Internal Revenue Service Voluntary Disclosure Program Regarding Unreported Offshore Accounts and Entities

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1 Dear Clients and Friends of the Firm: Re: Internal Revenue Service Voluntary Disclosure Program Regarding Unreported Offshore Accounts and Entities The purpose of this letter is to advise you of the Internal Revenue Service s (IRS) program for voluntary disclosure of unreported offshore accounts and entities and the important approaching deadline associated with it. The IRS has directed this voluntary disclosure program specifically at U.S. taxpayers (both individuals and entities) who have failed to report the existence of and pay tax on income from foreign accounts. The goal of the program is to bring these taxpayers back into compliance with U.S. tax laws. This voluntary program will be available to such taxpayers only through September 23, Background On March 23, 2009, the IRS announced steps to a six-month program to encourage taxpayers with previously undisclosed foreign bank and investment accounts to voluntarily come forward. In return for paying back taxes for the past six years, plus interest and substantial penalties, the IRS will promise not to bring criminal charges or to assess the 75% fraud penalty against taxpayers agreeing to the terms of voluntary disclosure. The IRS estimates that more than $50 billion of tax revenue is lost annually to offshore tax havens. Earlier this year in a criminal case, Swiss bank UBS AG admitted helping U.S. taxpayers hide accounts from tax authorities and agreed to disclose names and account information of U.S. customers to the IRS. In addition, the IRS is currently pursuing a John Doe Summons against UBS AG to gain access to information on 52,000 offshore accounts the bank holds for U.S. customers. The two sides are actively negotiating ahead of an August court hearing. Accordingly, the IRS is stepping up its international enforcement efforts, and can be expected to aggressively pursue taxpayers who do not come clean under the terms of the temporary voluntary disclosure program. The six-month period of the current voluntary disclosure initiative will expire on September 23, The IRS has not yet announced whether it will extend the program for an additional time period. It should also be noted that the availability of the voluntary disclosure period does not offer taxpayers 100% protection against detection by the IRS until September 23, If the IRS receives specific information about a taxpayer s noncompliance before the Schneider Downs & Co., Inc Penn Avenue Pittsburgh, PA TEL FAX S. High Street Huntington Center, Suite 2100 Columbus, OH TEL FAX

2 Page 2 taxpayer attempts to make voluntary disclosure, the IRS can consider the disclosure not to be timely. In these cases, the taxpayer will not be eligible for the criminal and penalty relief available under the voluntary disclosure initiative. Thus, any U.S. taxpayer having unreported taxable income from offshore accounts needs to evaluate the benefits of accepting the voluntary disclosure program before earlier detection by the IRS, or by the expiration date of September 23, The IRS settlement with UBS could come any day and be accompanied by immediate disclosure of account information. Accordingly, the window of opportunity for those taxpayers who wish to elect voluntary disclosure could be closing fast. The Voluntary Disclosure Program The mechanism for reporting a U.S. person s interest in foreign accounts is Treasury Form TD F , Report of Foreign Bank and Financial Accounts (referred to as FBAR). A summary of the IRS s voluntary disclosure program related to FBARs, and other information returns that have not been filed, follows: The program is not available to taxpayers that have already been contacted by the IRS regarding this issue. A new penalty framework will apply for voluntary disclosures that are true, timely, and complete and presented with full cooperation of taxpayers in all areas, including payment. Assurance that those taxpayers who qualify will not be subject to criminal or civil fraud penalties. Establishes specific sets of procedures and guidelines for how disclosures will be handled, which expires on September 23, Is the only means by which offshore noncompliance may be resolved with the IRS. Covers the six-year period 2003 to There are two scenarios that might apply under this voluntary disclosure program: 1. Taxpayer failed to file FBAR and to report and pay tax on foreign income: File six years of amended or delinquent tax returns and FBARs by September 23, Pay all taxes and interest due for the six years. Pay a 20% accuracy penalty or 25% delinquency penalty. Pay a one-time 20% penalty in the year with the highest aggregate account balance (in certain circumstances, this penalty will be reduced to 5%). 2. Taxpayer failed to file FBAR only: Assumes all income from foreign accounts has been reported and taxes have been paid. Taxpayers should file delinquent FBARs and attach an explanation for late filing by September 23, IRS will not impose a penalty for the failure to file the FBARs. (FBAR filing requirements and penalties for failure to file an FBAR follow.)

