This is a digest of presentation made to the 2013 NYU Tax Controversy Institute by Scott Michael of Kaplan & Drysdale in Washington.
Since 2008, IRS has been aggressively moving against thousands of taxpayers who maintain foreign bank accounts that do not get reported on their tax returns. There is a growing trend of agreements among governments to share information that will lead to an eventual transparency of personal financial account information.
Enforcement starts with reporting requirements. U.S. taxpayers (this includes citizens and residents) are required to report and pay tax on their worldwide income. Schedule B requires filers to check a box answering the question of whether they have signatory authority or financial interests in any foreign accounts. Additionally, they have to answer a question as to whether they are required to file a foreign financial account form, TD F 90-22.1(FBAR) and if they have interests in specified foreign assets. Additional forms must be filed to report these. Failure to comply creates criminal exposure and serious penalties.
The FBAR penalties can be assessed and collected against third parties who aid and assist U.S. taxpayers in their failure to declare accounts. This means that the foreign banks, which used to conspire with U.S. taxpayers to hide money and evade U.S. taxes, will be forced to get out of that business and will be turning over information on their customers.
Foreign gifts and bequests and distributions from and relationships with foreign trusts are reportable on Form 3520. Ownership of a foreign company is reportable on Form 5471. Certain other foreign assets must be reported on Form 8938. Failure to file these forms creates criminal exposure and exposure to significant penalties.
Beyond voluntary compliance by taxpayers, the IRS learns about foreign accounts through whistleblowers and other informants who turn over information in hopes of obtaining a reward, criminal investigations of financial institutions, civil summonses, requests under tax treaties and mutual information exchange agreements, and voluntary disclosures by other taxpayers seeking to avoid criminal prosecution.
In 2006 the Whistleblower Office at IRS was revamped and a legal industry has emerged in which practitioners represent whistleblowers for contingency fees based upon rewards paid. The Whistleblower Office recently paid Bradley Birkenfeld $104M for information he furnished concerning Swiss banks. In the typical prosecution of a financial institution, the government starts with questioning lower level employees and gets them to flip in order to avoid prosecution.
In settlement of cases against them, many Swiss banks have disclosed names and personal information of thousands of their employees to the U.S. government. This is in addition to the disclosure of account information on thousands of formerly secret accounts.
When taxpayers make a voluntary disclosure and negotiate a settlement with the IRS, part of the deal is that they tell the full story and name all parties who assisted them or advised them. This is resulting in numerous follow-up investigations.
John Doe summonses have been very effective in uncovering the identity of U.S. taxpayers with undisclosed bank accounts. When the IRS turns up a pattern of a foreign bank having accounts for U.S. taxpayers that don’t get reported on returns, it can go into a district court and force the bank to identify U.S. taxpayers with accounts in the bank. The banks fold because if they don’t they would be held in contempt and subject to unacceptable fines. The leading case on John Doe Summonses involves UBS, which provides the template for how these cases will be handled in the future.
John Doe Summonses have been particularly effective because they can be served on correspondent banks in the U.S. A correspondent banking relationship is one in which. With such a relationship a foreign bank can conduct transactions for its customers in the US through its correspondent US bank. John Doe Summons can force the U.S. bank to disclose all the information about transactions conducted for the customers of the foreign banks.