Asset Protection BLOG - Mark Nestmann

Bye-Bye Tax Free Munis?

There's been a lot of buzz in the media that President Obama might try to confiscate privately held retirement plans, or at least end tax deferral for them.

Anything is possible in the current financial crisis, but there's another initiative underway right now, and that's received scant media attention.  And that's the impending elimination—or at least scaling back—of tax-free interest payments from municipal bonds. 

For more than 60 years—ever since the Roosevelt administration—presidents have tried to tax interest payments from municipal bonds without success.  However, the economic crisis has now provided Obama with a way to do just that. 

At the outset, it's important to remember the central operating tenet of the Obama administration: “A crisis is a terrible thing to waste.”  That aphorism comes from Obama's Chief of Staff, Rahm Emanuel, Obama's right-hand-man.   And this economic crisis has given the government the opportunity to take over partial responsibility for financing state and local government operations, via so-called "Build America Bonds," or BABs.

The Bush administration's TARP legislation authorized BABs as a "temporary" government initiative.  Unlike ordinary muni bonds, BABs are taxable, but offer a higher return than ordinary munis—up to 7% or more.  BABs can pay higher returns because the federal government subsidizes 35% of the interest.  Moreover, due to the federal government subsidy, many investors believe they're safer than ordinary munis. 

To date, BABs have had a relatively minor impact in the market, with only US$14 billion or so sold.  But sales are growing quickly, and the combination of higher yields and federal subsidies have led some analysts to predict that sales will grow to US$150 billion or more annually.

If you were Rahm Emanuel, what opportunities would you see in this development?  Here's what I would be thinking if I shared his mindset:

• First, introduce legislation to extend the "temporary" authorization for BABs from year-end 2010 for another five years.
• Second, propose beefing up Treasury supervision of BABs so that, in effect, the federal government effectively decides which state and local projects receive funding.  This essentially ends state or local control over funding decisions, especially in states like California with low credit ratings for many traditional munis.
• Third, begin issuing press releases from the White House pointing out how "unfair" it is that high-income investors reap most of the tax benefit from traditional munis.  Surely the mandarins in Obama's Treasury have notified Mr. "Waste no Crisis" Emanuel that U.S. taxpayers earn US$72 billion in tax-free income each year (2006 figures).  And, they've certainly let him know that households earning over US$500,000/annually account for more than US$30 billion of that amount.

I suspect that it will be impossible to eliminate tax-free munis all at once.  But several interim steps leading to possible elimination are also possible:

• First, phase out the exemption for alternative minimum tax (AMT) for high-income muni investors.  President Obama has already made it clear that anyone who earns more than US$250,000 annually will pay more in tax under his tax reform plans.  And what better way to do it than to target an investment primarily used by the wealthy?  Plus, there's a precedent: investors are already subject to AMT on interest paid by munis issued by not-for-profit 501(c)(3) organizations and other “private activity” issuers such as airports and certain housing agencies.
• Next, tighten the regulations on the use of muni proceeds.  The U.S. Tax Code already prohibits using munis to finance racetracks, massage parlors, golf courses and other privately owned projects.  The Obama administration could always propose legislation to extend these restrictions.  It could even mandate that any traditional muni offering pass a Treasury cost-benefit analysis or pass a similar hurdle. 
• Finally, prohibit bailout money from being used to pay interest on munis.  Congress and the Obama administration already are telling corporations how much they can pay their executives and placing unsecured creditors ahead of secured ones in federal bankruptcy proceedings.  So why shouldn't it screw muni bondholders too, particularly if they're "rich?"

No less an authority that PIMCO's Bill Gross, perhaps the world's most prominent bond investor, says "Don’t turn your back on the government when it comes to your investments."  That's good advice if I ever heard it.

Copyright © 2009 by Mark Nestmann

Nothing Like Giving Us Plenty of Notice…

In case you haven't noticed, there has been an unprecedented amount of publicity in the financial media about tomorrow's date, June 30, 2009. Forbes, The Wall Street Journal, and many other financial publications have devoted a surprising amount of coverage of this date.

What's the fuss?  Well, it turns out that June 30 is the deadline for filing the Treasury's annual foreign bank account reporting form (FBAR), Form TD F 90-22.1.

