IRS Will Now Accept an ‘I Was Clueless’ Defense for Offshore Tax Evaders

As the Justice Department winds down its eight-year crusade against Swiss banks selling offshore tax-dodging services to wealthy Americans, the Internal Revenue Service is offering its own parting gift: softer penalties for taxpayers who come out of the woodwork to disclose their secret accounts.

Call it the advent of the “I was clueless” defense.

The IRS announced Wednesday it would ease the financial and legal pain for the estimated 6 million expatriate Americans who live and work abroad, many of whom don’t know that they must pay U.S. taxes on their foreign income. People who come forward under an amnesty program to disclose their foreign accounts and settle their U.S. tax bills won’t be charged any penalties and will simply owe back taxes and interest. Previously, they would have owed a penalty of 27.5 percent, computed as a percentage of each undisclosed foreign account.

The IRS also said it is eliminating a requirement that expats wanting to qualify for the amnesty program had to owe a maximum of $1,500 in unpaid taxes per year, a small amount that had blocked many would-be filers.

The agency extended an olive branch to Americans living in the U.S. as well, effectively saying that the “I didn’t know” argument would now be available to some Americans with undisclosed offshore accounts who live in the United States. People who come forward now will owe back taxes, interest and a reduced “miscellaneous offshore penalty” equal to 5 percent of their undisclosed foreign financial assets. Previously, they would have faced a 27.5 percent penalty.

The IRS used to consider all tax deficiencies to be the work of tax cheats but is now distinguishing between criminal tax evasion—done knowingly and willfully—and noncriminal cluelessness, including that by heirs to Holocaust-era accounts.

Until now, “if Al Capone and Mother Theresa had an overseas bank account, they were treated the same” by the IRS, says Jeffrey Neiman, a tax lawyer and former prosecutor in Fort Lauderdale, Florida. “Finally, the IRS recognizes that not everyone with a foreign account is a criminal.”

For willful, knowing tax evaders who get caught by the IRS before they can out themselves and settle their bills, life just got a little tougher. The agency said Wednesday that a taxpayer who tries to enter into an amnesty program but whose identity is discovered by the IRS before he does so will get socked with a 50 percent penalty. “We have made important adjustments to provide opportunities for all U.S. taxpayers to come in, including those who are not willfully hiding assets,” IRS Commissioner John Koskinen said in a statement Wednesday.

The United States and Eritrea are the only countries to tax their citizens and residents on their worldwide income, regardless of where they live or work. That unpopular system has led thousands of Americans to renounce their U.S. citizenship—and the accompanying U.S. tax bills—in recent years. “I am that expat that Koskinen is pretending to have sympathy for, but I have no interest in ‘coming into compliance’ at any time in the future,” posted “John Doe” on the website of Accounting Today, a trade publication, on Wednesday. “The U.S.A.’s concept of citizen based taxation is just plain wrong, and I won’t be playing along.”

Since 2009, when the Justice Department’s war on tax evasion through Swiss banks began, three IRS amnesty initiatives have enticed some 45,000 Americans to pay back taxes, interest and penalties totaling $6.2 billion. The penalties, known in technical jargon as the Fbar penalty, are for failure to file the Foreign Bank and Financial Accounts disclosure form with U.S. federal tax returns.

The Fbar penalty got progressively tougher across the three initiatives, first at 20 percent, then 25 percent and then 27.5 percent, calculated as a percentage of the amount of undeclared foreign account money.

Taxpayers entering the programs generally get two valuable things in return: a bulwark against being criminally prosecuted for tax evasion, and a significant break on the maximum Fbar penalty of 50 percent.

The softening comes one month after the Justice Department obtained a guilty plea from Credit Suisse AG, Switzerland’s largest bank, to one count of aiding tax evasion by American clients. The bank, which had been under criminal scrutiny, agreed to pay a $2.6 billion fine. A dozen other Swiss banks and foreign banks with major Swiss operations are still under scrutiny, an outgrowth of the probe of UBS, Switzerland’s largest bank, which in 2009 paid a $780 million fine as part of a deferred-prosecution agreement with the Justice Department over its sale of tax-evasion services to wealthy Americans.

The prospect that those other banks under scrutiny, including HSBC and Swiss cantonal banks, might disclose American client names is an incentive for willful evaders to come forward. Adding to the pressure: the July 1 start of a sweeping new law called FATCA, or the Foreign Account and Tax Compliance Act, in which thousands of foreign financial institutions will begin reporting to the IRS data on American clients with accounts containing at least $50,000, or withholding 30 percent of the dividends, interest and other payments on U.S.-sourced income due to those clients. Countries with secrecy laws protecting client confidentiality, including Switzerland, are not exempt.