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Asset Protection Blog

Historic Opportunity Until December 31, 2012 to Avoid Tax on Over $10 Million+ of Assets

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In addition to taxing your income during life, and your estate at death, the IRS also can tax gifts you make.  The rationale is to prevent someone from giving his or her assets away in order to avoid the estate tax.  Thus, gifts are subject to tax, whether made during your life or at your death.
However, until the end of 2012, a person can gift up to $5 million of assets and get $5 million out of the reach of the estate and gift tax ($10 million for a married couple).  This means that if your net worth is below $5 million ($10 million for a married couple), you could avoid gift and estate taxes entirely, and pass your assets to loved ones, free of tax.  If your net worth is above $5 million,  the first $5 million can still go to your loved ones, tax free.  The exemption from gift and estate tax has never been higher and will only last until December 31, 2012.
If your assets are owned by family limited partnerships (FLPs) or Limited Liability Companies (LLCs), then even more can be gifted out of your estate via the principle of discounting, as discussed below.  However, one need not own an LLC or FLP to make gifts and avoid tax.  But, if you own an FLP or LLC, you can get even more out of the reach of taxation.
There are two ways to gift assets and lower estate tax.  The first way is via annual gifting.  The amount that an individual may gift to another individual, without tax consequences or a reporting requirement, is currently $13,000 per annum, per recipient.  Gifting is an effective strategy to reduce estate tax liability.  For example, if a husband and wife each gift $13,000 to three children, the value of the couple’s estate is decreased by $78,000 ($13,000 x 2 x 3).  The husband and wife can make these gifts annually, and remove $78,000 each year from their estate.
In addition to annual gifts of up to $13,000 per recipient, a second way to lower the value of your taxable estate is via a lifetime gift.  You may utilize your “unified lifetime credit” to avoid gift taxes and make one or more gifts equal in total value to $5,000,000 ($10,000,000 together with your spouse; total value for all gifts).  Such a lifetime gift is in addition to annual gifts of up to $13,000 per recipient.  You will be required to file a gift tax return, but the gift taxes will be offset by your $5,000,000 unified lifetime credit.  A husband and wife, together, may make joint tax-free gifts equal in total value to $10,000,000 in this manner.  Read the last sentence again.  Yes, $10 million in assets passing to your heirs, free of tax, but only if you act before December 31, 2012!
Clients with FLPs should consider gifting an equivalent amount of limited partnership interests, so as to decrease the value of their estate.  As long as clients retain their General Partner (GP) interests, clients will continue to control all assets within their partnership.  Yes, you can escape the estate tax and still control the assets.
Here’s how you can get even more than $5 million ($10 million for a married couple) out of the reach of taxation, if you own FLP interests:
Gifting of partnership interests works hand-in-hand with the principal of discounting of those interests.  The IRS recognizes a discount in the value of an LP interest.  The discount is due to a lack of marketability of an LP interest on the open market (you can’t sell a limited partnership interest to an outsider), as well as a lack of control by a limited partner (as contrasted to full control by the general partner).  Thus, LP interests are not “worth as much” in the eyes of the IRS, while the value of the underlying FLP asset remains unchanged.  This is a rare instance where the IRS recognizes a value less than the actual asset value.  Once discounted, more LP interests can be gifted tax-free to the next generation, which results in more assets passing out of an individual’s taxable estate and thus decreased estate taxes.  In some cases, after applying a 50% total discount to the value of the LP interests, as much as $20,000,000 of their estate may be gifted by a married couple.  It is important to understand that only LP interests are gifted, not the underlying FLP assets.
In the current recessionary economy, now is the time to consider gifting assets that are presently at abnormally low values.  The decline in the stock and real estate markets have created further built-in discounts for many assets.  When the economy rebounds, these assets will begin to increase in value, and that future appreciation will occur outside your estate.
It is possible that the federal government will make unfavorable changes to the estate and gift tax laws in order to compensate for huge government deficits.  If passed by Congress, proposed legislation will eliminate the ability to discount the value of FLP gifts.  Clients should consider taking advantage of current favorable laws while they still exist.  The $5 million gift and estate tax exemption only applies until December 31, 2012.  The exemption will go back down to $1 million on January 1, 2013, unless Congress acts before then.  Now is the time to capitalize on this window of opportunity to avoid gift and estate taxes on a significant amount of wealth.
In summary:
– You can lower the value of your taxable estate, and pass $5,000,000 ($10,000,000 for a married couple) to your heirs, tax free;
– If you own an FLP, you can gift Limited Partnership (LP) interests to your heirs, and take advantage of discounting, to get even more out of your estate, tax-free (up to $20,000,000 in some cases).
– You can keep your General Partner (GP) interests and still control the FLP and its assets, even if you give away all of the Limited Partnership (LP) interests.
– The gift and estate tax exemption has never been higher.
– The gift and estate tax exemption expires on December 31, 2012.  Beginning January 1, 2013, the exemption is only $1 million.
We realize that gifting and discounting are not simple concepts, and we welcome your questions.  We can advise you as to appropriate FLP discounts, prepare memoranda of gift for you, as well as the partnership valuation and gift valuation calculation letters (necessary for the IRS).  Please contact us for further information, but don’t wait too long; this historic opportunity ends December 31, 2012.