The IRS has issued numerous warnings to taxpayers and their advisors letting them know it's "really serious" about enforcing this report filing obligation.  It's even announced a sort of "amnesty" to encourage people who haven't previously filed the FBAR to become compliant.  (The IRS calls this "voluntary disclosure," as if we really voluntarily bare our souls to the tax man).  But unfortunately, the IRS keeps changing its mind over who has to file the form, and when it's really due.

First, a little background: Back in the "good old days," i.e., before 2009, the IRS defined U.S. persons subject to filing the FBAR as:

1. A citizen or resident of the United States
2. A domestic partnership,
3. A domestic corporation, or
4. A domestic estate or trust.

Those of us fortunate enough to be "U.S. persons" must report the existence of all “foreign bank, securities or ‘other’ financial accounts” if the aggregate value of those accounts exceeded US$10,000 at any time during the preceding year.  Failing to do so may result in a fine up to US$250,000, imprisonment up to five years, or both.

Anyway, these were the filing requirements in the good old days.  Then, in October 2008, the Treasury Department unveiled a new FBAR form that significantly expanded the reporting requirements for foreign accounts.  It also helpfully extended the definition of a "U.S. person" to foreign persons "in and doing business in the United States." 

Not surprisingly, this change led to consternation among some foreigners.  They were, to put it mildly, nonplussed by the new requirement to reveal the name, address, account number, and highest value in the preceding year of each non-U.S. account over which they had signature or "other" authority. 

"We hear your pain," said the Treasury.  And so a few weeks ago, the IRS announced that it would revert back to the previous definition of "U.S. person."  You could almost hear an audible sigh from those foreigners "in or doing business" in the United States. 

Now, in its latest missive, the IRS has issued a new "frequently asked questions" explanation of its latest offshore voluntary disclosure initiative.  Among other changes, it extended the June 30 deadline to Sept. 23, 2009 for the FBAR form for "…taxpayers who reported and paid tax on all their 2008 taxable income but only recently learned of their FBAR filing obligation and have insufficient time to gather the necessary information to complete the FBAR." 

If you're in this situation, the IRS says you should file the delinquent FBAR report according to the instructions and attach a statement explaining why the report is filed late.  (How about, "I had no f___ing idea I needed to file it?"  But then again, that might not be the best choice of words.) 

Then you send a copy of the delinquent FBAR, together with a copy of your 2008 tax return, by September 23, 2009, to what the IRS calls its "Philadelphia Offshore Identification Unit."  Under these circumstances, says the IRS, you won't have to pay a penalty for failing to file the FBAR on time.

This story has more twists and turns than a mountain road in my home state of West Virginia.  And here's the last one: if you're not eligible for an extension of the June 30 deadline, make sure the Treasury office in Detroit designated in the FBAR instructions receives your FBAR by tomorrow.  Unlike most tax forms, you can be penalized if the Treasury doesn't receive your FBAR by the deadline.  It's not sufficient that it's postmarked June 30.

Copyright © 2009 by Mark Nestmann

The Justice Department Plan to Maximize Asset Forfeiture

I've written many times in this blog on the abominable practice of "civil forfeiture," a legal procedure in which prosecutors can seize your property without accusing you—much less convicting you—of any crime.

The civil forfeiture racket raises billions of dollars for federal, state, and local governments.  Most of the time, the seizing agency gets to keep the money it confiscates, creating a bounty hunter mentality throughout the law enforcement system.

But that's not enough, according to the U.S. Department of Justice.  The DOJ is now implementing its first-ever National Asset Forfeiture Strategic Plan, with the goal of ensuring that prosecutors recover every last dollar of potentially forfeitable assets.  That's a big job, because more than 300 federal laws authorize civil and/or criminal asset forfeiture.  Not to mention tens of thousands of state, local, and county asset forfeiture laws and ordinances.

According to former assistant Attorney General Alice S. Fisher:

"Today, there is legal authority to forfeit the proceeds of virtually all serious offenses including terrorism, drug trafficking, organized crime, child pornography, alien smuggling, human trafficking, white collar crime, and money laundering. The National Asset Forfeiture Strategic Plan seeks to develop and implement policies and procedures to ensure that asset forfeiture is an integral part of every investigation and prosecution."

In other words, the government wants to make absolutely sure that no forfeitable assets slip through the proverbial cracks.

How might this affect you?  Well to begin with, consider what might happen if you have undeclared monies outside the United States and have used a structure such as an offshore trust or international business company (IBC) to hold those funds. 

