U.S. Taxpayers with Undisclosed Accounts at UBS AG Should Consider Voluntary Disclosure
April 3, 2009
U.S. taxpayers who have held accounts at UBS AG that have not been disclosed to the IRS should be aware of legal action that the U.S. Department of Justice has taken against UBS with respect to those accounts. On February 18, 2009, UBS entered into a deferred prosecution agreement pursuant to which it agreed to pay the U.S. government $780 million in connection with its admission that it had “participated in a scheme to defraud the United States and its agency, the IRS, by actively assisting or otherwise facilitating a number of United States individual taxpayers in establishing accounts at UBS in a manner designed to conceal the United States taxpayers' ownership or beneficial interest in these accounts.” On February 19, 2009, the Justice Department asked the U.S. District Court for the Southern District of Florida to order UBS to disclose to the IRS the names of its U.S. account holders. If UBS were to disclose all of the names of its U.S. customers, it is possible that more than 50,000 U.S. taxpayers could be affected.

As reported in The New York Times on April 2, 2009, the Justice Department has opened approximately 100 criminal investigations against American customers of UBS, and UBS has so far turned over more than 250 names to the U.S. government. As further reported in The Wall Street Journal and other news outlets on April 3, 2009, the Federal government arrested an American customer of UBS on April 2, 2009, and charged him with filing a false tax return.

Although UBS has offered some resistance to the Justice Department’s efforts to force it to turn over the names of its U.S. customers, it is now clear based on recent news reports and court filings that UBS has begun to disclose some names. Those U.S. taxpayers whose names are disclosed to the IRS may face both criminal prosecution and substantial civil penalties for their failure to disclose the existence of, and to report the income earned on, those accounts. For this reason, voluntary self disclosure, prior to disclosure by UBS (or any other party), is often a more prudent course of action.

U.S. taxpayers with undisclosed accounts at UBS (or other foreign banks which have been or might someday be subject to scrutiny by the IRS) should consider disclosing those accounts and any associated unreported income to the IRS. U.S. taxpayers who voluntarily disclose to the IRS within the six-month period beginning on March 23, 2009 may be able to reduce their risk of criminal prosecution by taking advantage of the IRS’s enhanced voluntary disclosure program. Participants in the enhanced program will generally be subject to a civil accuracy-related penalty or a delinquency penalty (rather than the much higher fraud penalty) with respect to the previously undisclosed income and a reduced civil penalty with respect to the failure to report the existence of the foreign bank account. Care must be taken, however, in making any disclosure, as an improperly made disclosure may potentially do more harm than good.

Requirements of the IRS’s Enhanced Voluntary Disclosure Program

For a disclosure to reduce a taxpayer’s risk of criminal prosecution (and the amount of civil penalties) under the IRS’s enhanced voluntary disclosure program, the disclosure must meet certain requirements. To qualify for the enhanced voluntary disclosure program, the disclosure must be truthful and complete. In addition, the taxpayer must show a willingness to cooperate (and must in fact cooperate) with the IRS in determining his or her correct tax liability, and the taxpayer must make good faith arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable.

The disclosure must also be timely. A disclosure will generally not be timely if the IRS has already initiated a civil examination or criminal investigation of the taxpayer. In addition, it is the IRS’s official position that a disclosure is considered to not be timely if the IRS has received information from a third party regarding the taxpayer’s noncompliance. While IRS officials have suggested informally that it might be possible for an account holder to take advantage of the enhanced program if the account holder’s name has already been provided to the IRS, account holders should not assume that they can take advantage of the enhanced program after UBS (or another person) discloses their names to the IRS.

The IRS’s Standard Voluntary Disclosure Program

Account holders who do not take advantage of the enhanced voluntary disclosure program before it terminates may still be eligible to make a voluntary disclosure under the IRS’s standard voluntary disclosure program. Such account holders would face additional risks, however. While such a disclosure may reduce the risk of criminal prosecution, disclosing account holders would face the likely possibility of increased civil penalties, including substantial fraud penalties for the failure to report the existence of the foreign bank account and the income earned in the account.

In addition, the requirements of the standard voluntary disclosure program are generally more strict than the requirements under the enhanced voluntary disclosure program. In particular, eligibility for the standard program will be forfeited once the IRS has received information from a third party regarding the taxpayer’s noncompliance. Thus, for example, if UBS were to disclose an account holder’s name to the IRS, that account holder would cease to be eligible for the standard voluntary disclosure program and would therefore face an increased risk of criminal prosecution. In contrast, as noted above, the IRS has unofficially indicated that a taxpayer may be eligible for the enhanced voluntary program even if the taxpayer’s name has been disclosed to the IRS before the taxayer has initiated compliance with the enhanced voluntary program.

For account holders who do not take advantage of the enhanced program or who are ineligible for it, different strategies may be available to try to minimize potential penalties. The success of such strategies will depend, to a large extent, on the facts and circumstances relating to the particular account holder and his or her failure to report the existence of the account and the associated income.

There are other eligibilty requirements for the standard voluntary disclosure program and the enhanced program. Account holders should consult with an attorney to determine whether they are potentially eligible for relief under either program.

Importance of Consulting with an Attorney

Account holders should exercise caution in consulting with an accountant regarding a potential disclosure. The limited accountant-client privilege is narrower in scope than the traditional attorney-client privilege, and provides no protection in the case of criminal investigations (unless the accountant has been engaged directly by the account holder’s attorney and certain other requirements are met). Accordingly, account holders who are considering making a voluntary disclosure should consult with an attorney. The attorney, if necessary, can separately engage an accountant to assist the attorney. Through this arrangement, the attorney-client privilege can be extended to cover communications with an accountant, provided certain other conditions are met.

Swift Action May be Required

Account holders who wish to take advantage of the IRS’s standard voluntary disclosure program or enhanced program with respect to undisclosed accounts at UBS (or other foreign banks) should act quickly. The enhanced program will only be available for the six month period beginning on March 23, 2009. In addition, once UBS (or another person) discloses the name of a U.S. account holder, an account holder would cease to qualify for the standard voluntary disclosure program (and there is no assurance that the account holder would continue to qualify for the enhanced disclosure program) to avoid criminal prosecution unless the account holder previously made a disclosure to the IRS that meets all of the requirements of the applicable program.

Kelley Drye & Warren LLP

The Tax Practice Group represents numerous clients in tax controversies at both the field office and appeals levels and in judicial proceedings. The Group also advises international and domestic corporations, partnerships, limited liability companies, individuals and tax-exempt entities on a full range of strategic tax planning issues. Attorneys in the Group represent clients in a diverse variety of transactions, including mergers and acquisitions, equity and debt financings, leasing transactions, financial products, venture capital and restructurings. In addition, we advise foreign clients on formation and operation of their U.S. businesses and U.S. clients on the complex tax aspects of their foreign operations. Additionally, the attorneys in the Tax Practice Group have expertise in joint venture planning, including partnership and limited liability company issues.

For more information about this Client Advisory, please contact:

Gregory M. McKenzie
(212) 808-7689
gmmckenzie@kelleydrye.com

Andrew H. Lee
(212) 808-7859
alee@kelleydrye.com

This client advisory is provided by Kelley Drye & Warren LLP for educational and informational purposes only and is not intended and should not be construed as legal advice. This document is not intended and cannot be used for the purpose of avoiding tax-related penalties. Account holders seeking advice regarding potential tax penalties should consult directly with an attorney.