In addition to taxing your income during life, and your estate at death, the IRS also can tax gifts you make.  The rationale is to prevent someone from giving his or her assets away in order to avoid the estate tax.  Thus, gifts are subject to tax, whether made during your life or at your death.Continue Reading

How Foreign Purchasers of U.S. Real Estate Can Save Significant Taxes

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Foreign buyers have purchased more than $83 billion worth of U.S. residential real estate over the past year, representing close to ten percent (10%) of the residential market.  These numbers are a 24% rise from last year, itself a strong year for sales to international buyers.  (Source: Wall Street Journal, June 12, 2012).
The American real estate market is seen as a buying opportunity for wealthy foreigners, in light of the decline in U.S. home prices and the lower value of the U.S. dollar against some foreign currencies.  Foreigners are buying U.S. real estate for their own use, as well as investments – to rent or re-sell.
However, when the foreign buyers later sell these homes, they will have to pay a tax pursuant to the Foreign Investment in Real Property Tax Act (“FIRPTA”).  The tax is 10% of the gross sale proceeds of the sale, withheld at closing.
There is a way to avoid the FIRPTA tax.  Prior to the actual purchase of U.S. real estate, the foreign party should set up a U.S. trust, with a U.S. trustee, properly established and with an IRS taxpayer number for that trust.  The trust should buy the real estate.  The deed should be in the name of the trustee, as Trustee of the trust.  The trust is recognized as the buyer and owner of the property.  Later, the trust will sell the real estate.  At the time of that sale, the trust will pay capital gains tax on the net capital gain earned on the real estate; the FIRPTA tax would be avoided.  (More sophisticated tax-compliant strategies also exist for the minimization or deferral of even the net capital gains tax through the use of charitable remainder trusts <<https://www.assetlawyer.com/estate_tax_planning_bypassing_capital_gains_tax.htm>>.)
The foreign buyers could be the beneficiaries of the trust and enjoy use of the real estate.  The trust could distribute the net (after capital gains tax) proceeds of the sale to the beneficiaries.  The trust might also offer additional benefits, including asset protection and estate planning.
Please contact us <<https://www.assetlawyer.com/contact_us.htm>> for additional information on how foreign purchasers of U.S. real estate can minimize their tax consequences.

Foreign buyers have purchased more than $83 billion worth of U.S. residential real estate over the past year, representing close to ten percent (10%) of the residential market.  These numbers are a 24% rise from last year, itself a strong year for sales to international buyers. (Source: Wall Street Journal, June 12, 2012).

The American real estate market is seen as a buying opportunity for wealthy foreigners, in light of the decline in U.S. home prices and the lower value of the U.S. dollar against some foreign currencies.  Foreigners are buying U.S. real estate for their own use, as well as investments – to rent or re-sell.

However, when the foreign buyers later sell these homes, they will have to pay a tax pursuant to the Foreign Investment in Real Property Tax Act (“FIRPTA”).  The tax is 10% of the gross sale proceeds of the sale, withheld at closing.

There is a way to avoid the FIRPTA tax.  Prior to the actual purchase of U.S. real estate, the foreign party should set up a U.S. trust, with a U.S. trustee, properly established and with an IRS taxpayer number for that trust.  The trust should buy the real estate.  The deed should be in the name of the trustee, as Trustee of the trust.  The trust is recognized as the buyer and owner of the property.  Later, the trust will sell the real estate.  At the time of that sale, the trust will pay capital gains tax on the net capital gain earned on the real estate; the FIRPTA tax would be avoided.  (More sophisticated tax-compliant strategies also exist for the minimization or deferral of even the net capital gains tax through the use of charitable remainder trusts.)

The foreign buyers could be the beneficiaries of the trust and enjoy use of the real estate.  The trust could distribute the net (after capital gains tax) proceeds of the sale to the beneficiaries.  The trust might also offer additional benefits, including asset protection and estate planning.

Please contact us for additional information on how foreign purchasers of U.S. real estate can minimize their tax consequences.

Do You Have Foreign Assets?

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NEW IRS FORM 8938 REQUIRES DISCLOSURE BY APRIL 17, 2012

Over the last few years, the U.S. government has enacted a series of laws and regulations designed to create greater transparency of assets held overseas by U.S. taxpayers.  In order to track and tax those foreign assets, the IRS has created Form 8938, Statement of Specific Foreign Financial Assets, a new form which requires taxpayers who own certain specified foreign assets to disclose these assets annually to the IRS.  Many taxpayers who own such specified foreign assets are now required to file Form 8938, or risk being penalized by the IRS.  The requirement to file new Form 8938 is already effective.  The form is due by April 17, 2012, along with your Form 1040, for calendar year 2011.

