“Each year, in the United States alone, offshore tax evasion produces an estimated $100 billion in unpaid taxes that could help pay for health care, education, and more. It’s time to put an end to offshore tax dodging that robs the U.S. Treasury of needed funds.” —Statement of Senators Carl Levin (D-Mich.) Norm Coleman (R-Minn.), March 6, 2008.
All U.S. Persons are subject US taxation on their worldwide income. The threshold question is whether the taxpayer is a U.S. Person. A U.S. Person is generally defined as a U.S. citizen or resident or domestic entity (corporation, partnership, estate, trust). IRC §7701(a)(30).
There are two types of U.S. residents. The first type is the lawful permanent resident, which is a foreign person who has received a U.S. green card. The second type is the substantially present resident. This is a person who is present in the United States for 183 days either (1) during the current year, or (2) over 122 days per year, over the past three years based on the following formula: (A) number of days present during the current year, plus (B) number of days present in prior year multiplied by 1/3, plus (C) number of days present two years ago multiplied by 1/6.
For taxpayers who disclaimed their U.S. citizenship or terminated their residency, they are subject to foreign-interest reporting rules. Regardless of their status under immigration law, a taxpayer is still treated as a U.S. citizen or resident for tax purposes until proper notice is given to both the Department of State (or Homeland Security) and the IRS.
Many U.S. Persons living in Israel are holding bank accounts or other financial accounts without reporting these funds to the Internal Revenue Service (IRS). The US tax net is closing down on US taxpayers all over the world starting in Switzerland but also in Israel. In the coming months, Israeli banks like most financial institutions worldwide, will be signing an agreement with the IRS to disclose bank transaction of U.S. Persons. In this regard one should plan his or her financial position accordingly and not be caught unprepared.
On February 8, 2011, The IRS announced a special voluntary disclosure initiative designed to help ensure that funds held worldwide are brought into the US tax system and help individuals with undisclosed income from hidden offshore financial accounts get current with their taxes.
The IRS decision to open a second special disclosure initiative follows continuing interest from taxpayers with foreign accounts. The first voluntary disclosure program ended with 15,000 voluntary disclosures on October 15, 2009.
The new voluntary disclosure initiative, called the 2011 Offshore Voluntary Disclosure Initiative (OVDI), allows individuals with previously unreported foreign financial accounts to significantly reduce their exposure to substantial civil tax penalties and, in many cases, to eliminate the potential of criminal prosecution. This program will only be available through August 31, 2011.
The OVDI program requires individuals to pay a penalty of 25% of the amount in their foreign bank accounts for the year with the highest aggregate account balance – from 2003 to 2010. Participants must also pay back taxes and interest for up to eight years as well as paying accuracy-related and/or delinquency penalties.
In limited situations, taxpayers can qualify for a five percent penalty.
The IRS also created a new penalty category of 12.5% for addressing smaller offshore accounts. Individuals whose offshore accounts or assets did not surpass USD$75,000 in any calendar year covered by the OVDI program will qualify for this lower rate.
The OVDI program offers clear benefits to encourage taxpayers to reconcile their tax issues rather than risk IRS detection. Taxpayers hiding assets offshore who do not come forward will face far higher penalty scenarios including a 50% of the balanced account penalty for every year that an FBAR (Foreign Bank and Financial Accounts) has not been reported as well as many other penalties (the IRS gives an example of an uncovered, unreported foreign account with USD$1.05 million – USD$1.4 million between the years 2003 and 2010 that will face USD$4,543,000 in tax and penalties if the taxpayer did not come forward within the program parameters) and the possibility of criminal prosecution.
In this regard, it should be mentioned that according to the Foreign Account Tax Compliance Act (FACTA), which was enacted on March 18, 2010, foreign financial institutions (FFIs) are required to deduct and withhold a tax equal to 30% of the amount of any payment to an FFI unless the FFI agrees to disclose the identity of the U.S. Persons and report on their bank transactions. In this regard the Israeli banks will not take the risk of 30% withholding on US investments so that one should assume that they will enter the FACTA arrangement and will disclose information on U.S. Persons with bank accounts in Israel.
Taxpayers participating in OVDI program must file all original and amended tax returns and include payment for taxes, interest and accuracy-related penalties by the August 31, 2011 deadline.
It is also worth noting that once the IRS begins an investigation concerning a U.S. Person’s assets in Israel, it may cause compliance complications for that individual in Israel as well. The IRS’s reciprocal information exchange arrangement with the Israeli tax authorities often leads to information being passed on to the Israeli tax authorities regarding funds being held in the US by that same individual. Needless to say, if those funds were not reported in Israel, the Israeli tax authorities will take issue.