It would be difficult for prosecutors to claim that mere failure to disclose a foreign account constitutes money laundering.  However, what if prosecutors discover you've formed a bearer share IBC, and you've used it to operate a bank account that has generated hundreds of thousands of dollars in untaxed profits? 

Under that scenario, prosecutors could argue that you're using "sophisticated means" to defraud the government.  This elevates a relatively mundane reporting violation into a tax fraud case involving money laundering.  And in a money laundering prosecution, the government can confiscate not only the proceeds of a crime, but all assets "facilitating" that crime.

A jury might or might not agree that your domestic bank accounts, your home, your vehicle, and your business "facilitated" a money laundering violation, but that doesn't prevent a prosecutor hunting for scalps from alleging that they did.  And in many cases, prosecutors can freeze your assets pending trial.

There's no question that the Obama administration and is determined to go after tax evaders who move their money offshore.  Nor is there any question that the Department of Justice wants to maximize forfeiture revenues by any means necessary.  That makes it more important than ever to be 100% compliant in your offshore dealings—or face the consequences.

Copyright © 2009 by Mark Nestmann

Could You be Imprisoned for Estate Planning?

American jails are bulging with "criminals" guilty of nothing more than indulging in their favored herbal remedy, seeking privacy in their financial affairs, or building on their own property.  In certain circumstances, you can also be imprisoned for trying to protect your assets.  And now, your legal advisors—and by extension, perhaps you as well—may be committing tax fraud if you form a limited partnership to reduce estate taxes. 

On June 9, in a Manhattan federal courtroom, the Department of Justice unveiled a tax fraud indictment against several prominent tax attorneys and tax planners.  They  stand accused of marketing "tax shelters" that lacked economic substance and had little chance of withstanding an IRS challenge. 

The indicted attorneys created opinion letters stating that clients would "more likely than not" prevail in claiming the tax benefits from the tax shelters if challenged by the IRS.  Since the IRS believes the opinion letters contained false statements, the indictment claims the attorneys made false representations to the IRS.

The essence of these alleged false representations was that the tax shelters—which generally involved complex investment strategies involving hedges and options—had a non-tax purpose.  For instance, a legal opinion one of the indicted attorneys prepared stated:

"You entered into the purchase and sale of the options for substantial non-tax business reasons, including (i) to produce overall economic profits because of your belief that the [foreign currency]/U.S. dollar exchange rate and the [second foreign currency]/U.S. dollar exchange rate relationships would change; and (ii) your belief that the most direct way, with the most leverage, to realize gain from expected changes in currency prices was the purchase and sale of the options."

However, the indictment alleges that:

“In truth and fact, the clients entered into the purchase and sale of the options in order to obtain the desired tax benefits, and had no substantial non-tax business reasons for entering into them…the clients took that step because the conspirators directed them to do so in order to achieve the tax losses or benefits they purchased.”

If the Feds win this case, you can expect a major crackdown against any tax planning strategy in which non-tax benefits are alleged, but can't be proven.  And limited partnerships—along with those who create them—will be one of the prime targets.

Estate planning with a limited partnership typically involves forming the partnership, funding it with a substantial portion of your estate, and then making periodic gifts of minority partnership interests to your heirs.  Planners often discount the value of such gifts for gift and estate tax purposes.   Discounts vary from 10% to 50% or more, although 25% is a typical adjustment.  The discount exists because it's often not possible to sell partnership interests—particularly minority interests—for the full value of the underlying assets.

However, even though the courts have repeatedly upheld the validity of valuation discounts, the IRS has continued to challenge them.  And if prosecutors succeed in convicting the indicted attorneys in New York, the agency will have one more arrow in its quiver--the threat of prison. In addition, the Obama administration is sponsoring legislation that would eliminate most valuation discounts. 

How might the IRS equate estate planning using valuation discounts with tax fraud?  Because the planning documents for limited partnerships usually contain the same type of language that the prosecutors in New York are trying to prove is fraudulent.  Some of the non-tax justifications used for limited partnerships include:

• Discouraging frivolous lawsuits
• Combining family assets for streamlined management and superior investment options
• Reducing the likelihood of disputes between over family assets.