The new form is broad in its coverage of foreign assets that require disclosure.  Foreign assets required to be reported include:

  • foreign bank and brokerage accounts (which are already reportable on Form TD 90-22.1, Report of Foreign Bank and Financial Accounts, known as the “FBAR”);
  • stock of foreign corporations and interests in foreign limited liability companies (LLCs), partnerships and other entities, whether publicly traded or privately held;
  • interests in foreign Exchange Traded Funds (ETFs) (but interests in Passive Foreign Investment Companies [PFICs] that are reported on IRS Form 8621 need not be repeated on new Form 8938);
  • interests in a foreign entity such as a trust or foundation;
  • ownership of investment instruments and contracts issued by a foreign entity, including foreign annuity contracts and insurance policies (also already subject to FBAR disclosure);
  • interests in a foreign investment fund, hedge fund, mutual fund and private equity fund (but note the PFIC exemption above);

Note that even though certain foreign assets may not be reportable on new Form 8938, these assets may still be reportable on other IRS forms and on the FBAR.  Note also that even though an asset is already reportable on, e.g., the FBAR, it may be reportable on Form 8938 as well, notwithstanding the resulting redundancy.  It is also important to note that even if a foreign asset is not reportable if directly owned (e.g., real estate or bullion), if such asset is owned by a foreign entity, a U.S. taxpayer’s interest on the foreign entity is reportable.

Form 8938 requires details of the foreign assets, along with their values.  Form 8938 is required if the total value of all foreign assets exceeds certain predefined threshold amounts, depending on the taxpayer’s residency during the tax year.  In general, reporting is required for assets valued in excess of $50,000 for a single U.S. taxpayer and $100,000 for a married couple filing jointly, living in the U.S.  If the U.S. taxpayer lives abroad, he or she must report any assets in excess of $200,000 for a single taxpayer and $400,000 for a married couple filing jointly.  Financial accounts, and the assets in those accounts, held at a foreign branch of a U.S. financial institution or a U.S. branch of a foreign financial institution are not subject to reporting on Form 8938.

If a taxpayer has reported the foreign assets on another IRS form (e.g., Form 3520 for foreign trusts, Form 5471 for foreign corporations, etc.), he or she need not report these assets on Form 8938,  but must still complete Part IV of Form 8938 and specify on which other tax form the assets were reported.  The amounts reported on the other IRS forms will count towards the aggregate threshold amount for Form 8938.  Therefore, if the amounts reported by the taxpayer on the other IRS forms meet the Form 8938 threshold amount, then any other foreign assets not reported on the other forms must be disclosed on Form 8938.

There are numerous IRS penalties associated with a failure to report foreign assets, as well as potential fines and criminal prosecution.  Taxpayers who own foreign assets and are unsure whether they must file new Form 8938 should seek guidance from an experienced offshore tax compliance attorney.

Additional Important Points

  • The disclosure requirements for Form 8938 are already effective.  While FATCA regulations are coming into effect over time, this new Form 8938 is due this year, i.e., with your 2011 tax return, due April 17, 2012, or later if you receive an extension.
  • Form 8938 is an informational return, whereby ownership interests in foreign assets are reported.  However, Form 8938 does not assess tax on foreign income.  Income from foreign assets is reported on other forms such as Form 1040, Form 8621, etc.  The U.S. Internal Revenue Code assesses income from all sources world wide.  Income includes interest, capital gains, dividends, royalties, etc., from all foreign sources.
  • Any interest in social security, social insurance or other similar foreign government program need not be reported on Form 8938.
    However, an interest in a foreign pension plan or foreign retirement account requires reporting.
  • A mere signatory authority (e.g., power of attorney, co-signatory) over a foreign account does not require disclosure via Form 8938.  However, the FBAR form is still required for a power of attorney or co-signatory authority.
  • Taxpayers filing Form 8938 may still be required to file an FBAR in addition.
  • Form 8938 requires the reporting of the value of foreign assets.  Many cases, e.g., ownership of a fraction of a foreign entity or investment fund, may require complex valuation and obtaining financial information from foreign sources.
  • With respect to beneficiaries of foreign trusts, whereas such beneficiaries are required to file an FBAR if they have a “present” beneficial interest (defined as the right to receive a mandatory distribution, or actual receipt of 50% of trust income or assets), Form 8938 is required if the trust beneficiary receives a distribution that, together with other specified foreign assets, meets the Form 8938 specified threshold (e.g., $50,000 for a single taxpayer; see supra).  If the foreign trust is a discretionary trust and the U.S. taxpayer does not receive a distribution (or receives a distribution that, when combined with his/her other specified foreign assets, does not exceed his/her reporting threshold), the value of his/her interest in the trust is zero and therefore not subject to reporting.
  • For the time being (until the IRS issues additional regulations), Form 8938 reporting requirements apply only to U.S. individuals.  U.S. corporations and other entities are not required to report ownership or interest in foreign assets on Form 8938.  (Note, however, that the FBAR does apply to entities like corporations).
  • Form 8938 applies to various components of offshore asset protection structures (e.g., foreign trusts).  However, the offshore asset protection is still intact, because Form 8938 is for IRS reporting purposes only and does not impact the integrity of a foreign asset protection structure.  This form merely makes an already reportable offshore entity or asset more transparent to the government.  As we have long counseled, foreign asset protection structures do not rely on secrecy and give no expectation of tax secrecy.  However, vis-a-vis private civil creditors, tax complaint offshore strategies still offer concrete asset protection.

