Thursday, August 20, 2009

The Swiss Connection and FBAR

At the top of the list of current events in Washington these days is the just announced UBS settlement, where some 4,000 names of U.S. citizens with Swiss bank accounts will be disclosed to the Internal Revenue Service. This settlement raises some fascinating issues of public policy and how it is always what you don't know about the Internal Revenue Code that hurts you.

As the comments to yesterday's New York Times article on the settlement revealed, there is quite a bit of anger among people who think that others may be evading taxes. However, I suspect that a good number of the people who have these Swiss accounts are not captains of industry but relatively ordinary people seeking some international diversification who may now be caught up in the enforcement plan described below. As you will see, although taxpayers are in theory offered a break if they engage in voluntary disclosure, the penalties, like many in the international trust and account area, are fairly severe.

As a bit of background, it is common for clients who engage in estate planning to inquire about foreign accounts and foreign trusts. After all, who has not seen The Bourne Identity and imagined himself or herself showing up in Zurich with money already waiting? However, the reality is that the United States is not Belgium or some other small member of the European Union, where the majority of citizens may have business dealings in other countries. U.S. tax law has never approved of U.S. taxpayers moving money or assets offshore, and because of the size of the United States it is not common for people to need to do so.

Somewhat less common are clients with foreign business interests or dual citizenship, who maintain residences in foreign countries and bank accounts there. Typically, these clients already have good accounting advice which helps them navigate filing obligations in two countries. In some cases, we even have to examine the applicable Estate Tax Treaties while drafting their documents.

Set against this background of a country where the vast majority of citizens have no foreign financial interests at all, you can see why the initial reaction to the UBS settlement might be "track down every last one of those rich guys!" But some people, who are not actually very rich, may be in for a big shock.

Most people don't give it much though when they get their annual Form 1099s from their banks and financial institutions. You simply attach them to your tax return and file it. However, those forms are of course also disclosed to the IRS, and it then uses them to cross check the income reported on the return. U.S. banks however, would usually have no way of knowing whether a customer was a dual citizen or resident and had a filing requirement in another country, or what that filing requirement would be.

This is why a knee jerk reaction to the "secretive Swiss banks" is a bit off the mark. Even though a large amount of the money in Swiss banks is from people or companies who are not Swiss, its not up to the Swiss to report to the IRS, is up to the taxpayers.

If a taxpayer reported the income from their Swiss accounts on their form 1040, they are sleeping through the night these days. They may even have gotten a credit for taxes paid in Switzerland.

However, many ordinary, non-sophisticated-secret-agent-types might not have known about the U.S.'s foreign account equivalent to the 1099, the Report of Foreign Bank and Financial Accounts, Form TD F 90-22.1 (the "FBAR" for short). Its a simple form, but because it does not apply to the vast majority of U.S. filers, it is not filed with a Form 1040 income tax return, but is filed separately to a separate IRS department dealing with foreign accounts.

Perhaps the worse case to be in is if you had a foreign account, did not disclose the earnings (because perhaps you thought the foreign withholding was the only tax owed) and did not file the FBAR.

Then, you have until September 23, to file the FBAR and pay the tax, an extra 20% of the tax, interest on both, and another penalty of 20% of the largest account balance over the last six years. For a $50,000 account, which have netted the client three figures of interest income per year (hardly Bourne territory) the penalty could near $15,000. The alternative could be even higher penalties and theoretical criminal prosecution.

Of course, in my example the U.S. treasury might not actually be out any money. Perhaps a couple of hundred dollars. Fifteen thousand for failing to report a few hundred. This is all you need to know about the U.S. view of foreign accounts -- be careful!

Posted by Henry Moravec, III. Any questions or comments should be directed to: hm@moravecslaw.com or (626) 793-3210. The firm website is http://www.moravecslaw.com/