Currency Exchange

Tax Rules for Offshore Banking

As far as the U.S. tax law is concerned, U.S. citizens and permanent residents are required to report any income from foreign bank accounts. The fact that the income is not reported to the IRS on an information return does not alter the legal duty of the U.S. citizen/resident. The existence of a foreign bank account is required to be disclosed on Form 1040, Schedule B, Part III and a Form TD F 90-22.1 must be filed by June 30th of each year to disclose the location and other information about any foreign “financial accounts” with an aggregate value of more than $10,000 at any time during the prior calendar year. There are substantial penalties for failing to report income from foreign accounts and for failing to file the form TD F 90-22.1.


The IRS has been trying to convince the U.S. Congress that a lot of people are evading taxes with offshore financial accounts, trusts and corporations. It’s their bureaucratic assumption that they can and should somehow uncover every dime of unreported income – regardless of what it costs.


We’re not about to try to tell you that offshore tax evasion isn’t widespread. We doubt if there are a lot of people from the U.S. with foreign bank accounts who are reporting it all to the IRS. After all, if the Swiss banker or the Austrian banker won’t send an information return to the IRS, why should the taxpayer volunteer? “Who wants to be a sucker anyway?” At least that’s the argument of many people for not reporting income from foreign accounts.


Let’s not get derailed at this point into a discussion of the moral issues of whether it’s right or wrong to evade taxes. Our focus is on the practical issues of what’s legal and what isn’t.


First, you need to know that when you fail to report income, there is no U.S. statute of limitations on your tax return for that income. If the IRS finds out about some foreign bank account twenty years from now, it’s all subject to penalties and interest plus the taxes that should have been paid. It only takes one audit out of a lifetime to get caught.


Second, you should also know that there is no dollar threshold for tax evasion. As a practical matter, the IRS rarely tries to pursue a criminal conviction for small amounts, but that’s not because there is any legal reason to ignore the small fry. They just don’t have the staff or the budget (at this time) to pursue more than a few tax evaders.


Now then, how can they catch you if you fail to report a few dollars of interest in a foreign bank account? For one thing, it’s nearly impossible to move more than a few dollars offshore without leaving a paper trail. For now, you can move as much as $10,000 in currency offshore without leaving tracks. But that only works if the withdrawal of $10,000 is from such a large domestic account that it won’t be noticed if you are audited. If you don’t have a habit of carrying around that much cash, some bank employee is likely to file a suspicious activity report on you. Basically, you would have to engage in a lot of very small transfers of money, spread out over many years, in order to avoid leaving a trail. The travel costs would far exceed the tax savings.
Transfers of large amounts (in relation to what you have) leave a trail. They even leave a trail when there is something missing. For example, you had $1 million of net assets last year, you made $150,000, you spent $100,000 (including the taxes you paid) and this year you have $900,000 of assets instead of $1,050,000. What happened to the other $150,000? Most auditors spend four or five years in college learning their craft. Then they often spend another four years with one of the big CPA firms as an auditor. Or they go to work for the IRS and get a crash course on how to find hidden money. An auditor’s job is to find things that don’t fit a pattern. Ratios are out of whack. Financial trends change for no apparent reason. Most IRS agents are auditors. Only a few are lawyers.


Like the detectives in the movies, books and television, the IRS auditors acquire a sixth sense of when something isn’t in sync with everything else. They soon learn to sense when someone is lying or is nervous. They even learn to observe body language to get a feel for whether the taxpayer might be trying to hide something. The more of these clues they get, the more they want to get to the bottom of it. They ask leading questions of the taxpayer in different ways. If they are auditing a business, they ask seemingly innocent questions of the employees. They look for large deposits or withdrawals of cash from bank accounts or other financial accounts.


Frequent foreign travel without an obvious business reason tends to make the auditors suspicious. They will want to know the reason for the trips. Are you going to the same place each time? Who did you visit? What did you discuss with them? Where did you stay? When did you see them? Where did you meet? Was it a profitable trip? Did you establish new business relationships? What are you buying or selling to this new foreign contact?


If they have sufficient reason to doubt the information they are getting from a taxpayer, they can begin a lifestyle type of audit. Instead of just looking at your tax returns and supporting records, they look into every nook and cranny of your personal life for clues to unreported income. They then try to reconstruct how much income you would need to support a particular lifestyle. If you haven’t reported that much income, they dig deeper.


But maybe you will win the audit lottery and not get selected for one of the random audits that occur just because yours was one of the random numbers they pulled for that year. There’s a serious problem of being reported to the IRS by someone you know. You have to resist the huge temptation to tell someone about your exciting and ingenious scheme to hide some income from the IRS. A lot of people can’t resist telling someone. But then they get divorced, they have to fire the employee who knows what they did, the business goes broke, a former partner is angry over the breakup, a lover gets mad at them and someone blows the whistle with the IRS. Did you know that most IRS informants don’t want the money the IRS is willing to pay for information leading to collecting more taxes?


What about all the communications you have with your foreign banker? Will you be making monthly phone calls to Zurich? Or will you have to travel frequently in order to take care of such matters in person? How much tax would you have to save in order to pay for the plane fare and other travel costs? Of course, you could use the internet with encrypted email messages. But first, the foreign banker has to get well enough acquainted with you to do business by email, phone or other impersonal means. With the pressure of the U.S. and other major countries to require bankers to “know their customers”, it will be much more difficult to establish a new banking relationship outside the U.S.


And – if you decide to do business through someone who is willing to lie for you, to commit a felony with their own government, to sign documents that are false, how can you be sure this person will be honest with you? Secret bank accounts may sound easy in the movies and the novels, but they actually require a lot of hard work and expense.


Source: By Vernon K. Jacobs and J. Richard Duke – The Offshore Press,


Vernon Jacobs is a CPA who provides tax accounting and consulting services for clients with international interests,  J. Richard Duke , JD, LLM is an attorney who specializes in international tax law and is an Adjunct Professor of International Tax Law.