it could be from a civil tax
payment standpoint for the taxpayer who chooses not to use the
Amnesty Program but chooses to sit and wait and hope for the best.

The reader will note that the example in Question 12 of the I.R.S.
publication produced a total amount of tax, not including interest equal

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to $386,000 as the cost of full compliance for an unreported deposit of $1


Million that earned $300,000 in income for the six year reporting period.
The I.R.S. in Question 12 also published the cost to the taxpayer who
chooses not to comply. This time the cost would be 600% higher than the
taxpayer would pay under the potential Amnesty Program with a total of
interest and penalties of $2,306,000.

If the taxpayer did not come forward and the IRS discovered other
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 possible 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 - $600,000.

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.

Practical Solutions

This author has found on multiple occasions that when dealing with cases
such as those involved in the Amnesty Program, the taxpayer is best
served by making his first few steps the right ones which include hiring the
right team of counsels that include both a tax lawyer and a criminal
lawyer.

These two disciplines of law working together will generally come up with
the best solution. Often the tax lawyer believes that certain taxpayer
disclosures and presentations will be helpful in deterring an I.R.S. criminal

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investigation while the criminal lawyer must always keep his eyes on the
taxpayer’s Fifth Amendment rights to make sure the disclosures necessary
to tell the taxpayer’s story do not violate the taxpayer’s constitutional
rights and do great harm. The resulting work product of the two disciplines
generally seems to have outcomes that include the best of both worlds.

There is one area in particular where much more guidance is needed


from the I.R.S. to make sure that potential applicants to the Amnesty
Program are not driven away for fear of the requirement that their income
must be from “legal sources”. There is very little information available by
way of case law, contemporary writings, I.R.S. publications and other
sources that provide any parameters to the term “legal” or “illegal”
sources of income for purposes of the Amnesty Program. This presents a
problem since the Amnesty Program will attract taxpayers in many
borderline cases, that may be unnecessary scared away.

For example, assume a taxpayer is indicted for a criminal misdemeanor


involving the violation of a state law while conducting his or her business.
Assume all of the charges against the taxpayer are later dismissed either
immediately or after exhausting the legal process.

Query: Is this illegal income?

The handling of the question of “legal source income” needs to be


treated with delicacy by taxpayer and counsel alike. This author has
found on many occasions that it is extremely helpful to request that
counsel meet directly with the I.R.S. criminal investigator, without
discussing the taxpayer’s name, for advice on dealing with gray areas of
the law.

###

Richard S. Lehman, P.A.


2600 Military Trail, Suite 270
Boca Raton, Florida 33431
Phone: 561-368-1113
Fax: 561-998-9557
http://www.lehmantaxlaw.com

Today’s tax and financial planning landscape is a complex one,


undergoing constant change. If businesses and individuals expect to
make the proper moves, keep abreast of changing legislation, and make
sure that they legally pay the least amount of taxes, they must rely on tax
attorneys.

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Richard S. Lehman, P.A. has been meeting these needs when it comes to
dealing with the federal tax law for more than three decades. Thanks to a
team of tax attorneys who are familiar with every aspect of the Internal
Revenue Code, the tax needs of international and domestic clients,
corporations and individuals have been met. The firm has been involved
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beginning.

Richard S. Lehman, with four years of U.S. Tax Court and Internal Revenue
Service experience in Washington D.C., has built a boutique tax law firm
with a national reputation for being able to handle the toughest tax
cases, structure the most sophisticated income tax and estate tax plans,
and defend clients before the Internal Revenue Service. It regularly works
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As a sole practitioner, Mr. Lehman assures each client of his personal


attention at all times.

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