Conclusion

Taxpayers who own or have interests in specified foreign financial assets may have to report the existence and value of those assets on new IRS Form 8938, or face penalties.  We have long assisted clients with the many compliance and disclosure requirements for offshore assets.  We can assist in determining whether you are subject to new Form 8938, and can answer any other questions you have regarding U.S. tax compliance for foreign assets.

Expect More Tax Audits, More Aggressive IRS in 2012

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As I sat down to write this article, I re-read my December 2009 article “Get Ready for a One-Two Punch: More Taxes and More IRS Audits“. I realized that with the exception of adding a few more contemporary examples, the article had already been written. The point of that article – – that the IRS and State tax authorities are both increasing the scrutiny of tax filings and aggressively pursuing taxpayers for deficiencies and penalties – – is just as apparent, if not even stronger, in 2012.

The IRS recently reported that one in eight taxpayers showing more than $1 million in income were audited during 2011. This is the third consecutive year showing an increase in audit rates at this income level (which, I humbly submit, makes my 2009 article rather prescient). The IRS also stated that much of the increase in audits is attributable to its crack down on foreign accounts.

The increase in audits has been picked up in the press. For example,

What should you do? We repeat the advice we offered previously.

First, work with competent, experienced tax counsel, who utilize proven, tax-compliant strategies.

Second, have tax counsel conduct a “friendly audit” – review your financial activities, bookkeeping and record keeping procedures, and accounting practices to uncover and correct sensitive areas before they are discovered in an IRS audit. Become essentially “audit proof”.

If you are being audited or investigated by the IRS or a state tax authority, hire legal counsel with a proven track record of success against the government. Rubinstein & Rubinstein, LLP has been advocating on behalf of taxpayers for close to twenty years. Our attorneys have extensive experience in the representation of clients before the IRS and before state tax departments. Such representation has included:
“the review and analysis of tax returns and underlying documentation;

  • representation at audits;
  • representation in Voluntary Disclosure initiatives;
  • negotiation of Offers In Compromise, abatements of penalties and/or interest and installment payment plans;
  • protest and/or appeal of determinations of tax deficiency and tax assessments; and removal of tax liens;
  • representation of clients in civil and criminal tax investigations;
  • litigation on behalf of clients before the U.S. Tax Court.

As the Government – – at the federal, state and local levels – – attempts to raise revenue, it calls upon more tax collection and enforcement, and aggressive IRS and state action in pursuit of maximum taxpayer dollars. Against this context, you need tax lawyers who can help you legally and effectively lower your tax bill. And if you are challenged by the IRS or by a state tax authority, you need effective legal counsel to fight back on your behalf.

 

Asher Rubinstein quoted by Reuters on Gingrich and Romney Tax Returns

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Asher Rubinstein quoted by Reuters on Gingrich and Romney Tax Returns
(Reporting By Samuel P. Jacobs; Reporting by Kim Dixon; Editing by Eric Walsh and Philip Barbara)
For original article, please click here

Gingrich releases tax returns during debate

(Reuters) – Republican presidential hopeful Newt Gingrich released his tax returns on Thursday, revealing that he and his wife Callista paid $995,000 on an income of $3.1 million in 2010.

In a move designed to embarrass rival Mitt Romney, who has not made his tax forms public, Gingrich issued his returns during a presidential debate in South Carolina.

The bulk of Gingrich’s income appears to come from Gingrich Holdings, one of the companies run by Gingrich before he ran for president. Of his total income, $2.4 million, apparently largely related to Gingrich Holdings, was likely taxed at the “ordinary income” tax rate of 35 percent.

Gingrich’s return showed relatively small capital gains and dividends holdings, which would be taxed at the 15 percent rate – about what Romney estimated his effective tax rate would be earlier this week.

Altogether, Gingrich paid a tax rate of 31.5 percent in 2010. The campaign said Gingrich and his wife donated $81,000 to charities in 2010.

During Thursday’s debate, Gingrich called on Romney to release his tax returns now while the presidential race was still reasonably early.

“If there’s anything in there that is going to help us lose the election, we should know before the nomination. If there’s nothing in there, why not release it?” Gingrich said.

“I’ll release my returns in April, and probably for other years as well,” Romney, a multimillionaire, said.

The debate moderator asked Romney if he would follow the example of his father George, who released 12 years of tax returns when he campaigned for president in 1968.

“Maybe,” Romney said.

This week, Romney said that he pays a tax rate close to 15 percent, much lower than that of most working Americans, because much of his earnings come from investments.

“I’m not going to apologize for being successful,” Romney said.

Rick Santorum, a former U.S. senator from Pennsylvania who is battling with Gingrich to be the conservative alternative to Romney, said he would release his tax returns, but they were at home on his computer.

Speaking before Gingrich released his returns, New York high net worth attorney Asher Rubinstein said Romney’s 15 percent tax rate was legal and to be expected.

“Newt Gingrich has stated that his tax rate was 31%, in contrast to Romney’s 15 percent. It seems … that Mr. Romney is not only a better investor, he also consulted better tax lawyers,” he said.

Lessons from the Mitt Romney and Newt Gingrich Tax Returns

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The tax returns of the Republican presidential candidates have been the subject of many news reports and discussion this week.  In these days of high unemployment and economic uncertainty, Mitt Romney has been demonized by his own party and by Democrats for being wealthy and for running a successful investment fund.  Now, he is being criticized over his taxes.

