Is Soft Disclosure your answer to IRS Offshore Voluntary Disclosure?

We handle a lot of inquiries from taxpayers trying to figure out if they really need to enter into the 2012 IRS Offshore Voluntary Disclosure Program. Oftentimes, we are told that a CPA has recommended to our client that they merely amend past returns and file FBAR‘s going forward. This is known as soft or quiet disclosure. This article will give just one reason why this could be the worst advice ever.

Soft Disclosure: The IRS gives its warning

Never mind that the IRS OVDI FAQ explicitly warns against soft disclosures.  (“Those taxpayers making “quiet” disclosures should be aware of the risk of being examined and potentially criminally prosecuted for all applicable years.”)

Putting that unambiguous statement aside for a moment, how would soft disclosure actually work in the real world?  Let’s use a hypothetical situation.

Burt Burton was an American expatriate working for an European beverage conglomerate.  In 1998, he received a bonus of $350,000. He paid US taxes on the money, but he squirreled it away in a Credit Suisse bank account, never reporting the existence of the account nor any money it made over the years.   The account rose in value to a high of $900,000 in 2007 until it dropped to its present value of $750,000.

Burt asked his brother-in-law, Rodney, a CPA, what to do. Burt didn’t want to pay the high FBAR penalties and associated interest because he thought it would reduce his account back to its 1997 level. Rodney told Burt to amend his last six years of returns, and file an FBAR form for the upcoming year. This will make it very difficult for the IRS or Department of Justice to bring criminal charges, and, if he is audited, the auditor will be frustrated from assessing any additional penalties because all unreported income would have been properly reported and pai.

Seems like a pretty reasonable course of action, right?

It’s a trap.

So let’s think about this first FBAR that Burt is going to file to get into present and future compliance. This FBAR will list the following information:

  • the bank
  • the account number
  • the value of the account.

Seems harmless enough. But the truth is that this information tells the IRS a lot more than that. For instance, let’s suppose that the IRS knew, through intense data collection, that any Credit Suisse bank account that starts with “240″ and was opened between 1997 and 1999.

So what is Burt’s  2012 FBAR really saying? “Hey IRS, here is a foreign bank account that I opened around 1997-1999. I never had an FBAR filing obligation before because the account must have been under $10,000.00 But now, out of the blue, this account has blossomed from next nothing to $750,000.00 overnight.”

So then what would the IRS do with that information?  Look back at our post about how FBAR investigations work.  It would begin a civil audit or criminal investigation. The problem is that the IRS civil division has the ability to assess FBAR penalties, and the penalty is 50% of that account’s value for the year. Armed with a John Doe summons, the IRS could assess FBAR penalties for each of the years.

So even if the FBAR penalties were successfully negotiated down by 50%, the amount due would exceed the value of the accounts meaning Burt could wind up with nothing, the accounts totally wiped out, or even a tax bill.  And not only that, but the person who actually has the most to worry about it his brother-in-law, Rodney. By advising Burt to NOT fully comply, the IRS could charge Burt with a criminal conspiracy to commit tax evasion or to defraud the United States government.

Our advice for those wondering what to do is to make a decision that you can live with. And for CPA’s or any other tax professional: never advise anyone to make a quiet disclosure (that’s not to say a disclosure is required for every instance of FBAR non-filing). You could be setting your client, family member or friend up for a hidden trap, and you could be putting your own license and freedom in jeopardy. Advise them to come clean or give no advice at all.

UPDATE: My friend Steven Mospick, Esq. tax attorney Sacramento, additionally points this out to me:

Anthony: excellent post. There is another angle to your example. If Burt failed to include the interest earnings on his Credit Suisse account and most likely checked the box “no” on schedule B which asks about the existence of foreign accounts, he has also filed false and fraudulent income tax returns for which he has exposure to the 75% civil fraud penalty. Unlike the normal six year statute of limitations for tax evasion, there is no statute of limitations for the civil fraud penalty. Do the math on that one and you have the FBAR penalties you mentioned plus the tax, interest and civil fraud penalty for multiple years from 1999. That said, Burt has now placed not only his nest egg in Switzerland at risk for collection of the FBAR penalties but all his domestic assets as well for the collection of the tax, fraud penalty and interest.

So you see, a soft (or quiet) disclosure places ALL of Burt’s wealth at risk, not just his offshore accounts. So although a quiet disclosure may make it difficult for  the IRS to get a criminal conviction, this will not stop them from (1) bringing criminal charges (the criminal process is a punishment in of itself) and (2) completely wiping out a taxpayers entire net worth.

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