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Unreported Offshore Accounts? New Yorkers Can Avoid State Tax Penalties Through Voluntary Disclosure
By William Comiskey, JD

For New York taxpayers with unreported income in hidden offshore accounts, now is the time to come forward and disclose that income to both federal authorities under the IRS offshore voluntary disclosure initiative, and to state and local tax authorities under New York’s Voluntary Disclosure and Compliance Program. Because the stakes are so high, practitioners should do their best to persuade any clients in this situation to participate to reduce federal penalties and avoid all state penalties.

The Time Is Now

The IRS is currently administering a widely publicized federal offshore voluntary disclosure initiative offering reduced federal penalties for taxpayers who failed to report non-U.S. financial accounts and assets on an FBAR (Report of Foreign Bank and Financial Accounts) and who failed to report income from those accounts and assets on their federal income tax returns. That initiative is the second such program offered by the IRS to encourage taxpayers to voluntarily disclose the existence of any hidden offshore accounts. The first program ended on Oct. 15, 2009, and the current program will end on Aug. 31, 2011.

Taxpayers and practitioners who are considering participating in the federal program—or those who participated in the earlier federal initiative—who have New York tax liabilities would be well-advised to also apply to the New York program. For eligible taxpayers, participating in the New York program is an easy and safe way to avoid all state penalties, including criminal sanctions, for delinquent tax liabilities disclosed through the program.

Offshore Accounts: Riskier Than Ever

Disclosure under the federal and state programs makes sense because, for taxpayers with tax liabilities arising from unreported income in offshore accounts, the risks have never been greater. Indeed, the so-called “safe haven” that some found in offshore financial institutions is rapidly disappearing under the relentless pressure of the IRS to break through the wall of foreign secrecy rules.

That effort continues unabated, and any individual with unreported offshore income is “playing with fire,” according to John DiCicco, acting assistant attorney general of the United States Department of Justice Tax Division, as reported in Tax Notes Today on Feb. 28, 2011 in a piece by R. Jackson and J. Coder entitled, “Government to use TIEA Network to Fight Offshore Tax Evasion.”

Indeed, by way of example, on April 7, the IRS successfully secured judicial authorization under IRC Section 7602 to issue a John Doe summons on HSBC Bank USA, through which the agency will be able to obtain information identifying potentially thousands of U.S. taxpayers with substantial unreported accounts in HSBC’s India arm, the Hong Kong and Shanghai Banking Corp., Ltd.

In addition to ramped-up IRS investigative efforts, taxpayers with hidden offshore accounts also have to contend with the new, and unquestionably real, danger presented by banking insiders who are threatening to publicly expose foreign account holders by posting account information on whistleblower website Wikileaks.

A similar, and potentially greater, threat to those with offshore accounts is presented by the recent increase in government tax whistleblower programs. Both the IRS (through its whistleblower program) and now New York (through the False Claims Act, codified in Article 13 of the State Finance Law, Sections 187 to 194, are offering potentially huge awards to those who blow the whistle on tax cheats. Some whistleblower law firms even specifically target offshore account cases in an active search for viable whistleblower cases.

The Stakes are High in N.Y.

The IRS is not the only agency to increase its efforts to target tax fraud. In recent years, the New York State Department of Taxation and Finance greatly increased its commitment to tax enforcement. The department has also been proactive and aggressive in targeting and pursuing tax evaders.

The numbers, which demonstrate the huge jump in state tax criminal enforcement, tell the story. The following statistics, which relate to cases of income and sales and corporate tax fraud, were presented to the State District Attorneys Association in July 2010:

In addition to more aggressive criminal enforcement, new laws enacted in the last several years gave department staff and prosecutors stronger tools to punish tax fraud. For example, in 2009, Article 37 of the tax law was amended to greatly increase the criminal sanctions for state tax evasion. The new provisions created a new crime—tax fraud—and adopted a classification system for felony offenses that markedly increased the severity and punishment for acts of serious tax evasion.