We wish to point out that our comments are in no way an endorsement of any candidate or any political party.  We strive to write about issues of taxation and law, and we do not take a political stance.  With this in mind, we would like to comment on some of the recent news reports.

1.  Romney “has been paying a far lower percentage in taxes than most Americans, around 15 percent of annual earnings”.

This is because most of his income is investment income, taxable at 15% capital gains rate (after they are first taxed on the corporate level), rather than 30+% income tax rate.  This preferential tax rate encourages investment in corporations, new technologies, real estate, etc. and stimulates the economy.  To increase the capital gains tax rate to income tax levels would discourage investment and cause people to park money in, e.g., bank accounts paying very low interest.

2.  “Bain Capital, the private equity partnership Romney once ran, has set up some 138 secretive offshore funds in the Caymans.”

Hedge funds and private equity funds are regularly established in foreign jurisdictions such as Cayman in order to attract investment from non-US persons (who may be reluctant to invest in the US for reasons including high tax rate, State and Federal regulation, etc.).

Cayman funds are not “secretive”.  They are publicly registered, annually reviewed and are subject to KYC, anti-money laundering regulations.  Moreover, Cayman and the US have signed a Tax Information Exchange (TIE) agreement and a Mutual Legal Assistance Treaty (MLAT).

There is no prohibition on a US person from investing in a Cayman fund.  It is not illegal.  So long as the investment is disclosed to the IRS (on the FBAR form) and foreign income reported and tax paid on that income, there is nothing wrong.

There is no tax advantage for a US person to invest in a Cayman fund.  The investment is reported to the IRS, and will be taxed at the same rate as if it had been a US investment.

Even if there was a tax reason to direct investment to Cayman, people and businesses very often chose their course of action, including major decisions, on the basis of tax minimization through geography.  Hedge funds legally move from New York City to Connecticut to save taxes.  Elderly people move to Florida for reasons other than weather.  Howard Metzenbaum, who spent decades of public service as a U.S. Senator, moved to Florida in his final years because there is no estate tax in Florida.

3.  “Unlike most Americans, Mr. Romney has between $20.7 million and $101.6 million in his IRA.”

Romney’s IRA was funded with shares (or partnership interests) of Bain many years ago, when the share prices (or partnership interests) had a much lower value.  Over time, those shares (interests) grew in value.  That is the purpose of an IRA – the tax-deferred accumulation of gains over time.

When Romney withdraws from the IRA, gains will be taxed at ordinary income tax rates (30+%), rather than capital gains rate (15%), even though the gains are technically capital gains rather than income.

Even if Romney does not withdraw from the IRA, when he is 70.5 years old, the IRS will still tax the funds not withdrawn, at income tax rates.

It seems to us that Mr. Romney availed himself of legal opportunities to pay less in taxes.  We are reminded that lowering one’s taxes is neither illegal nor immoral.  On a basic level, people take either the standard deduction or itemize deductions, depending on the more favorable outcome.  There is nothing sinister in this.

Judge Billings Learned Hand (1872-1961), one of the most important federal judges of the last century, wrote:

“Over and over again, courts have said that there is nothing sinister in arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich and poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions.”  (Commissioner of Internal Revenue v. Newman, 159 F.2d 848 (2d Cir. 1947) (dissenting opinion)).

Moreover, Justice George Sutherland (1862-1942) of the United States Supreme Court wrote:

“[T]he legal right of a taxpayer to decrease the amount of… what otherwise would be his taxes, or altogether avoid them, by means which the law permits cannot be avoided.”  (Gregory v. Helvering, 293 U.S. 465 (1935)).

These words establish a clear principal: Tax minimization, through legal means, is not only allowable, it is wise and it is universal.

Newt Gingrich has stated that his tax rate was 31%, in contrast to Romney’s 15%.  It seems to us that Mr. Romney is not only a better investor, he also consulted better tax lawyers.

Offshore Update: Continued Investigation and Prosecution of Foreign Accounts Amidst a New Opportunity for Pre-emptive Disclosure

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Offshore Update: Continued Investigation and Prosecution of Foreign Accounts Amidst a New Opportunity for Pre-emptive Disclosure
by Asher Rubinstein, Esq.

The U.S. government continues in its offensive against non-compliant offshore banking, targeting both the U.S. taxpayers who failed to declare foreign accounts, as well as the foreign bankers who provided non-compliant banking services.

Last month, a US taxpayer in San Francisco was indicted for failing to declare his UBS account.  Last week, a doctor and medical professor was sentenced by a federal court in New York for failing to declare his account at UBS.  Additional, non-UBS banks were also included in both cases.

At the same time, prosecutors are also charging the foreign bankers who facilitated the foreign accounts and provided foreign banking services.  Bankers at Wegelin & Co., a private Swiss bank, were indicted in early January.  Bankers at Julius Baer were indicted last October.
The indictments detail tactics such as setting up accounts using code names, sham corporate entities and having foreign relatives as the purported owners of the accounts.  The indictments also allege that the bankers told U.S. clients that their accounts were not vulnerable to discovery by the IRS because the banks did not have a U.S. presence such as a U.S. branch office.

