The latest amnesty program for U.S. taxpayers who willfully hide income in foreign accounts is winding down with few tax cheats fessing up.
A similar program instituted two years ago lured 15,000 delinquent taxpayers to pay overdue taxes to the Internal Revenue Service. The IRS, which is still tabulating the take, collected $400 million from the first 2,000 cases, largely because foreign banks under U.S. pressure had threatened to release the names of depositors.
But with that threat gone, tax experts say that “far fewer” taxpayers with overseas accounts will come to the table to pay their back taxes this time around. There are about 2 million U.S. taxpayers with overseas accounts, many of which are undeclared. The government loses an estimated $100 billion in yearly from offshore tax abuse, the IRS estimates. The offer expires at the end of August.
Tax experts offered two reasons why the current amnesty has failed to generate customers for the IRS.
• The tax cheats are aware they’re getting a worse deal than those who turned themselves in two years ago. “The terms are not nearly as favorable as the last amnesty,” said Catherine Wilkinson, a tax practitioner at Steptoe and Johnson in Washington, D.C. The program, called the Offshore Voluntary Disclosure Initiative, reduces the statutory penalty imposed on U.S. taxpayers who put assets in undeclared or secret foreign bank or investment accounts and fail to report interest income or capital gains. It also allows them to avoid criminal prosecution. The IRS usually imposes a 50 percent penalty on taxes due if it can prove the taxpayer “willfully” dodged taxes on income derived from overseas assets. The current amnesty program seizes 25 percent of the assets in the account, plus charges back taxes and a 20 percent penalty. The 2009 amnesty seized just 20 percent of the assets in the account.
• The threat of disclosure from abroad has dissipated. “That sword of Damocles that was hanging over their heads during the UBS probe—that real threat of disclosure—is what motivated so many people to make voluntary disclosure in 2009,” says Barbara Kaplan, head of the New York tax practice at Greenberg Traurig. The Swiss government that year ordered United Bank of Switzerland to turn over the names and account information of 4,450 offshore account holders to the IRS. “This population of depositors doesn’t seem to feel as threatened as those who came in in 2009,” she says. “The universe of customers is definitely smaller.”
Taxpayers holding foreign mutual funds are also shying away from the latest program. The IRS stipulated part way through the 2009 program that disclosed offshore mutual funds would be deemed Passive Foreign Investment Company (PFIC) transactions. That means dividends from those accounts would be taxed at a higher income tax rate instead of the 15 percent capital gains rate.
Another roadblock discouraging participation is the broader scope of the assets deemed taxable. During the last program, taxpayers and professionals anticipated that the penalty would only apply to foreign bank accounts. But late in the process the IRS said it would also apply to gains from selling homes, artwork, and jewelry held abroad.
“There’s a fair amount of concern this time that things may be modified, changed, or applied in an unfavorable fashion to some of these taxpayers once they’re in the program, so many are reluctant to take the jump,” Kaplan said.
The IRS refused to estimate how many taxpayers would take advantage of the program this time around. “We worked closely with the tax community to develop a fair, workable program that added some important features that were not present in the 2009 offshore disclosure effort,” says Steve Miller, IRS Deputy Commissioner for Services and Enforcement. “But from a fairness standpoint, it was also important for us not to offer a better deal this year than under the 2009 program.”
The latest program does lower the penalty to 12.5 percent of the highest aggregate account balance for taxpayers whose accounts and assets total less than $75,000, and to five percent if taxpayers can prove that they weren’t aware of the foreign reporting requirements or had minimal dealings with the account.
“But there really are very few people who are going to be eligible for those reduced penalties, and the way the program is set up, there is a presumption of willfulness that the IRS can cite to deny lower penalties,” Wilkinson said.
The IRS still has ammunition for going after overseas tax cheats. The agency will gain additional access to U.S.-owned foreign accounts once the 2010 Foreign Account Tax Compliance Act takes effect. Under the new law, which goes into effect in 2013, the U.S. will require every U.S.-based bank with foreign branches to disclose foreign accountholders’ names. It also gives the IRS the right to impose a 30 percent withholding tax on all the income of people who fail to disclose those accounts.