Why is this Topic Important to Wealth Managers? Discusses voluntary disclosure program available to clients with offshore accounts.

The Internal Revenue Service announced earlier this week a special voluntary disclosure initiative (the second one of its kind in the past few years).  The Internal Revenue Service states the program is designed to bring offshore money back into the U.S. tax system and assist individuals that may have undisclosed income from hidden offshore accounts to pay taxes owed.  The new voluntary disclosure initiative will be available through Aug. 31, 2011.

The IRS decision to open a second special disclosure initiative follows continuing interest from taxpayers with foreign accounts.  According to the IRS, the first special voluntary disclosure program finished with 15,000 voluntary disclosures on Oct. 15, 2009.  Since that time, the Service notes, more than 3,000 taxpayers have come forward to the IRS with bank accounts from around the world.

The new initiative is being called the 2011 Offshore Voluntary Disclosure Initiative, which includes several changes from the 2009 Offshore Voluntary Disclosure Program.  The overall penalty structure for 2011 is higher, meaning that people who did not come in through the 2009 voluntary disclosure program will not be rewarded for waiting.  However, the 2011 initiative does have additional features.

For the 2011 initiative, there is a new penalty framework that requires individuals to pay a penalty of 25 percent of the amount in the foreign bank accounts in the year with the highest aggregate account balance covering the 2003 to 2010 time period.   However, some taxpayers will be eligible for lower 5 or 12.5 percent penalties.  Participants also must pay back-taxes and interest for up to eight years as well as paying accuracy-related and/or delinquency penalties.

Notably, the IRS’s newly created penalty category of 12.5 percent applies to smaller offshore accounts. Individuals whose offshore accounts or assets did not surpass $75,000 in any calendar year covered by the 2011 initiative will qualify for this lower rate.

Taxpayers with undisclosed foreign accounts or entities are encouraged to make a voluntary disclosure because it enables them to become compliant, avoid substantial civil penalties and generally eliminate the risk of criminal prosecution.   Making a voluntary disclosure also provides the opportunity to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues.

Taxpayers who do not submit a voluntary disclosure run the risk of detection by the IRS and the imposition of substantial penalties, including the fraud penalty and foreign information return penalties, and an increased risk of criminal prosecution.

Under the penalty framework, the values of accounts and other assets are aggregated for each year and the penalty is calculated at 25 percent of the highest year‘s aggregate value during the period covered by the voluntary disclosure.  If the taxpayer has multiple accounts or assets where the highest value of some accounts or assets is in different years, the values of accounts and other assets are aggregated for each year and a single penalty is calculated at 25 percent of the highest year‘s aggregate value.

Example:

Assume the taxpayer has $1,000,000 in a foreign account over the period covered by his voluntary disclosure.  It is assumed for purposes of the example that the $1,000,000 was in his account before 2003 and was not unreported income in 2003.  The account earns 5% each year and no tax is paid from years 2003-2010.

If the taxpayers in the above example were to come forward and their voluntary disclosure is accepted by the IRS, they face this potential scenario:

They would pay $518,000 plus interest. Which includes:

• Tax of $140,000 (8 years at $17,500 at 35%) plus interest,
• An accuracy-related penalty of $28,000 (i.e., $140,000 x 20%), and
• An additional penalty, in lieu of the FBAR and other potential penalties that may apply, of $350,000 (i.e., $1,400,000 x 25%).

If the taxpayers didn’t come forward, when the IRS discovered their offshore activities, they would face up to $4,543,000 in tax, accuracy-related penalty, and FBAR penalty. The taxpayers would also be liable for interest and possibly additional penalties, and an examination could lead to criminal prosecution

Tomorrow’s blogticle will discuss relevant topics to wealth managers in 2011.

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