In additional to Wegelin and Julius Baer, Credit Suisse, the local Swiss Kantonal banks, as well as banks in Israel, India and Liechtenstein are all under investigation for aiding and abetting tax fraud by US taxpayers.  The IRS and Department of Justice (DOJ) are pursuing these banks because of the purported “money trail” that left UBS as UBS prepared to surrender once-“secret” bank data to the U.S. government.  According to one recent indictment, UBS bankers suggested only transferring Swiss Francs from UBS to a local Kontonal bank in order to minimize detection.
Tracing noncompliant funds to other banks, in Switzerland and elsewhere in the world, is indicative of the expanding global scrutiny and effectiveness of the investigations.

As legal counsel to many taxpayers with foreign accounts, when we read the news reports of new tax investigations, indictments and prosecutions, we note that the names of some foreign bankers appear again and again.  We have been able to observe connections between separate clients who had common foreign bankers.  The IRS, of course, is reaching similar conclusions.  If the name of a banker appears again and again, that banker comes to be “on the radar” at the IRS and DOJ.  If the banker is then criminally charged, the banker is likely to cooperate with prosecutors and divulge bank account information as part of a negotiated settlement.  For instance, Renzo Gadola, a former UBS banker in Switzerland was charged with facilitating US tax fraud.  He pled guilty in December 2010 and has been cooperating with DOJ prosecutors.  He has provided information about U.S. clients and other Swiss bankers who assisted in hiding foreign assets.  As part of Gadola’s settlement, he must return to the U.S. annually to further assist DOJ investigations of foreign banking.

Many of our clients who came forward with timely voluntary disclosures were relieved when they later learned that their foreign bankers had been criminally charged.  If the clients had delayed in coming forward, and the bankers had shared account information with the government, then the clients would not have been accepted into the voluntary disclosure program and might have faced criminal prosecutions themselves!

At the same time that the government is going on an offensive against non-compliant offshore accounts, it is also offering yet another opportunity to come forward and declare such accounts in return for lower penalties and no criminal prosecution.

In January, 2012, the IRS announced the re-opening of the 2011 Offshore Voluntary Disclosure Initiative (OVDI), which had previously expired in September, 2011.  The 2011 OVDI followed a similar 2009 program that likewise encouraged taxpayers to bring their foreign accounts into tax compliance, in return for lower penalties and avoidance of criminal prosecution. The renewal of the OVDI presents another opportunity for taxpayers to bring their foreign accounts into tax compliance.  The terms of the program are the same as the OVDI, but the penalties have been increased.  Still, the penalties are significantly lower than the penalties that would apply if the IRS discovers the account, and criminal prosecution can also be avoided.

In light of the erosion of foreign banking secrecy, discovery of the account by the IRS is very likely.  Notwithstanding promises to its clients of banking secrecy, UBS revealed the names of almost 5,000 U.S. clients to the U.S. government, in return for the U.S. dropping a civil and criminal tax fraud prosecution against UBS.  Credit Suisse is facing similar charges and is expected to settle these charges by likewise handing over client names.  Negotiations are currently underway between the U.S. and the Swiss for a global settlement that will involve all Swiss banks, including Wegelin, Julius Baer, the Kantonal Banks, and others.  It is expected that the settlement will require the Swiss banks to reveal the names of U.S. account holders to the U.S. government.  The announcement of the re-opening of the OVDI is well-timed to allow another opportunity for such account holders to pre-emptively disclose their accounts to the IRS before the Swiss do so.

Another threat to bank secrecy comes from bank employees who divulge account details of customers, in contravention of bank policy and local (e.g., Swiss) law.  The most recent example is the case of the Central Governor of the Swiss National Bank, Philipp Hildebrand, who last week resigned following allegations of improper currency trades made by his wife.  The allegations resulted from information disclosed by an IT employee “whistle blower” at the Swiss National Bank.

Bank employees handing over supposed “secret” banking data is not new. Back in 1999, John Mathewson, the former owner of Guardian Bank and Trust, a defunct Cayman Islands Bank, was charged in the U.S. with money laundering. When Mr. Mathewson was arrested, he gave U.S. investigators bank records that contained information about American depositors at the bank who had evaded U.S. tax obligations. Mathewson gave up the banking data in return for leniency in his criminal sentencing.

In 2008, a renegade employee of LGT Bank in Liechtenstein stole data about client accounts and sold the data to the German intelligence service in return for millions of Euros.  With that data, the German government prosecuted many prominent Germans for tax fraud.  The German government also shared the data with other governments around the world.  In 2009, an employee of HSBC provided bank account data to the French government.  In 2010, Germany again purchased banking data, stolen by an employee of a Swiss bank.  The DOJ was able to successfully prosecute UBS, and then UBS clients, because of information that had been disclosed by UBS banker Bradley Birkenfeld to the U.S. government.

For our prior articles on banking secrecy undermined by whistle blowers, please see here and here.

