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Dragging Secret Accounts Into The Open

As I learned back in elementary school, “Secrets, secrets are no fun.” This is especially true when the secrets involve billions of dollars in hidden offshore accounts and hundreds of millions in unpaid taxes.

Earlier this year, the Internal Revenue Service filed a lawsuit against the Union Bank of Switzerland (UBS), seeking the identities and account information for as many as 52,000 accounts. After months of negotiations, including high level diplomatic sessions, UBS, which is the largest bank in Switzerland, agreed to turn over the account information for 4,450 of its U.S. clients. UBS also admitted conspiring to defraud the IRS and agreed to pay $780 million to settle a federal investigation into its activities.

U.S. prosecutors estimate that from late 2002 to 2007, UBS helped American clients illegally hide some $20 billion, allowing them to evade $300 million per year in taxes. And that’s just accounts at UBS. A 2008 Senate report estimated the total cost of offshore tax evasion schemes by U.S. citizens is $100 billion per year. That adds up to $1 trillion over 10 years, enough to fully fund even the more expensive health care reform measures now being debated in Congress.

It is not illegal to have an offshore account, but keeping it a secret from Uncle Sam is never a good idea. Form TD F 90-22.1 - Report of Foreign Bank and Financial Accounts (FBAR), must be filed by each United States person who has a financial interest in, or signature or other authority over, any foreign financial accounts, including bank, securities, or other types of financial accounts, in a foreign country, if the aggregate value of these financial accounts exceeds $10,000 at any time during the calendar year. This form is due June 30 for the preceding calendar year, with no extensions of the deadline ordinarily available. In 2009, however, the deadline was extended multiple times in an effort to promote a special voluntary disclosure program set up by the government.

As a result of the IRS hunt for tax cheats, there was a great deal of confusion and anxiety over just who was required to file the FBAR form. Many of our clients have investments in private equity partnerships that invest in foreign companies that maintain foreign accounts. It is possible to conclude that an equity interest in such an investment would be deemed a “financial account” for purposes of filing the FBAR form. The Treasury Regulations and the FBAR filing instructions are unclear at best and misleading at worst.

Failure to file the FBAR form can result in stiff penalties. The maximum penalty for a willful violation is the greater of $100,000 or 50% of the aggregate account balance at the time of the violation. Even a non-willful violation can result in a $10,000 penalty for each misfiling.

In an effort to encourage tax cheats to come forward, the U.S. has offered an amnesty program allowing taxpayers with undeclared offshore accounts to voluntarily report the accounts in exchange for avoiding criminal prosecution. The IRS says more than 7,500 taxpayers have come forward through the amnesty program, reporting accounts that range in size from just over $10,000 to more than $100 million, held at several hundred banks in 70 countries. This special voluntary disclosure program ended October 15 after it was twice extended from its initial June 30 deadline.

The amnesty program only protects against criminal charges. Taxpayers will still owe back taxes, interest and a special penalty that could work out to as much as 60% of the offshore account’s peak balance over the period during which it was undeclared. Additionally, the taxpayers are sure to face large legal, accounting and other professional fees as they work through the process with the government.

Some taxpayers took the catch-me-if-you-can approach, and some of them have gotten caught. In September, Juergen Homann became the fifth UBS client to plead guilty to U.S. tax evasion, admitting he concealed more than $5 million in offshore accounts. Homann’s sentencing is scheduled for January, and he faces a maximum of five years in prison, on top of a fine of $250,000 plus 50% of the highest balance in his offshore accounts, which comes to about $3 million. You can see a list of the most up-to-date cases at the IRS website.

The U.S. is not the only government going after tax cheats. Germany and France have recently stepped up efforts to curb tax evaders as well. In August, France was able to obtain the information for 3,000 suspected tax evaders with Swiss accounts. According to estimates by France’s Budget Minister, √âric Woerth, the accounts totaled $4.3 billion across three Swiss banks. And, unlike the U.S., the French government is not offering an amnesty program to give tax cheats the opportunity to come forward in exchange for protection from criminal charges. Mr. Woerth said if the taxpayers involved do not come forward by the end of this year they will come under investigation, but even if they do come forward, there will be no amnesty.

Does all this mean we have seen the end to Swiss banking as we know it? If people perceive Swiss banks as no longer willing or able to protect that country’s long-standing privacy laws, they will no longer trust that their money is safe in Swiss accounts. As a result of its legal battle, UBS already has stopped offering its offshore banking services to U.S. clients. This could have severe consequences for Switzerland’s overall economy, which derives 8.5% of its GDP from the banking sector.

Cheating is cheating, and taxpayers who use offshore accounts to evade taxes should be punished accordingly. But offshore banking has many benefits, which I discussed in a previous Sentinel article, “Maximize Benefits Of Banking Without Borders.” As the global economy continues to expand and become more interconnected, offshore accounts should become more common, not less.

We are sure to see more regulation and government oversight as a result of the UBS case. The IRS has recently announced plans to hire 800 new employees and open new offices in Beijing, Sydney and Panama City to expand its hunt for secret offshore accounts. Ideally, policymakers will be able to find a balance that promotes both fair tax reporting practices and individual privacy, without excessive regulation and cumbersome filing requirements.

Unfortunately, governments seem to be well equipped to over-regulate, which could seriously hamper the global banking system at a time when the world is trying to recover from the worst recession in over 50 years. As the end of the saying goes: “...Secrets, secrets hurt someone,” and, in this case, that someone is everyone.

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