These are all legitimate goals.  But if the IRS audits your estate, and your heirs can't prove that the partnership was used primarily or at least substantially for non-tax purposes, it might not just invalidate the valuation discount.  It might also threaten to indict your heirs for tax fraud.

This may seem like an extreme interpretation of the implications of the New York litigation.  And in reality, what the IRS is most likely to do is to tell your heirs that if they forget about the valuation discount, they won't be indicted.

The handwriting is definitely on the wall: estate planning with limited partnerships will become an increasingly risky affair.  Fortunately, there are numerous alternative strategies—life insurance, various types of trusts, lifetime gifts—that I'll discuss in future blog entries.

Copyright © 2009 by Mark Nestmann

Will Pandemic Declaration Lead to Financial Defaults?

Earlier this week, the World Health Organization declared the spread of the H1N1 flu virus, the causative agent of the so-called "Swine Flu" to be a "flu pandemic." 

This is the first time in more than 40 years that the WHO has made such a declaration.  And it seems rather odd that it would do, given that this "pandemic" has had such minimal impact.  The last time that the WHO declared a flu pandemic was in 1968, when the Hong Kong flu strain killed more than a million people. 

By contrast, as of June 15, the H1N1 flu strain has killed a mere 163 people.  That's a significant number, but by comparison, complications of ordinary flu kill about 36,000 Americans every year.  True, the spread of the H1N1 strain technically meets the definition of a pandemic—an epidemic that is geographically widespread.  Since its discovery in April in Mexico, the virus has spread to 74 countries on five continents.

But the pandemic declaration also has some very significant collateral side effects that could be extremely useful to banks, insurance companies, and hedge funds locked into losing positions on derivative contracts.  Call me paranoid if you want, but many such contracts contain a "force majeure" clause that allow the signatories to cease meeting their obligations in situations beyond anyone's control. Pandemics are typically listed as reasons for calling a force majeure.

Now, it so happens that Friday, June 19 is a very significant date when it comes to derivative contracts.  That's because the last hour of trading will be one of only four so-called "Quadruple Witching Hours" each year, in which contracts for stock index futures, stock index options, stock options and single stock futures all expire simultaneously.  That's only two days away, but if all hell breaks loose in the markets between now and then—or if any of the counter-parties for these contracts can't deliver—they may well declare force majeure.

Seen in this light, the WHO's declaration of pandemic may be more of an economic diversion than a public health emergency.  Indeed, interpreted in this light, a more accurate rendition of "swine flu pandemic" may be one its anagrams; "unwind limp faeces."

Copyright © by Mark Nestmann

The Internet Never Forgets

Web-savvy employers and universities are increasingly employing a new tactic to screen applicants: conducting online research to unearth photos, blog entries, or other "digital dirt" you might prefer to keep private. 

Indeed, companies are springing up to dig up Internet postings that might be of interest to employers, government agencies, or whoever else might be interested.  For instance, you can view Web pages that were modified months or even years ago through the Internet Archive, also known as the Wayback Machine, at http://www.archive.org. 

But that doesn't mean you can't obscure your digital trail.  While I normally suggest that anyone interested in privacy avoid posting information to the Internet about themselves, if data you don't want others to see is already there, here are a few suggestions on how to cope:

Delete, delete, delete.  Start by deleting any photo, personal profile, or personal description on any social networking or dating Web site that is even mildly embarrassing.  For instance, I suspect Sergey Brin, the co-founder of Google founders, might prefer not to have this photo of him in drag immortalized.  While Sergey may be wealthy enough not to care, you may not be. 

Unfortunately, most social networking sites create archives in which your photos may reside permanently, even if you delete them from your profile.  Someone with a link to the original photo—or using the Internet Archive—might be able to find it. 

Do a search of yourself on Google.  Look for any links back to potentially incriminating or embarrassing posts or photos.  Unfortunately, Google won't remove content itself, but merely will refer you to the Webmaster posting the content.  If you can't figure out who's in charge of a Web site, search for the owner at www.whois.net.  Contact the owner of the site and ask that comments by or about you be deleted. In most cases the owner has no obligation to remove the content, but it may do so if you persist or threaten legal action.

Set up a Google alert for yourself.  You'll receive a daily e-mail update of the latest updates of whatever topic—yourself in this case—that you choose.  This is a great way to monitor what others are saying about you online.