Thus, there is no bank secrecy.  The discovery of a “secret” offshore account can be the result of numerous factors:  First, internally at the bank, via whistle blowers, “snitches” and thieves.  Second, due to the vigilance of the U.S. government in pursuing foreign banks and bank accounts, demonstrated by IRS/DOJ success against UBS, and current investigations of numerous other banks (including HSBC, Credit Suisse, Wegelin, Julius Baer, Leumi, Hapoalim, Liechtensteinische Landesbank and others).

A third significant blow to foreign banking secrecy is via the newly implemented Foreign Account Tax Compliance Act (FATCA), which imposes new offshore reporting requirements on account owners and on foreign banks.  New IRS Form 8938 requires disclosure of foreign financial assets with an aggregate value in excess of $50,000, and applies to offshore assets owned during 2011. Form 8938 will be due, along with Form 1040, by April 15, 2012.

In light of the above challenges to offshore secrecy, clearly anyone with a foreign asset that is still not tax compliant must take immediate measures to bring the asset into tax compliance.  As noted, it is widely believed that the renewal of the Offshore Voluntary Disclosure Initiative is purposely timed to incentivize compliance before the next wave of banking data is released to the U.S. government.  Whether through additional prosecutions of banks and bankers, or via a settlement with Swiss banks, each outcome will lead to the revelation of the identities of account owners and other banking data to the U.S. government.  Once the U.S. government has the identities of the account owners, a pre-emptive disclosure is too late, and all penalties, including criminal prosecution, may apply.

The renewal of the OVDI presents an opportunity for those who still have not brought their offshore assets into compliance.  The new penalties are 27.5%, 2.5% greater than the 25% penalty under the 2011 OVDI, yet less than the 50% penalty that the IRS has been imposing in recent criminal tax fraud prosecutions.  In addition to lower penalties, a proper, timely voluntary disclosure can still avoid criminal prosecution.  As we’ve noted repeatedly, the IRS continues to target foreign accounts. We strongly advise taxpayers to bring non compliant foreign accounts into tax compliance, in order to avoid discovery by the IRS, higher penalties and criminal prosecution.  In this new era of international transparency, decreased banking secrecy and stronger enforcement efforts, offshore banking compliance is very highly recommended.

Effectively Representing the Client in a Voluntary Disclosure of a Foreign Account

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We have represented and advised many clients in the 2009 Offshore Voluntary Disclosure Program (OVDP), the 2011 Offshore Voluntary Disclosure Initiative (OVDI) and have already begun advising clients regarding the recently-announced 2012 revival of the OVDI.

From our involvement in many voluntary disclosures, we have heard a significant number of people reporting their their prior attorneys and advisors have not effectively represented the client’s interests before the IRS.  Many people have reported to us that their advisors have “pressured” them into making disclosures, instilling a fear of either making a voluntary disclosure or “going to jail”.  Other advisors were little more than paper-pushers, taking foreign banking statements and other documents, and simply turning them over to the IRS with little to no advocacy on behalf of the clients.  While practitioners may be correct that failing to bring an offshore account into compliance could result in criminal prosecution, we believe that the role of the client representative is not merely to scare, but to properly advise the client as to all options and all potential outcomes.  Please see our prior article, The Role of the Attorney in the Voluntary Disclosure Process, also published in Tax Notes Today.

Along these lines, we have fought hard on behalf of our clients and in some cases achieved notable successes with the IRS, including significant reduction of penalties.  Please see our article, A Few Voluntary Disclosure Successes.

We are also proud of our advocacy on behalf of taxpayers facing IRS “bait and switch” policies within the 2009 OVDP.  In our article, Offshore Voluntary Disclosure Penalties: The IRS Quietly Drops a Bombshell, we wrote about the IRS reversing its position, and no longer allowing taxpayers to argue “reasonable cause” for their non-compliance.  We took issue with the new IRS presumption that all foreign accounts were wilfully concealed, and the IRS refusal to consider evidence of non-willfulness.   In our article, Standing Up to IRS “Bait and Switch” Tactics, we noted how the Taxpayer Advocate Service (TAS), in its Fiscal Year 2012 Objectives Report to Congress (published in June, 2011), essentially agreed with our very concerns.

The TAS has once again sided with us against the IRS.  In its end-of-year 2011 Annual Report to Congress (December 31, 2011),  the TAS has once again criticized the IRS for its unfairness and inconsistent policy.  Among the TAS’ criticisms:

  • The IRS’s Offshore Voluntary Disclosure Program “Bait and Switch” May Undermine Trust for the IRS and Future Compliance Program;
  • The Potential for Strict Application of FBAR and Other Penalties Causes Unnecessary Stress and Fear Among Benign Actors Who Made Honest Mistakes;
  • U.S. Taxpayers Abroad Face Challenges in Understanding How the IRS Will Apply Penalties to Taxpayers Who Are Reasonably Trying to Comply or Return into Compliance.

The TAS noted that “the IRS Is perceived as having “reneged on” the terms of the 2009 OVDP that would benefit taxpayers whose violations were not willful.  Many felt that the IRS placed them in the unacceptable position of having to agree to pay amounts they did not owe or face the prospect the IRS would assert excessive civil and criminal penalties.  This perceived reversal burdened taxpayers, wasted resources, violated longstanding IRS policy, opened the IRS to potential legal challenges, and . . . damaged the IRS’s credibility.”

