Recent Publications

September 13, 2007
U.S. Taxes on Foreign Accounts Can Be Tricky

For more information, please contact Bob Webb.

In today's world, United States citizens regularly travel to foreign countries for vacation and business.

Millions of United States citizens open bank accounts in foreign countries. United States citizens use foreign bank accounts for several reasons -- to protect assets from creditors, to increase financial privacy and to avoid taxes.

It is not illegal to deposit money in a foreign bank account if you comply with U.S. tax laws.

In fact, many high-net-worth individuals should have money in foreign banks -- many countries have laws that protect bank accounts from creditors.

Foreign accounts and taxes

Unfortunately for many U.S. citizens, sophisticated promoters have convinced them that money deposited in a foreign bank account will not be taxed by the United States.

This commonly held belief is simply incorrect. A U.S. citizen is taxed on his worldwide income.

For example, a U.S. citizen who deposits money in a Cayman Islands bank account must pay U.S. tax on all interest payments that he receives from the foreign bank.

U.S. citizens who have foreign bank accounts generally use a credit card or debit card to withdraw money from their foreign accounts.

Many have failed to pay U.S. taxes on the money deposited in the foreign bank account and the interest received from the bank.

The IRS has obtained the names of many U.S. citizens who have money deposited in foreign accounts.

During the past several months, the IRS has convinced a federal judge to order American Express, MasterCard and Visa to provide lists for 1998 through 2001 containing the names of U.S. citizens who hold credit cards issued by banks from tax-haven countries such as the Cayman Islands, the Bahamas and Antigua.

It is only a matter of time until the IRS audits these individuals to determine if they have paid taxes on the money deposited overseas.

Going after scam artists

The IRS is attacking abusive schemes, high-income non-filers and unreported income. Many offshore schemes being promoted by so-called professionals claim to reduce a person's tax liability by inflating expenses, creating false deductions or creating unallowable credits.

These schemes all are targeted under the IRS's new audit guidelines.

Unreported income creates the largest audit problem for the IRS. But the agency has developed a new tool to detect unreported income -- the unreported income discriminate index formula (UIDIF) analysis.

The new UIDIF score will rate the probability that income has been omitted from an individual tax return.

This new screening tool will result in more high-income tax returns being audited by the IRS.

Fortunately for U.S. citizens who have used offshore banks to avoid paying taxes, the IRS has a new program designed to bring U.S. citizens into compliance with all U.S. tax laws.

The new IRS program is called the "IRS Voluntary Compliance Initiative for Offshore Credit Card Users and Accounts."

But the program is not available after April 15, 2003.

Voluntary disclosure policy

The purpose of the new IRS program is to do the following: Quickly bring U.S. citizens into compliance with all U.S. tax laws; permit U.S. citizens to avoid paying substantial civil penalties relating to their offshore accounts and avoid being criminally prosecuted by the IRS; and to gather information to pursue the individuals who promoted the offshore banking arrangements.

For example, a taxpayer who understated his income to avoid $100,000 in taxes in 1999 would wind up paying $149,319 to the government. This includes the tax liability plus $29,319 in interest and an additional accuracy-related penalty of $20,000.

If a taxpayer did not step forward, his tax liability generally would include the civil fraud penalty of $75,000, and therefore higher interest of $42,758.

The total amount due would be $217,758, without considering probable additional civil penalties for failure to file certain information returns.

The accuracy-related penalty, cited in the above examples, is equal to 20 percent of the tax underpayment.

The civil fraud penalty is up to 75 percent of the unpaid tax liability attributable to fraud.

U.S. citizens who want to participate in the new IRS programs must comply with several guidelines before the IRS will waive civil fraud and criminal penalties.

Requirements for participating

U.S. citizens must comply with the following requirements to qualify for the program.

1. They must contact the IRS in writing by April 15, 2003, and ask to participate in the program.

2. The IRS must receive the written request before it begins an investigation of the taxpayer.

3. Taxpayers must provide specific information about all aspects of how they used the offshore bank account and who promoted the offshore banking arrangements.

4. Taxpayers will not qualify for the program if they deposited any illegally obtained money in the offshore bank account.

Taxpayers who qualify for the IRS Disclosure Program will avoid substantial civil fraud and criminal penalties.

But if the IRS determines that a taxpayer does not qualify for the program, he or she may be criminally prosecuted and forced to pay civil fraud penalties.

If you have deposited money in a foreign bank account, now is the time to consult with your tax lawyer and confirm with the IRS that you are in compliance with all U.S. tax laws.