3 Page 3 Procedure to Initiate Voluntary Disclosure Taxpayers with undisclosed foreign accounts or entities who have failed to report income and pay tax on those accounts must initiate the voluntary disclosure process by sending a letter to the nearest Special Agent in Charge, IRS Criminal Investigation Division, stating that they wish to make voluntary disclosure. The letter should include all taxpayer identification information, an explanation of the income or credits related to the undisclosed foreign accounts and the reason for error or omission. A power of attorney (Form 2848) of the taxpayer s representative should accompany the letter. The amended or delinquent returns need not accompany the letter. The Criminal Investigation Division will contact the taxpayer or the taxpayer s representative to initiate the disclosure proceedings. Accordingly, legal representation in this matter is highly recommended. Sources of Information The IRS has released guidance on the voluntary disclosure program in the form of Frequently Asked Questions (FAQs). The original 30 FAQs were released on May 6, A revised and expanded list of FAQS, increasing the list to 51 questions, was released on June 24, We have referred to several of the specific FAQs for guidance and discussions on procedures in this document. The FBAR can be obtained at and the list of FAQs concerning FBARs is available at As noted, the IRS s separate set of FAQs concerning delinquent filing of FBARs and its voluntary disclosure program is located at FBAR Filing Requirement U.S. persons with a financial interest in or signature or other authority over a foreign financial account may be required to file Form TD F (Report of Foreign Bank and Financial Accounts) with the U.S. Treasury Department if the aggregate value of all such accounts of the U.S. person exceed $10,000 at any time during the calendar year. Completed FBARs for a calendar year must be received by the Treasury Department no later than June 30 of the following year. No extensions are available for this filing deadline, and an extension of time to file federal income tax returns does not extend the due date for filing an FBAR. Foreign Financial Account A financial account includes any bank, securities, securities derivatives or other financial instruments accounts. Such accounts generally also encompass any accounts in which the assets are held in a commingled fund, and the account owner holds an equity interest in the fund (including mutual funds). The term also includes any savings, demand, checking, deposit or any other account maintained with a financial institution or other person engaged in the business of a financial institution. However, individual bonds, notes or stock certificates held by the FBAR

4 Page 4 filer are not considered financial accounts. A financial account is foreign if it is located outside the United States. Financial Interest The definition of financial interest is broad and, in addition to an account for which such person is the owner of record or has legal title, a U.S. person is deemed to have a financial interest in a foreign financial account for which the owner is: (1) a partnership in which the U.S. person owns directly or indirectly more than 50% of the profits or of the capital of the partnership; or (2) a corporation in which the U.S. person owns directly or indirectly more than 50% of the voting power or of the total value of the stock of the corporation; or (3) a trust in which the U.S. person has a beneficial interest either directly or indirectly in more than 50% of the assets or receives more than 50% of the account income. It should be noted that the attribution rules in the Internal Revenue Code are not applicable with respect to FBARs in the determination of ownership. Signature or Other Authority Over a Foreign Financial Account Signature authority over an account includes the ability to control the disposition of the assets of an account by delivery of a document containing his or her signature to the bank or other person with whom the account is maintained. Other authority over an account is comparable power to signature authority over the account, either directly or indirectly or through an agent, nominee or attorney. The IRS has explained that other authority does not include a person who has the power to direct how an account is invested, but who cannot make disbursements to or from the account. FBAR Filings for Previous Years The IRS has issued official guidance pursuant to which taxpayers who failed to file a required FBAR for previous years (2003 through 2008) but who reported and paid tax on all taxable income in such years may file the delinquent FBARs, with an attachment explaining the failure to file in a timely manner, and copies of tax returns for the relevant years. The IRS has indicated that it will not impose penalties for late FBARs that satisfy the requirements of this voluntary compliance program. In order to be eligible for this penalty relief, late FBARs must be filed by September 23, See FAQs No. 9 and 43 for specific guidance. Taxpayers should use the current version of the FBAR (revised in October 2008) to file the delinquent FBARs to report foreign accounts maintained in prior years. Application to Offshore Hedge Funds, Private Equity Funds and Other Pooled Investment Funds During a June 12, 2009 teleconference, senior IRS personnel indicated that it was the position of the IRS that an offshore hedge fund is a foreign financial account for FBAR purposes.