Create favorable content about yourself.  You can do this in many ways.  For instance, create a professional Web site and/or professional blog.  For blogs, Wordpress, LiveJournal and TypePad all have high Google page ranks. You can also create a Wikipedia entry for yourself.  To further insure these sites are at the top of any Google search of your name, use title tags and headers to highlight information about you that you want people to see.  Don't forget to create a Google profile that contains the information about yourself you wish to highlight.  You can also leave comments on blogs and Web sites you respect under your own name. 

Use social networking sites intelligently.  It's almost impossible to permanently eliminate content you post to social networking sites, even if you unsubscribe.  However, you can also use these sites to your advantage, especially if you're setting up a profile for the first time.  Web sites like Facebook, MySpace, LinkedIn, Flickr, and Twitter are a good place to begin.  You don't even need to use these sites.  Just create a profile and add the content you want people to see.   Web sites that let you create a unique link with your name in it are especially useful (e.g., LinkedIn).  Those pages will show up ahead of most other sites that might contain content you don't want others to view.

Use protection.  There's no such thing as an Internet condom, but you can hire companies that will contact sites that have published material pertinent to your character.  One that has good reviews—although I haven't used it personally—is http://www.trackur.com.

Just don't forget that once you've posted something on the Internet, it's very difficult to permanently delete it.  So before you hit the "post" button, be absolutely certain that whatever you're about to send into cyberspace belongs there.

Copyright © 2009 by Mark Nestmann

What's Next for Caribbean Offshore Centers?

The global recession and the U.S. crackdown on offshore jurisdictions have seriously affected Caribbean economies.  One of my colleagues recently returned from a two-week visit to several Caribbean countries.  Here's his report:

Panama: Real Estate Boom Ending

A year ago, the real estate boom was in full swing.  About 17,500 units—mostly high-rise condos—were ready to come on the market.  In some cases, a condo would double in value during the time it was being built.  Some developers even sold the same unit twice.  For instance, a developer would sell a unit for US$500,000, and then sell it a second time for US$1 million.  If the first buyer complained, the developer would refund his or her deposit.

Fast forward 12 months…prices are in free-fall.  Many buyers who put down deposits are simply walking away from their units.  Numerous high-rise condo towers are empty.  Foreclosure is inevitable, and several complete towers are now up for auction.  You can buy a nice apartment or condo in Panama City for US$80,000 today that a year ago cost US$500,000. 

The cash fueling the boom was primarily Venezuelans fleeing with their money to Panama, but those with real money arrived years ago.  Venezuelan men often seek out Panamanian women to date, but these women joke among themselves that if a Venezuelan man arrived in the last three years, he probably has no money.  Local real estate developers hope for an influx of American expats—but it can't happen soon enough to unload the thousands of unsold condos on the market. 

On the political front, Ricardo Martinelli won the latest presidential election.  His election platform was essentially, "I own lots of grocery stores and since I'm already wealthy, I don't need to steal from the people or the government."  About as effective as a platform I have heard anywhere in the world.

Panama hopes to join the North American Free Trade Agreement in the next few years.  That could spell major benefits of Panama's economy, but the price may be relaxation of the country's famous bank secrecy laws.  Still, Panama has the canal, and that may give it enough leverage to push through NAFTA and keep bank secrecy intact.  The next few years should be very interesting!

Bahamas: Demise of the US$10 Million Yacht

It's spring and the US$100 million yachts are in the harbor of the Atlantis Hotel, but the US10 million ones are in foreclosure.  And so it goes: the mega-rich haven't been affected—yet—by the recession, but those who can only afford a small yacht have had to sell it to pay the bills. 

Nearly a decade ago, the Bahamas shot itself in the foot by enacting a series of laws and regulations that satisfied U.S. government demands, but also resulted in the loss of most of its offshore business.  Since then, the Bahamas has tried to reinvent itself by catering to Latin American and European clients.  Unfortunately, this effort hasn't been particularly successful.

In the meantime, violent crime is becoming an increasingly severe problem.  The murder of Hywell Jones, a longtime Bahamian offshore services provider is a recent example.  Late in April, Jones was shot in the back of the head execution-style as he exited his car at his office.  Before his murder, Jones told friends he feared for his safety after being badly beaten and left severely injured in an attack at his home.  Perhaps coincidentally—or not—Jones was engaged in ongoing litigation with local businessman Lester Turnquest, a former member of Parliament. 

