The Internal Revenue Service has had success encouraging taxpayers with offshore accounts to disclose their foreign accounts and pay back taxes.  In 2009 and 2011, the IRS announced the Offshore Voluntary Disclosure Program (OVDP) which allowed taxpayers to come forward and report foreign income, bank accounts, and other assets.  The IRS had 33,000 voluntary disclosures, resulting in $4.4 billion in taxes, interest and penalties.  In 2012, the IRS reopened the OVDP and set no deadline for the program to end.

The IRS voluntary disclosure programs represent a portion of a larger push by the US government to identify United States taxpayers with undeclared foreign income and assets. The Foreign Account Tax Compliance Act (FATCA) was enacted in 2010, and is aimed at foreign financial institutions and other financial intermediaries to prevent tax evasion by US citizens and residents through use of offshore accounts.

FATCA is intended to reduce evasion of taxes by U.S. citizens and residents who hold offshore assets. To accomplish this objective, FATCA encourages (i) foreign financial institutions (“FFIs”) to sign agreements to report information on their U.S. account holders to the IRS and (ii) other, non-financial foreign entities (“NFFEs”) to provide information regarding their beneficial owners to withholding agents. If entities do not comply, FATCA requires withholding agents to collect a 30 percent withholding tax on payments of U.S.-source “withholdable payments” made to these entities.

FATCA turns foreign banks into arms of the IRS – foreign banks will report to the IRS on accounts and assets held by US persons overseas.  Some banks are asking US persons to withdraw their money and leave the bank.

In general, voluntary disclosure minimizes the risk of IRS criminal prosecution.  The 2009 and 2011 voluntary disclosure programs were so successful because of the clearly-stated penalties and procedures for participating in the program.  As FATCA becomes more of a reality, the voluntary disclosure calculation for individual taxpayers will become more intense as taxpayers will know that foreign banks have turned over information to the IRS about their accounts.

Each week, the Treasury Department announces a new agreement with a foreign country on FATCA cooperation.  Just last week, the Swiss government and the United States announced such an agreement.

IRS’ voluntary disclosure program has been a model of success because of its clarity in advance as to the benefits of making such a disclosure.  There have been very few criminal prosecutions for failure to pay taxes resulting from voluntary disclosures.  However, the IRS’ voluntary disclosure program does not provide any protection against a prosecution for illegal source income – failure to pay taxes on money earned illegally.

Again, for individual taxpayers with foreign assets, the calculation will soon change since the US government will be receiving mountains of data relating to foreign assets owned by US citizens.  The voluntary disclosure program provides only limited protection for a failure to file but will provide no relief for criminal exposure for other tax-related crimes, money laundering or other financial crimes.