Mr. Obama’s Big Tax Plans

Yesterday at a mid-day press conference, President Obama unveiled several new tax initiatives aimed at “curbing offshore tax havens and corporate tax breaks.” According to White House estimates, these proposals, if they became law, would raise $210 billion in new tax revenue over the next ten years. I suspect that this number, as is true with many government estimates regarding taxes, is based on a ceteris paribus estimate that assumes rational entities will simply pay higher taxes rather than try to avoid them. And, just for perspective, one-tenth of these new tax revenues (the amount we might expect to see in any given year) represent only 0.6% of this year’s government budget. But hey, at least he’s trying, right?

While the media seems focused on the corporate side of these proposals, what I really want to talk about today is the impact on individuals. Whenever I hear the words “tax haven,” I immediately conjure images of Swiss bank accounts and shady characters in Armani suits. But recent actions by the IRS have convinced me that they are casting a very, very broad net in an attempt to increase tax revenues. Thousands or even tens of thousands of people may be at risk.

Specifically, they are targeting all foreign bank and brokerage accounts held by U.S. citizens and tax residents and even some non-citizens who work in the U.S. The following information comes to me via the international tax experts at The Wolf Group.

Income from foreign bank accounts is taxable and should be reported on a taxpayer’s personal return if that person is a US citizen or resident regardless of where they live. In addition, taxpayers are required to report their ownership interest in a foreign financial account every year to the U.S. Treasury (separate from their income tax return) regardless of whether the accounts generated income that was or was not reported on the income tax return. This report is called the Foreign Bank Account Report (FBAR).

This rule has been on the books for years, but according to The Wolf Group, the penalties associated with failure to file have been levied only 3 times in the last 35 years. This is about to change. The IRS is hiring more agents to discover and research these accounts. They have new and better ways of collecting information about these accounts, aided by new treaties between the U.S. and other nations. Foreign banks are now required to file 1099 forms with the IRS, showing interest income earned offshore. Conservative estimates put the deposits subject to new and intense IRS scrutiny in the hundreds of billions of dollars.

The law states that failure to file these reports on a timely basis carries civil penalties up to 50% of the maximum account value, and the penalty applies to each year the account is not timely reported. Criminal penalties may also be imposed. Each year! That means for an account of say $50,000 that a person held for 6 years without filing the FBAR could be liable for 50% x $50,000 x 6, or $150,000! This kind of draconian penalty is rare but not unprecedented. A person who only held an account open for a short period of time (on a business assignment or to purchase real estate, for example) may still be liable for FBAR filing.

Now the “good” news. In late March, the IRS announced a partial amnesty to encourage voluntary compliance with FBAR rules. Under the initiative, qualified taxpayers who voluntarily file delinquent FBAR reports will only(!) be penalized for one year (the year with the highest aggregate value of foreign accounts among the six prior years) at a rate of 20% (5% in very limited circumstances) of that highest aggregate value. Additionally, the IRS will not seek fraud penalties or criminal charges for tax evasion. Taxes and other civil penalties will apply to any unreported income from the accounts.

So, 20% of the assets or as much as 100%? Sounds like a tough choice, but such are the choices sometimes when dealing with the IRS.

For anyone thinking that this might just be tough talk from IRS, consider the following quotes from IRS Commissioner Doug Shulman:

“We are instructing our agents to fully develop these cases, pursuing both civil and criminal avenues, and consider all available penalties including the maximum penalty for the willful failure to file the FBAR report and the fraud penalty.”

“For taxpayers who continue to hide their head in the sand, the situation will only become more dire.”

I am not a tax expert, but if I knew someone who had foreign bank accounts, I would be sure to let that person know about this new IRS initiative and encourage him or her to consult an international tax expert right away. The amnesty program will end September 23, 2009.