Today, the IRS has issued a press release informing taxpayers that the deadline for the second special Voluntary Disclosure Initiative of Offshore Accounts has been extended from August 31, 2011 to September 9, 2011, due to the presence of Hurricane Irene on the east coast. According to the IRS, those who come forward voluntarily will get a better deal than those who wait for the IRS to find their undisclosed accounts and income. This initiative requires that individuals report any funds being held in foreign accounts. The 2011 initiative, proposes a new penalty framework that requires individuals to pay a penalty of 25 percent of the amount in their foreign bank accounts in the year with the highest aggregate account balance from 2003 to 2010. Some taxpayers will be eligible for 5 or 12.5 percent penalties in certain narrow circumstances. Individuals will also be required to pay back-taxes and interest for up to eight years as well as paying accuracy-related and/or delinquency penalties. Lastly, all original and amended tax returns must be filed by the deadline. There are several pressing questions that come to mind: (1) Is it even legal for the US Government to tax individuals on income held offshore, (2) What about income earned offshore that is held offshore, and (3) Who would consider coming forward only to be taxed and penalized?
Is This Initiative Legal?
Article I, Section 8, Clause 1 of the US Constitution gives Congress the power to Tax and it certainly has exercised that power. According to IRS Publication 525, "if you are a US citizen or resident alien, you must report income from sources outside the US on your tax return unless it has been deemed exempt under US law. This is true whether you reside inside or outside the US and whether or not you receive a Form W-2, Wage and Tax Statement, or 1099 from the foreign taxpayer. This applies to earned income as well as unearned income such as dividends, capital gains, pensions, rents, and royalties.
What About Income Earned Offshore and held Offshore?
Publication 54 holds that "If you are a US citizen or resident alien, your WORLDWIDE income generally is subject to US income tax, regardless of where you are living." However, taxpayers may be able to exclude $91,500 of their income as not taxable by the US, deduct part of their housing expenses from their income, or treat a limited amount of income used for housing expenses as not taxable under the Foreign Earned Income Exclusion and the Housing Deduction and Exclusion. However, they must meet the specified qualifications. So evidently, the US gave itself the right to tax US citizens and resident aliens no matter where they may reside or work.
Who Would Consider Coming Forward?
With the additional taxes and penalties involved in this initiative, who would consider coming forward to report themselves? The number of individuals who came forward could not have been that great because the IRS has issued an award to whistle blowers who report these individuals. It would be interesting to see how many of the individuals that actually came forward did so voluntarily versus those who came forward after a close friend or relative (back stabber if you will), informed them that they have reported them to the IRS in exchange for a bounty. There is a popular maxim that individuals will continue to do what the law allows them to get away with, and will not stop until they are caught. So if this is true, I think it is safe to assume that the US needs to make the reward a percentage of the individual's foreign wealth for more whistle blowers to appear. They may find that if high enough, individuals my anonymously report themselves in order to collect a bounty on themselves. Maybe this should be added to the initiative to add a favorable incentive to turning yourself in. If I had money abroad, I would enjoy the freedom of not having my money taxed and this initiative provides no incentive for me to report myself. Maybe if I had a conscience, I would. But then again, my conscience would say "do you really want to pay taxes on money you probably already paid taxes on before you transferred it offshore? And why would you want to pay taxes now, when the US does not know about your money unless you tell them?" I think my conscience would say that I need more of an incentive, and this initiative does not offer one.
Reference
http://www.irs.gov/newsroom/article/0,,id=235695,00.html
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