5 Page 5 Specifically, the IRS personnel indicated that a foreign partnership or corporation that is similar in function to, or invests in accounts like a mutual fund or investment company would be a foreign financial account. The IRS viewed the new reference to foreign hedge funds or private equity funds as a clarification, and not news, of the type of financial accounts that should be reported on the 2008 FBAR, and that should have been reported on the FBAR for previous years. This announcement by the IRS created substantial uncertainty as to whether the FBAR requirement applies to holdings in a foreign investment fund. Presumably, in response to the confusion surrounding its hedge fund announcement, on June 24, 2009, the IRS announced that it was extending until September 23, 2009 the filing deadline for the 2008 FBAR but only for taxpayers who: (1) have reported and paid tax on all of their 2008 taxable income; (2) have only recently learned of their FBAR filing obligation and have insufficient time to gather the necessary information to complete the FBAR; and (3) attach a statement to their filing explaining why the FBAR has been filed late. The IRS noted that it will not impose a penalty for the late filing in this situation. The extended filing deadline was announced by the IRS as a revised answer to Frequently Asked Questions (FAQs-Q.43) that the IRS had previously published regarding the voluntary disclosure program. Presumably, almost anyone who is filing late due to an interest in, or authority over, a private offshore fund would fit within the category of having only recently learned of their FBAR filing obligations. Unfortunately, the IRS did not provide any further guidance in the revised FAQs as to whether private offshore funds are financial accounts that must be reported. It is possible that the IRS will issue guidance in writing as to offshore private fund requirements before September 23, Accordingly, for taxpayers who meet the requirements for the filing extension, it may be worthwhile to delay filing the 2008 FBAR until September 2009, in hopes that the IRS will clarify whether an FBAR is required with regard to private offshore funds. U.S. persons who could potentially be subject to the FBAR filing requirement for an interest in or signature or other authority over foreign pooled investment funds include: Any U.S. taxable or tax-exempt investor in an offshore investment fund (including standalone offshore funds, offshore feeder funds and offshore master funds); Any U.S. fund with an equity interest in an offshore investment fund; Any U.S. person owning more than 50% of the ownership interests in a U.S. feeder fund that invests in an offshore investment fund; Any U.S. person who, by virtue of holding a position with a management company or otherwise, has signature or other authority over a foreign fund or any offshore bank or brokerage account (whether owned by the investor, management company or investment fund); and Any U.S. investment manager that has a financial interest (for example, through its carried interest) in any offshore investment fund (whether stand-alone, master or feeder). The IRS personnel at the recent teleconference suggested that an FBAR relating to offshore hedge fund interests be filed not only for 2008, but for the preceding six years, if applicable.

6 Page 6 Penalties for Failing to File FBARs A non-willful violation of the FBAR reporting requirements can result in a $10,000 penalty, subject to a reasonable cause defense. A willful violation can result in a penalty of the greater of $100,000 or 50% of the balance of the account at the time of the violation. Criminal penalties for willful violations can result in a fine of $250,000 and five years imprisonment, and if the violations are part of a pattern of illegal activity, a fine of $500,000 and ten years imprisonment. Possible Penalty Trap! If you did not file FBARs for prior years and had a responsibility to file either under the old or new IRS interpretations of what constitutes a foreign account, we recommend that you file for the last six (6) unfiled years. Otherwise, by filing for 2008, you make the IRS aware that you know you need to file, and after September 23, 2009, you may be held to have willfully not filed the prior-year FBARs within the voluntary disclosure window provided, possibly exposing you to the $10,000 non-willful or $100,000 willful penalty for nonfiling. Change in Definition of U.S. Person In the 2008 revision of the FBAR instructions, U.S. person was defined to include a person in and doing business in the U.S. The IRS provided no further explanation of the phrase. The IRS, however, issued an announcement suspending the FBAR filing due on June 30, 2009 for persons doing business in the U.S. who are not U.S. citizens, residents or domestic entities, and allowing the use of the prior definition of U.S. person to determine filing obligations for FBARs due June 30, The IRS noted that it will issue additional guidance for FBARs due in subsequent years for non-u.s. persons. (IRS Announcement ) Quiet Disclosures of Offshore Assets Rather than formally applying to participate in the voluntary disclosure program, some taxpayers have filed amended returns reporting previously undisclosed assets and income. The IRS is reviewing amended returns to detect this practice. The IRS has cautioned that, if it discovers evidence of criminal behavior in these amended returns, it will recommend criminal prosecution. The IRS reiterated in new frequently asked questions (FAQs; Q.49) that taxpayers who make quiet disclosures will not escape penalties and possible criminal prosecution. Taxpayers whose quiet disclosure returns have not been selected for examination, may request to participate in the voluntary disclosure program. These taxpayers must meet all of the criteria for participation. Penalties for Failure to File Certain Information Returns Other than FBAR In the Frequently Asked Questions (FAQs Q.42), the IRS indicates that taxpayers who have failed to file tax information returns other than FBARs but who have reported and paid tax on all transactions related to the information returns should file these information returns by September 23, If the procedure outlined in FAQs Q.42 is followed, the IRS will not impose a penalty for the failure to file the information returns. Such information returns would include:

7 Page 7 Form Form Form Form Information Return of U.S. Persons with Respect to Certain Foreign Corporations Information Return of a 25% Foreign-Owned U.S. Corporation Engaged in a U.S. Trade or Business Return by a U.S. Transferor of Property to a Foreign Corporation Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts Form 3520A - Annual Information Return of Foreign Trust with a U.S. Owner Form Return of U.S. Persons with Respect to Certain Foreign Partnerships The voluntary disclosure program outlined in Q.42 should be used to correct the delinquency of any of these forms for the 2003 through 2007 filing periods. Nonfiling of these information returns can result in substantial penalties. Procedure for Voluntary Disclosure for Unfiled FBARs 1. Taxpayers who have properly reported all taxable income but have not filed FBARs for 2003 through 2007 for a financial interest or signature or other authority over financial accounts. (FAQ Q.9) These taxpayers need not contact the Criminal Investigation Division of the IRS. The delinquent FBARs should be filed, accompanied by a statement explaining why the reports are filed late, with: Department of the Treasury Post Office Box Detroit, MI Send copies of the delinquent FBARs, together with copies of tax returns for all relevant years, by September 23, 2009, to the Philadelphia Offshore Identification Unit, at: Internal Revenue Service Roosevelt Blvd. South Bldg., Room 2002 Philadelphia, PA Attn: Charlie Judge, Offshore Unit, DP S Taxpayers who reported and paid tax on all of their 2008 taxable income or will file their 2008 tax returns after June 30, 2009, but only recently learned of their FBAR filing obligation and had insufficient time to gather the necessary information to complete the FBAR by June 30, 2009, should file the delinquent 2008 FBAR report according to the instructions in (1) above. For tax returns due after September 23, 2009, a copy of the tax return does not need to accompany the 2008 FBAR. 3. Taxpayers who reported and paid tax on all of their 2008 taxable income but did not file an FBAR should file the delinquent 2008 FBAR report as soon as possible but not later than

8 Page 8 September 23, 2009 according to the instructions in (1) above and attach a statement explaining the reasonable cause of why the reports are filed late. No penalty will be assessed if the IRS determines that the late filing was due to reasonable cause. We have requested clarification from the IRS with respect to the above-noted procedures on whether U.S. persons filing delinquent FBARs as persons with signature or other authority over foreign accounts are required to attach a copy of a tax return to the FBAR. It is not clear as to why a person with only signature or other authority would be required to file a copy of a return, and whether the individual s or entity s return, or both, should be attached. As of this date, the IRS has not responded to our inquiry. Summary and Conclusions Persons who have not properly reported income from foreign accounts for 2003 through 2008 should consider, with the assistance of counsel, participating in the IRS offshore voluntary disclosure program. This program is available until September 23, 2009 and will help those taxpayers avoid exposure to substantial civil and criminal penalties, and will generally eliminate the risk of criminal prosecution. We recommend that taxpayers finding themselves in this situation consult with tax counsel without delay. Taxpayers having only delinquent reporting requirements should take advantage of procedures made available by the IRS to cure these delinquencies. These procedures are also available until September 23, The IRS will not impose a penalty for the failure to file the FBAR, or other foreign information returns, if the delinquent returns are filed by this date. If you have any questions as to how the IRS s offshore voluntary disclosure initiative applies to you, or if you wish for Schneider Downs to assist you with your offshore reporting and compliance requirements, please contact your Schneider Downs tax services representative. Very truly yours, Certified Public Accountants /var Ref: This advice is not intended or written to be used for, and it cannot be used for, the purposes of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax-related matter.

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