Foreign Bank Accounts: Still Secret?

By: Robert W. Wood

With the ubiquitous press about reporting foreign bank accounts, where do we stand? Some of it is surprising. It has long been clear that U.S. citizens and permanent residents must report all worldwide income on their federal income tax returns, even if it is taxed elsewhere. You may get a U.S. tax credit for foreign taxes paid, but even with a tax credit, some double taxation is common.

Less known but equally clear is the rule that you must report the existence, location, and size of every non-U.S. bank account. This is done on a special Treasury Department "FBAR" form not part of your tax return. While tax returns are generally due April 15, FBAR forms are due June 30. You are exempt from filing FBARs only if your combined balance in all foreign accounts is less than $10,000. The tax penalties for failure to report your worldwide income can be severe, but the penalties for failure to file FBAR forms are even worse.

Going forward, most people have little excuse not to know these rules. That means reporting and paying tax on worldwide income, checking the box on your tax return that you have a foreign bank account, and filing FBAR forms for all foreign accounts. But starting the disclosure process can invite questions, and what to do about past transactions is less obvious.

In the face of 4,450 Americans whose names were revealed by UBS, about 15,000 people entered an Internal Revenue Service voluntary disclosure program in 2009. Most people who entered that program are still slogging through six years of amended tax filings, six years of FBAR forms, and extensive interactions with the IRS. The process is slow and painstaking.

Moreover, if you missed the IRS' Oct. 15, 2009 deadline to enter that prepackaged voluntary disclosure program, it's tougher still. It's nearly impossible to predict how much it will cost to come clean, especially now. That is leading some people who want to get right with the IRS to question the process and whether there are quieter alternatives.

I've been a tax lawyer for 30 years, and traditionally, nearly every client in this precarious situation came forward through his or her tax lawyer (not their accountant, since you need attorney-client privilege). Almost invariably, you can avoid prosecution and excessive fines if you come forward. But today, some clients fear they may face worse treatment by coming forward than by clamming up and seeing if the IRS eventually contacts them. Inevitably, they may think there's a good chance they will never be discovered.

While that can be a dangerous game of chicken, just how much the IRS can prove and what penalties they can impose is also becoming less clear. One recent case, J. Bryan Williams, (see docs.justia.com/cases/federal/district-courts/virginia/vaedce/1:2009cv00437/241710/55/0.pdf) suggests the IRS may have a hard time proving "willfulness" when a U.S. taxpayer with a foreign bank account didn't know he had to report it. Even though Williams checked the "no" box indicating he did not have a foreign bank account and did not file FBARs, the court was not persuaded he was willfully trying to evade taxes. Some advisors believe this case is an aberration.

But some people seem emboldened by the decision and may be reevaluating their situations. Moreover, the IRS has lost other criminal tax cases involving the amorphous question of intent, including one involving Brazilian racecar driver Helio Castroneves. (See www.reuters.com/article/idUSTRE53G5DF20090417.) Of course, several different circumstances bear on culpability - many foreign bank accounts were inherited, don't pay interest, lay dormant for years, or belong to those living overseas for decades.

Such facts may seem remote from a pattern of more active concealment and tax fraud. Nevertheless, even if you reported all your income, you are at risk if you failed to inform the government you have offshore money. The main reason to come forward in these situations is fear of prosecution. Coming forward and correcting all of the past is still the best safest approach.

However, taxpayers seem more circumspect today. They may prefer quieter alternatives. Plus, if the IRS loses additional cases regarding foreign accounts and offshore income, the fear of prosecution may seem reduced. That may lead to fewer taxpayers stepping forward.

Although it is still best and safest to come forward, if you're evaluating your options, you may wish to consider quiet disclosures, pre-clearances, and other creative ideas. Given the complexity of our system and the relatively recent publicity on these issues, some people think a little more sympathy may be in order. But above all, think carefully, don't act rashly, and get some professional help.

This discussion is not intended as legal advice, and cannot be relied upon for any purpose without the services of a qualified professional.

Robert W. Wood is a tax lawyer with Wood & Porter in San Francisco (www.woodporter.com). The author of more than 30 books including "Taxation of Damage Awards & Settlement Payments" (4th Ed. 2009 www.taxinstitute.com), he can be reached at wood@woodporter.com. <!-- Foreign Bank Accounts: Still Secret? -->