How to clean up

How to clean up
In the past we have informed you about the benefits of the Deferred Variable Annuities
(DVAs), the legal requirements for policies to qualify for tax deferred growth and all the
new reporting requirements.
In this letter we would like to discuss what you need to do, if – for whatever reason –
you failed to report your policy. Contrary to what you may think, this is not a hopeless
situation that willland you in jail automatically, provided you deal with it the right way:
Voluntary Disclosure (Standard Voluntary Disclosure vs Optional Voluntary
­Disclosure Program)
Both the recent Foreign Bank Account Report (FBAR) regulations (FinCEN Form 114) and
a new Specified Foreign Asset Reports (Form 8938) are part of the U.S. government’s
campaign against “international tax evasion”, which has included the indictment of Swiss
banks UBS and Wegelin, prosecution of various “promoters” and taxpayers, and the
transfer of Swiss bank account information as agreed between the Swiss and U.S. governments, including information on 4,500 UBS accounts and the ongoing negotiations
for the transfer of historical Credit Suisse account data.
In conjunction with this “campaign”, the IRS has instituted three “offshore voluntary disclosure initiatives” (“OVDI”) in 2009, 2011 and ongoing in 2012. Encouraging taxpayers
to voluntarily disclose tax errors and omissions has been an IRS “practice” for over fifty
years; historically this has been an informal practice in which the voluntary disclosure of
a taxpayer did not automatically guarantee immunity from prosecution but was a “factor” to be considered by the IRS in deciding whether to recommend prosecution (and
historically very few voluntarily disclosing taxpayers have been prosecuted).
For such an informal voluntary disclosure, the mechanics of a disclosure can differ
significantly. “Quiet disclosures” occur when accurate amended or delinquent returns
are filed with the IRS along with any taxes due and interest payments, but without any
penalty calculations or payments, in the hope that these filings will either be accepted
by the IRS, or better still never actively reviewed.1
The other method is the “noisy disclosure” where the taxpayer or his representative
contacts the IRS, generally describes the situation and tries to get an indication from
the IRS whether the taxpayer qualifies for voluntary disclosure and is eligible to avoid
criminal prosecution. Noisy disclosures typically involve filing back returns (including
taxes due and interest), accompanied by a “reasonable cause letter”. This letter is intended to explain why the failure to file has not been “wilful” and based on “reasonable
cause”, and is intended to mitigate IRS penalties per the discretionary powers of the
examining agent. A noisy disclosure is typically closed when an agreement is reached on
We note that the IRS now formally discourages quiet disclosures by promising to audit late filed and
amended returns and stating that it may criminally prosecute quietly disclosing taxpayers where appropriate.
NMG International Financial Services Ltd.
Hottingerstrasse 21 • 8032 Zurich – Switzerland • Phone: +41 44 266 21 41 • Fax: +41 44 266 21 49 • • [email protected]
the imposition of penalties – which agreement is based on the discretion of the examining agent and the negotiating skills of the taxpayer or his/her advisors.
The three OVDI programs have instead promised that cases would be settled “in an
organized, co-ordinated manner”, with an exposure to civil penalties that would be
“uniform”, and a centralized processing structure designed “to ensure that taxpayers are
treated consistently and predictably”.
Thus, under the 2009 OVDI, the IRS would not assess civil fraud penalties, and agreed
to limit all other applicable penalties (including not filing FBARs) by imposing a onetime “miscellaneous offshore penalty” equal to 20% of the highest aggregate balance
of undisclosed foreign bank accounts or other assets held during the period covered by
the disclosure (2003 through 2008). The 2011 OVDI was then launched under the same
premises, except that the penalties were more severe than under the 2009 program,
including an accuracy-related penalty, plus failure to file and failure to pay penalties, the
total of which can be up to 50% of the tax owed. In addition, the miscellaneous offshore
penalty was increased to 25% of the value of undisclosed foreign assets during the
relevant period (now 2003 through 2010). A reduced 5% penalty was also introduced
for taxpayers who, amongst other things, had exercised minimal, infrequent contact
with the account and not withdrawn more than $1.000 from the account in any year for
which the taxpayer was non-compliant.
On January 9, 2012, amid some fanfare the IRS announced that the 2009 & 2011 OVDIs had yielded 33.000 voluntary disclosures and $4.4 billion of collections, as well as
the reopening of the OVDI, this time with no closing date for the program, and with a
penalty increase from 25 to 27.5% with regards the miscellaneous offshore penalty. All
other aspects of the 2011 OVDI are in effect for this new initiative.
The stated “benefit” of the OVDI is mostly two-fold: no criminal prosecution and certainty of penalties. As to criminal prosecution, the criminal investigation division of the IRS
examines a taxpayer’s background and history, as well as the source of the undisclosed
assets, before accepting the taxpayer into the OVDI, but once accepted the taxpayer
can rest easy as long as the facts presented are truthful and complete.
With regard to certainty of penalties, an agreement as to what “statutory” penalties
should apply and in what fashion is not a straightforward process and often delayed
the closure of cases, or sent the taxpayer to appeals. For example, the determinations
of whether an act was wilful, or whether there was reasonable cause for the failure to
properly file, are not black and white questions but rather based on the “facts and circumstances” of each particular case. Also, the decision to consider extenuating circumstances and how to weight these when determining statutory penalties is in significant
part within the discretion of the particular examining agent – so for many taxpayers,
the “certainty” of the OVDI penalties, even though they are substantial, outweighs the
uncertainty which attends the statutory penalty process.
The Good News
To be clear, for a taxpayer who purchased a foreign annuity with previously undisclosed
assets, the purchase does not purge any of their past non-compliance and they remain
liable for their past, including not paying the excise tax or filing an FBAR in 2010. Our
advice to these taxpayers is to undertake a voluntary disclosure because in the current
NMG International Financial Services Ltd.
Hottingerstrasse 21 • 8032 Zurich – Switzerland • Phone: +41 44 266 21 41 • Fax: +41 44 266 21 49 • • [email protected]
climate of prosecutions and exchange of information, undisclosed assets may not remain undisclosed for much longer.
For those, however, who purchased a DVA with after tax money and simply forgot to report, the “back filing” can be done very easily and with very little penalty for the simple
reason that since the policy grows tax-deferred, you did not have taxable gains, you
simply forgot to report and this can be fixed fairly easily.
For all U.S. persons who continue to hold assets in foreign structures for all the traditional reasons: asset diversification, privacy, asset protection, etc., a foreign annuity
provides these benefits and remains one of the only tax efficient vehicles because the
deferral of tax on the inside build-up within the contract is still effective under the Code.
Of course Uncle Sam wants to collect an excise tax on premiums paid, and now requires
that information be provided on the annuity contract via the FBAR and Specified Foreign
Asset Report, but these compliance issues are fairly simple when compared to other foreign investment structures (e.g. controlled foreign corporation or foreign grantor trust
Need professional help
If you forgot to report your policy in the past and would like to “back file” or if you are
interested in the OVD program, we would highly recommend that you get professional
assistaelp. We work with skilled and experienced professionals who will be pleased to
consult with you. We maintain a network of experienced tax experts either in the U.S. or
here in Switzerland.
Here in Switzerland we established a cooperation with “U.S. Tax and Financial Services”,
an international group of experienced CPAs. They can assist you in all the above matters. Just let us know and we will be pleased to make an introduction to your personal
U.S. Tax and Financial Services adviser.
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NMG International Financial Services Ltd.
Hottingerstrasse 21 • 8032 Zurich – Switzerland • Phone: +41 44 266 21 41 • Fax: +41 44 266 21 49 • • [email protected]