Jones's death marks the 25th homicide in the Bahamas in 2009.  This grim statistic underscores the reality that the Bahamas has become one of the most violent locations in the western hemisphere.  On an annualized basis, there more murders per capita in the Bahamas than in the most violent U.S. cities.
 
Turks and Caicos Islands: Is Captive Insurance Enough?

Still recovering from two Category 2 hurricanes last year, the Turks & Caicos Islands (TCI) faces a major challenge in restoring its infrastructure.  And it doesn't help that the U.K. government doesn't want to invest more money in a dependent territory with massive corruption problems.  Indeed, the U.K. government recently suspended the constitution to deal with corruption issues.  A governor appointed in London now rules the island.

One of the few sources of hard currency for the TCI is tourism.  However, the government recently announced that it planned to ding departing tourists US$100 for the privilege of leaving.  Come back soon, now!  Meanwhile, import duties are to increase as well to raise revenue.  While the TCI was never a low cost jurisdiction, it's quickly getting even more expensive.

On the offshore front, the TCI is best known as a haven for captive insurance.  This industry remains relatively healthy, but the real question is whether this one trick pony is enough to make the TCI a viable offshore jurisdiction.  There simply isn't much else here, with banking and Internet infrastructure years behind what other offshore jurisdictions offer.

Copyright © 2009 by Mark Nestmann

IRS Backs Down on Foreigners' Obligations to Report non-U.S. Accounts

A few weeks ago, I described a new requirement from the IRS that requires foreigners "in or doing business" in the United States to report details of all their non-U.S. financial accounts to the U.S. Treasury.

I also described the downside of this obligation as it relates to foreign persons, especially if the information they provide finds its way to organized crime syndicates in their own countries.  This is hardly an unforeseeable consequence, as data from the Treasury's "Foreign Bank Account Report" form (FBAR) is widely shared with authorities in other countries.  And in some of these countries, government corruption is rife.

Not surprisingly, this new obligation led to an outcry by those affected by it.  And some of those persons hired the requisite legal talent in Washington, D.C. to persuade the IRS to temporarily suspend the reporting requirement for foreigners "in or doing business" in the United States.  As a result, the IRS has reverted to the narrower filing obligation that existed prior to the October 2008 revision of the FBAR.

Under those prior requirements, now reinstated, a "U.S. person" subject to filing the FBAR is defined as

(1)    A citizen or resident of the United States
(2)    A domestic partnership,
(3)    A domestic corporation, or
(4)    A domestic estate or trust.

Just as a reminder, if you or your partnership, corporation, estate, or trust is a "U.S. person," you must report the existence of all “foreign bank, securities or ‘other’ financial accounts” if the aggregate value of those accounts exceeded US$10,000 at any time during the preceding year.  Those failing to do so face a fine up to US$250,000, imprisonment up to five years, or both.

The report for 2008 is due June 30, 2009.  You can download the FBAR here.

Copyright © 2009 by Mark Nestmann

To File or not to File…that is the Question

If the date June 30, 2009 doesn't mean anything to you, you're not alone.  But if you're a U.S. taxpayer, or a foreigner foreign person "in or doing business" in the United States, June 30 is the deadline for filing a rather obscure form with the U.S. Treasury with the cryptic name "Form TD F 90-22.1" (link here to the form).

The "foreign bank account report" or FBAR requires you to disclose the details of all "financial accounts" you hold outside the United States, if their aggregate value exceeds US$10,000.  You must file the form if you're a U.S. citizen, permanent resident, or conduct business on a regular and ongoing basis in the United States.  Fail to file it, and you could face a negligence penalty of US$10,000.  If you "willfully" fail to file the FBAR, you face a fine up to US$250,000, imprisonment up to five years, or both. Penalties are doubled if you violate any other U.S. law.

While you're at it, don't forget that you have a separate obligation to disclose any "reportable" foreign accounts on Schedule B of Form 1040.  Hopefully you already made that acknowledgment when you filed your 2008 tax return.  If not, you should file an amended return and make the required disclosure (check "yes" on line 7a of Schedule B).

Unfortunately, it's not always easy to figure out whether you need to file the FBAR or not.  If you have financial interest in, or signature or other authority over foreign bank, securities or “other” financial accounts with an aggregate value exceeding US$10,000, you're supposed to file the form. (See IRS guidance here.)