We are proud that the TAS once again echoed our concerns and advocacy of taxpayers’ rights against IRS unfairness and inconsistency.  As we wrote:

We are proud that the TAS has echoed our very concerns.  We will continue to argue on behalf of our clients in support of non-willful penalties where the facts allow it.  TAS has already issued at least one Taxpayer Assistance Order (TAO) to the IRS regarding offshore accounts. Our advocacy, coupled with TAS support, could compel the IRS to stick to the original terms that it announced.

As we note the increasing number of attorneys and non-attorneys who have in recent years entered the “offshore compliance” world and promote themselves as taxpayer representatives  (especially lately, as the IRS re-introduced its 2011 Offshore Voluntary Disclosure Initiative), we respectfully and humbly point out that we have long been on the vanguard of representing taxpayers before the IRS and fighting for taxpayer rights and lower penalties.  As our actual clients have witnessed, we have closed many voluntary disclosure cases with great success for our clients, and we continue to advocate on behalf of our clients against the IRS.

Historic Opportunity to Avoid Tax on Over $10 Million+ of Assets

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Every year, we remind our clients that year-end gifting is an easy, tax-efficient way to reduce their taxable estate.  This year, the message is all the more significant because this year, for the first time, a person can gift up to $5 million of assets and get $5 million out of the reach of the estate and gift tax ($10 million for a married couple).  This means that if your net worth is below $5 million ($10 million for a married couple), you could avoid gift and estate taxes entirely.  If your net worth is above $5 million, that amount can still go to your family and loved ones, tax free.  If your assets are owned by family limited partnerships (FLPs), then even more can be gifted out of your estate via the principle of discounting, as discussed below.

The amount that an individual may gift to another individual, without tax consequences or a reporting requirement, is now $13,000.  Gifting is an effective strategy to utilize in reducing estate tax liability.  For example, if a husband and wife each gift $13,000 to three children, the value of the couple’s estate is decreased by $78,000.

In addition, you may utilize your “unified lifetime credit” to avoid gift taxes and make one or more gifts of limited partnership interests equal in value to $5,000,000 ($10,000,000 together with your spouse; total value for all gifts).  You will be required to file a gift tax return, but the gift taxes will be offset by your $5,000,000 unified lifetime credit.  A husband and wife, together, may make joint tax-free gifts equal in total value to $10,000,000 in this manner.  Read that again.  Yes, $10 million in assets passing to your heirs, free of tax!

Clients with FLPs should consider gifting an equivalent amount of limited partnership interests, so as to decrease the value of their estate.  Clients have until December 31, 2011 to effectuate a gift for calendar year 2011.  Clients should, in fact, make annual gifts of limited partnership interests, so that the value of their estates, over time, will decrease for estate tax purposes.  As long as clients retain their general partner interests, clients will continue to control all assets within their partnership.  Yes, you can escape the estate tax and still control the assets.

Gifting of partnership interests works hand-in-hand with the principal of discounting of those interests.  Once discounted, more FLP interests can be gifted tax-free to the next generation, which results in more assets passing out of an individual’s taxable estate and thus decreased estate taxes.

One short example may clarify how discounting and annual gifting work together to lower estate tax liability.  If a client owns real property valued at $130,000, the client might gift the property to his or her child over a ten year period ($13,000 annual gift tax exclusion, over ten years).  However, if the same property is owned by an FLP, the client may claim a 50% discount in the value of the limited partnership interests (for lack of marketability and lack of control).  Now, with a discounted value of limited partnership interests of $65,000 (50% discount on $130,000), via annual gifts of $13,000 worth of partnership interests, it would take the client only five years to gift away her partnership interests and eliminate estate taxes due on that property.  This is because a $13,000 gift equals 10% of the non-discounted FLP value ($13,000 = 10% of $130,000), but $13,000 equals 20% of the discounted FLP value ($13,000 = 20% of $65,000).

The same discounts, applied to an FLP containing $20,000,000 of non-liquid assets would allow for the total elimination of estate taxes on the $20,000,000 via a tax-free gift of $10,000,000 worth of limited partnership interests by a husband and wife.

Further, in the current recessionary economy, now is the time to consider gifting assets that are presently at abnormally low values.  The severe decline in the stock and real estate markets have created further built-in discounts for many assets.  When the economy rebounds, these assets will begin to increase in value, and that future appreciation will occur outside your estate.

Furthermore, it is likely that the federal government will make unfavorable changes to the estate and gift tax laws in order to compensate for government deficits.  If passed by Congress, proposed legislation will eliminate the ability to discount the value of FLP gifts.  Clients should consider taking advantage of current favorable laws while they still exist.  The $5 million gift and estate tax exemption only applies during calendar years 2011 and 2012.  Thereafter, the exemption will go back down to $1 million.  Now is the time to capitalize on this window of opportunity to avoid gift and estate taxes on a lot of your assets.

We realize that these are not simple concepts, and we welcome your questions.  We can advise you as to appropriate FLP discounts, prepare memoranda of gift for you, as well as the partnership valuation and gift valuation calculation letters (necessary for the IRS).  Please contact us.