The IRS Offshore Bank Account Amnesty Expires September 23, 2009

The IRS has been pursuing taxpayers with hidden money overseas for years.  At the moment, they're on a roll.  UBS recently settled with the IRS and agreed to turn over the names of 4,450 U.S. customers of the bank. 

The surrounding publicity has generated an enormous amount of business for the IRS in their current voluntary disclosure program -- where U.S. taxpayers with undisclosed bank accounts can turn themselves in to the IRS, pay taxes, penalties, and interest, and sleep easier at night. 

The amnesty program has a deadline of September 23, 2009.  If you think you might have a tax problem, be sure to take action before that date.

Caught in the crossfire

The IRS reminds me of Captain Ahab, hunting Moby Dick.  They're looking for the big whales -- people who parked millions in Swiss accounts and never paid tax on the interest, dividends, and capital gain.  But in fact the IRS is netting a multitude of minnows. 

The people who are coming to us for help are in most cases ordinary folks who, through neglect or ignorance (mostly) didn’t report income to the IRS or -- even if they reported the income and paid tax -- committed a tax filing foot-fault of some kind by failing to file a required form with their U.S. tax returns.

U.S. citizens living abroad

If you’re living outside the U.S. you have a bank account.  A pension, maybe.  An investment account.  Add them all up and if the total exceeds $10,000, you have a problem with the IRS. 

Here are the ways in which tax problems arise.

• Foreign Earned Income Exclusion.  If you’re living outside the U.S., you can exclude the first $85,000 of earned income from U.S. tax.  Entirely.  But you still have to file a tax return and claim the exclusion (use Form 2555).  We see people assume that because they’re under the threshold they don’t have to file.  Nope.

• But I Pay Income Tax!  If you’re living in a country where you file tax returns and pay income tax, you still have to file a U.S. tax return.  You get a credit in the U.S. for the income tax you paid.  But you still have to file in the U.S.

• Retirement Accounts.  Many countries have retirement accounts similar to the U.S. Individual Retirement Account.  Canada has its RRSP.  The U.K. has its ISA.  For U.S. income tax purposes these are not retirement accounts.  They’re treated as ordinary investment accounts and you are taxed on the income earned in them every year.  You can solve this problem with filing the right papers with the IRS.  But you have to file.  Watch out for pension plans that you have.

• The Weird Forms.  There is a whole set of weird IRS forms that you wouldn’t come across in day-to-day life.  Form 3520 (when you have a foreign trust).  Form 5471 (when you have a foreign corporation).  Form 8865 (when you have a foreign partnership).  There are others.  The penalties for failing to file these forms can be massive.  Form 5471, for instance, carries a $10,000 penalty for late filing.

• The FBAR.  Then there is the form that has driven the whole amnesty - Form TD F 90-22.1.  This is the form you use to disclose your ownership or control over foreign bank and other financial accounts.  Massive penalties again.

If you think you have a problem with any of these, there are three different ways to cure the problem.  (I’m not counting “Run Away!” as a cure).

File and Pray

The simplest solution is to figure out what tax forms you should have filed with the IRS.  Correct the prior years (six years for Form TD F 90-22.1, either three or six years for other forms, and of course exceptions to every rule but those are good working generalities for your purposes).  Mail them to the IRS, with or without “Why the dog ate my homework” letter explaining the situation. Sit tight and wait.  Likely you’ll get some inquiries, possibly have to pay some penalties.  You’re playing the lottery.  This is not recommended, by us or the IRS, for most people.  Too risky.  Too unpredictable.

FAQ #9 - File the Papers in Philadelphia

The next solution is part of the amnesty program.  See FAQ #9 and FAQ #42.  If you’ve reported the income and paid your tax in the U.S., but you didn’t file the right forms (in other words, you have a paperwork problem, not a tax liability problem), you can fix that by sending in all of your forms before September 23, 2009 to an address in Philadelphia.  No penalties.  That’s the IRS’s promise.  We find this process doesn’t apply to too many people.

The Amnesty

The most complex solution -- and the one we tend to recommend -- is the full voluntary disclosure program.  Announce yourself to the IRS.  (See FAQ #5 and #6).  Say you want to clean up the past (defined as 2003 - 2008).  Go through an explanation to the IRS of your situation, and an audit of the 2003 - 2008 tax years.  Come out the back end with an audit.  You’ll get one of three results:  pay a penalty of 20% of the high balance in all of your unreported accounts for any moment in 2003 - 2008, pay a penalty of 5% on the high balance, or pay a penalty calculated according to the “regular audit processes” (which is likely to be much lower).  And pay the back taxes with a bit of penalty and interest.

Why do we suggest that?  Because it’s the easiest one to start -- a simple one-page fax to the IRS protects your rights and gets you going.  That matters now that we are within 30 days of the deadline for the amnesty.  It may be impossible to get tax returns finished and physically delivered to Philadelphia before the September 23, 2009 deadline.

And we suggest this because the IRS officials who have discussed this on conference calls have suggested when in doubt, just push everything through the funnel. 

Finally, we like the voluntary disclosure program because you leave your choices open longer.  If you do the quiet disclosure, you are making a choice up front to leave yourself open to potential inquiry earlier than 2003, and you are foregoing the option of electing the amnesty package of penalties.  Better to make your choices later than earlier.  Procrastination sometimes helps!

However you choose to proceed, now is the time to fix problems.  If you are a small potato, get your tax returns filed and processed in the great flood of applications.  You’ll be the patient going to the emergency room and being handed an aspirin and told to go home -- the IRS is too busy dealing with the big stuff, including 4,450 new cases they’ll be getting shortly from UBS.

And if you’re a big potato, well, remember -- it’s only money.  Don’t make a money problem into a jail problem, as a number of UBS customer already have done.

-------

Phil Hodgen is an international tax lawyer in Pasadena, California.  Visit his firm’s websites at http://hodgen.com or http://foreignbankaccountamnesty.com