IRS Voluntary Disclosure Regime Expands Maximum Penalty Bracket

The IRS recently announced an expansion of the list of banks and advisors that trigger the highest penalty bracket within its Offshore Voluntary Disclosure Program.

The addition of Sovereign Management & Legal, Ltd. and Bank Leumi to the increased penalty list will have repercussions in Asia, Israel and the United States as their clients seek options to address their U.S. income and reporting deficiencies, while the IRS uses those submissions to identify still more financial institutions, advisors and noncompliant taxpayers.

New Year, Increased Penalty

Generally, taxpayers who submit a request for participation in the OVDP pay a miscellaneous offshore penalty equal to 27.5 percent of the highest aggregate value of OVDP assets during the period covered by the voluntary disclosure. The offshore penalty is in lieu of all other penalties that may otherwise apply to the undisclosed foreign accounts, assets and entities, including FBAR and offshore-related information return penalties and tax liabilities for years prior to the voluntary disclosure period. These penalties could otherwise far exceed the value in an undisclosed offshore account.

However, the offshore penalty rate is increased to 50 percent under certain circumstances. Under the newly released list, the 50 percent penalty would apply if, at the time of making the initial submission to request participation in the OVDP to the IRS, the taxpayer had an account at any of the following:

1.    UBS AG

2.    Credit Suisse AG, Credit Suisse Fides and Clariden Leu Ltd.

3.    Wegelin & Co.

4.    Liechtensteinische Landesbank AG

5.    Zurcher Kantonalbank

6.    swisspartners Investment Network AG, swisspartners Wealth Management AG, swisspartners Insurance Company SPC Ltd. and swisspartners Versicherung AG

7.    CIBC FirstCaribbean International Bank Limited, its predecessors, subsidiaries and affiliates

8.    Stanford International Bank, Ltd., Stanford Group Company and Stanford Trust Company, Ltd.

9.    The Hong Kong and Shanghai Banking Corporation Limited in India (HSBC India)

10.    The Bank of N.T. Butterfield & Son Limited (also known as Butterfield Bank and Bank of Butterfield), its predecessors, subsidiaries and affiliates

11.    Sovereign Management & Legal, Ltd., its predecessors, subsidiaries and affiliates (effective 12/19/14)

12.    Bank Leumi le-Israel B.M., The Bank Leumi le-Israel Trust Company Ltd, Bank Leumi (Luxembourg) S.A., Leumi Private Bank S.A. and Bank Leumi USA (effective 12/22/14)

Widespread Repercussions

Taxpayers with accounts at the banks listed above as numbers 1 through 10 became subject to the increased penalty regime on Aug. 4, 2014. Now, the increased penalty regime has been expanded to include Bank Leumi and taxpayers who used Sovereign Management & Legal, Ltd.

Bank Leumi is one of Israel’s largest banking groups with over 300 branches in Israel and throughout the world. The Department of Justice issued a news release on Dec. 22, 2014 to the effect that Bank Leumi agreed to pay the United States a total of $270 million in the wake of its admission that it assisted U.S. taxpayers in hiding assets in offshore bank accounts. As part of that deal, Bank Leumi will provide testimony and disclose details to the IRS on more than 1,500 account holders.

It is interesting to note that Sovereign is not in and of itself a bank. Among other things, Sovereign is known for the formation and administration of anonymous corporations and foundations in Panama, as discussed in the Department of Justice news release of Dec. 19, 2014. Accordingly, it may be particularly challenging for taxpayers to identify if they have a disqualified structure. Taxpayers may not even know that they are involved with Sovereign if they have a foreign account held through a structure created by Sovereign over a decade ago or if they inherited a Sovereign structure set up by a parent or grandparent. Panamanian structures are common offshore structures recommended in many jurisdictions, including the United Kingdom, Hong Kong, Greece and Italy. Accordingly, the repercussions may be widespread. Unfortunately for Sovereign clients, that investigation has progressed to the point where the DOJ has used John Doe summonses against Federal Express, UPS, DHL and Western Union to help identify additional tax evaders.

For Taxpayers Considering Coming Forward, Timing Matters!

The IRS maintains that the date the taxpayer submits their initial submission via the so-called pre-clearance letter to the IRS determines their penalty rate. That is, if the taxpayer has an account at a bank on the above list and submits their letter today, it is clear that their penalty rate is 50 percent. A taxpayer with only banks and advisors who are not disqualified under IRS FAQ 7.2 would face a penalty rate of only 27.5 percent.

Experts believe that the IRS will continue to add additional financial institutions and financial advisors to this list as investigations proceed. For taxpayers with undisclosed assets, winning the race to disclose makes a big difference. For a person with a $1 million dollar account, the penalty savings would be $225,000!

Of note, the IRS published this new list on Dec. 30, 2014. The effective date of the increase in penalties for newly added banks (shown above) precedes the publication of the new list. While some may say that it should come as no surprise that Leumi and Sovereign would be added to the list eventually, the retroactive applicability of the increased penalty creates unfairness for taxpayers and a period in which OVDP applicants were effectively potential victims of an IRS “bait and switch.” They thought that they were applying to one program when another may be applied to them.

It remains to be seen whether the agents will recognize this issue and apply the 27.5 percent penalty to any applicants during December 19 through December 29.

Consider Reducing the Penalty Through the Streamlined Program

Fortunately, this list does not apply to streamlined filing procedure participants. For many taxpayers, the streamlined program introduces a great chance to address inadvertent non-compliance through a quick and fairly painless process with a drastically reduced penalty.

The streamlined filing procedures were designed for taxpayers who can certify that their failure to report foreign financial assets and pay all tax due with respect to those assets did not result from willful conduct.

U.S. resident taxpayers must also pay a penalty equal to 5 percent of the highest aggregate balance/value of their foreign financial assets. For foreign residents, that penalty is reduced to 0 percent. For more details about the streamlined program, click here.