Under the old law, regardless of the amount of tax evaded, the vast majority of tax offenses were only punishable as misdemeanors or as low-level felonies. Under the new law, both the level of crime and the severity of the possible sentence hinge on the amount of tax evaded. At the top end of the new classification system, those convicted of evading more than $1 million in tax face a possible sentence of up to 25 years in state prison—a huge jump from the prior cap of four years which was only applicable in a limited number of instances.

In addition, as part of the same 2009 compliance package that increased criminal penalties, the state also increased the administrative fraud penalty that can be imposed in a department audit to a whopping 200 percent of the tax evaded. For example, see Section 685(e)(1) regarding income tax deficiencies and Section 1145(2) regarding sales tax deficiencies.

The drive for stronger state tax enforcement laws continued into 2010. In August, the New York State Legislature unanimously adopted a new tax whistleblower statute under the False Claims Act, found in New York State Finance Law Article 13, which imposes a 300 percent penalty on taxpayers who knowingly violate the tax law in cases of significant tax evasion. Under the new law, whistleblowers can earn rewards of up to 30 percent of the amount recovered from the tax evader.

Armed with these new enforcement tools, New York Attorney General Eric Schneiderman recently created a new unit in his office—the Taxpayer Protection Bureau—to investigate cases of fraud against the state, including tax fraud and whistleblower cases, and he has repeatedly vowed to aggressively use the False Claims Act to pursue such cases.

Given these federal and state governmental enforcement initiatives, it is not surprising that thousands of individuals with offshore accounts have already come forward under the federal disclosure program and that nearly a thousand—who have already paid New York state roughly $52 million in delinquent taxes—have come forward under New York’s program.

These taxpayers apparently recognized, correctly in my opinion, that it was better to self-disclose their offshore liabilities than to face the increasing risks presented by this array of strengthened, energized and committed tax enforcement agencies.

Easy Access to the N.Y. Program

The good news is that the voluntary disclosure program in New York is a simple and easy program.

Taxpayers apply online and are accepted into the program if they sign a compliance agreement; file amended, or new, returns; pay the tax due; and meet the statutory eligibility requirements.

Almost all taxpayers are eligible. Only those who are already under audit or investigation by the department for the tax liability being disclosed; who are under criminal investigation by a state or local law enforcement agency; who have already been billed for the liability being disclosed; or who are disclosing a liability based on an investment in a tax shelter—a federal or New York state listed or reportable transaction—are ineligible.

While the department has the right to review the taxpayer’s submission and to ask for additional information from the taxpayer, the department generally does not conduct an investigation of the submission prior to accepting the taxpayer into the program. The department may, however, audit any return filed as part of the taxpayer’s application.

The protections provided by the state program are more generous than those offered under the federal program. For eligible taxpayers, timely disclosure to the New York program will provide complete protection from all state and local tax penalties, including criminal prosecution. In contrast, participants in the federal initiative are still required to pay penalties, albeit at a reduced, but still substantial, rate.

In addition, while disclosure under the federal initiative will generally result in protection from criminal prosecution, the state program provides a statutory guarantee that participants who comply with their compliance agreement will not be prosecuted.

The look-back provisions of the state program are also more generous. Taxpayers disclosing liabilities based on an unreported offshore account have been allowed to use a six year look-back period in the state program. By way of contrast, the IRS program has an eight year look-back period.

More information on the federal voluntary disclosure initiative can be found on the IRS website.

Timing Is Everything

Disclosures must be timely. If the state learns of a taxpayer’s offshore account—whether through a whistleblower disclosure, an independent investigation or from the IRS—and opens an audit or investigation before the taxpayer makes his or her state disclosure, then all bets are off and that taxpayer can expect the state to aggressively seek some or all of the enhanced penalties described above including, in certain cases, criminal sanctions.

Taxpayers who want to take advantage of the state’s generous program should move quickly to make their state and local disclosures. Taxpayers do not need to wait until completion of the federal disclosure program process. Indeed, the longer taxpayers wait, the greater the risk they will lose the opportunity to disclose and to receive the benefits of the state program because of a state-initiated audit or investigation.

And that is not a position that any taxpayer will want to face.

Click here for more Tax Stringer coverage by Mr. Comiskey concerning New York’s statutory voluntary disclosure program and New York’s new tax whistleblower program under the False Claims Act.