Therefore, if you have a foreign bank account or securities account, it's clear you must file the form.  But it's less clear whether you must disclose details of other offshore relationships.

Late last year, the Treasury Department issued a revised version of the FBAR, along with revised instructions.  The instructions resolve some of the unanswered questions about reporting offshore accounts.  For instance, they make it clear that you must report financial interests in foreign mutual funds, even if you hold them outside a bank.   Hedge fund managers and other investment managers with control over offshore accounts must also file the form.

However, other questions remain unanswered.  For instance: 

• Are interests in offshore electronic gold accounts or offshore precious metals certificates reportable?
• Are offshore variable annuities or offshore life insurance policies reportable?

I've always recommended reporting these investments as "foreign accounts," although plenty of advisors disagree with me.  But I'd rather be safe than sorry.

There's another complication as well.  The IRS has unveiled a "voluntary compliance" program that offers reduced penalties for U.S. persons who disclose previously unreported offshore accounts before Sept. 23, 2009.   To qualify, you must file the FBAR for past years when you should have, but didn't, file it. 

If you're planning to go through this program, should you file the form before June 30?  Some attorneys say you should.  Others say don't do it, because doing so may red flag you for an audit and disqualify you for the voluntary compliance program.  If you're considering this program, I recommend contacting a tax attorney immediately to seek professional advice on whether to file by June 30, or not. 

Otherwise, while I realize the FBAR is a "tell all" form that you'd probably rather not file, my advice is to file it even in borderline situations.  The consequences of NOT filing are severe, should you get caught. 

Copyright © 2009 by Mark Nestmann

"Article 26" and the Demise of Offshore Banking Secrecy

If you invest or do business internationally, you need to know about double taxation agreements, more commonly called "tax treaties."  These agreements are designed to avoid or at least minimize double taxation.  However, they have another, less publicized function: to facilitate information exchange to help enforce domestic tax laws. 

One of the consequences of the political firestorm in recent months over bank secrecy laws in Switzerland and other offshore financial centers is that information exchange through tax treaties will become increasingly common.

Tax treaties are based on a model treaty prepared by the Organization for Economic Cooperation and Development (OECD).  The OECD regularly updates its model treaty.  Each successive model provides tax authorities greater powers to retrieve financial information from the other signatory.  This is accomplished via the "Exchange of Information" provision in the model treaty; Article 26.

Early tax treaties gave signatories wide latitude to turn down requests for information under Article 26.  Signatories could turn down requests for information under several different rationales, all based on the concept of "comity;" i.e., the recognition accorded by one nation to the laws and institutions of another. 

For instance, a signatory could turn down an information request if it concerned a tax not imposed by that country (“domestic tax interest”).  It could also invoke a "dual criminality" requirement: if the conduct in question wasn't illegal in both countries, the request wouldn't be honored. 

However, in 2000, the OECD completely revamped Article 26 to expand the scope of information exchange.  Bank secrecy laws, dual criminality requirements, and domestic tax interest requirements could no longer be invoked to prevent information exchange.  These provisions have gradually made their way into the international network of tax treaties. 

Therefore, if a particular country agrees to implement information exchange arrangements "consistent with OECD standards," the laws you thought might have prevented your financial information from being disclosed to your domestic tax authorities may no longer apply.  Almost every country with strict bank secrecy laws, including Andorra, Austria, Belgium, Liechtenstein, Luxembourg, Monaco, and Singapore, has announced it will comply with the expanded version of Article 26.  Panama has not provided specific assurance on this point, but has made a commitment for "effective exchange of information" in accordance with OECD standards.

Still, there are limits to Article 26.  The OECD model only requires treaty signatories to exchange information on request.  That is, the country requesting information must know that your assets or accounts are in a particular jurisdiction—and likely, in a particular institution—before it can request information.

These limits are unlikely to satisfy the more rabid advocates of full disclosure.  You can likely expect the next round of the OECD model tax treaty to include a provision for mandatory "automatic" exchange of information between tax authorities. 

In the meantime, the handwriting is definitely on the wall.  Offshore bank secrecy laws will not protect you from having your account information turned over to your domestic tax authorities.  If you have unreported offshore accounts, you need to deal with the problem now—not later.  A good start would be a call to an attorney specializing in criminal tax defense.

Copyright © 2009 by Mark Nestmann