U.S. Tax Reporting Requirements for U.S. citizens and Green Card holders who are

residents of Israel and How to Solve Compliance Problems

Thursday, December 15, 2011

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.

Circular 230 Disclaimer: To ensure compliance with

requirements imposed by the IRS, we inform you that any U.S.

federal tax advice contained in this presentation is not intended

or written to be used, and cannot be used, for the purpose of (i)

avoiding tax-related penalties under the Internal Revenue

Code or (ii) promoting, marketing or recommending to another

party any transaction or tax-related matter(s) addressed

herein.

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U.S. VOLUNTARY DISCLOSURE

Voluntary Disclosure

The Voluntary Disclosure Practice is a longstanding practice of

IRS Criminal Investigation (―CI‖) whereby CI takes timely,

accurate, and complete voluntary disclosures into account in

deciding whether to recommend to the Department of Justice that

a taxpayer be criminally prosecuted.

It enables noncompliant taxpayers to resolve their tax liabilities

and minimize their chance of criminal prosecution. When a

taxpayer truthfully, timely, and completely complies with all

provisions of the voluntary disclosure practice, the IRS will not

recommend criminal prosecution to the Department of Justice.

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VOLUNTARY DISCLOSURE

Truthful, Timely & Complete

Under IRM 9.5.11.9:

A voluntary disclosure occurs when the communication is

truthful, timely, complete, and when:

a. the taxpayer shows a willingness to cooperate (and does

in fact cooperate) with the IRS in determining his or her

correct tax liability; and

b. the taxpayer makes good faith arrangements with the IRS

to pay in full, the tax, interest, and any penalties determined

by the IRS to be applicable.

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Voluntary Disclosure - Timely

A disclosure is timely if it is received before:

a. the IRS has initiated a civil examination or criminal investigation of the

taxpayer, or has notified the taxpayer that it intends to commence such an

examination or investigation;

b. the IRS has received information from a third party (e.g., informant (such as

ex-spouse or business partner), other governmental agency, or the media)

alerting the IRS to the specific taxpayer‘s noncompliance;

c. the IRS has initiated a civil examination or criminal investigation which is

directly related to the specific liability of the taxpayer; or

d. the IRS has acquired information directly related to the specific liability of

the taxpayer from a criminal enforcement action (e.g., search warrant,

grand jury subpoena).

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Voluntary Disclosure

Examples of voluntary disclosures include:

• A letter from an attorney which encloses amended returns from a client

which are complete and accurate (reporting legal source income omitted

from the original returns), which offers to pay the tax, interest, and any

penalties determined by the IRS to be applicable in full and which meets

the timeliness standard.

• A disclosure made by an individual who has not filed tax returns after the

individual has received a notice stating that the IRS has no record of

receiving a return for a particular year and inquiring into whether the

taxpayer filed a return for that year. The individual files complete and

accurate returns and makes arrangements with the IRS to pay the tax,

interest, and any penalties determined by the IRS to be applicable in

full. This is a voluntary disclosure because the IRS has not yet

commenced an examination or investigation of the taxpayer or notified the

taxpayer of its intent to do so.

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Voluntary Disclosure

Examples of what are NOT voluntary disclosures include:

• A letter from an attorney stating his or her client, who wishes to remain anonymous,

wants to resolve his or her tax liability. This is not a voluntary disclosure until the

identity of the taxpayer is disclosed.

• A disclosure made by a taxpayer who is under grand jury investigation. This is not a

voluntary disclosure because the taxpayer is already under criminal investigation.

• A disclosure made by a taxpayer, who is not currently under examination or

investigation, of omitted gross receipts from a partnership, but whose partner is

already under investigation for omitted income skimmed from the partnership. This is

not a voluntary disclosure because the IRS has already initiated an investigation which

is directly related to the specific liability of this taxpayer.

• A disclosure made by a taxpayer, who is not currently under examination or

investigation, of omitted constructive dividends received from a corporation which is

currently under examination. This is not a voluntary disclosure because the IRS has

already initiated an examination which is directly related to the specific liability of this

taxpayer.

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Voluntary Disclosure

• Silent Disclosure

• Noisy Disclosure

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SILENT DISCLOSURE

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Voluntary Disclosure – Silent Disclosure

A ―silent disclosure‖ occurs when a U.S. taxpayer with an undeclared foreign account files FBARs

and amended returns and pays related taxes and interest for previously unreported offshore income

without notifying IRS of the undeclared amount through the Voluntary Disclosure Procedure

(―VDP‖). The IRS warns taxpayers that make silent disclosures instead of using the VDP that they

risk being criminally prosecuted for applicable years.

Example. According to a criminal information document filed in U.S. District Court for the District of

Massachusetts, Michael Schiavo, a Boston bank director, failed to report his interest in offshore

accounts on an FBAR for the 2003 through 2008 and tax years.

The government alleged that Schiavo hid $99,273 from a partnership that invested in medical

devices, in an undeclared account at HSBC Bank Bermuda. Schiavo‘s partner, Peter Schober,

directed the funds to HSBC in 2006 from a UBS account in Switzerland, which was also

undisclosed.

The court document claimed that Schiavo willfully failed to file FBARs disclosing his financial

account in Bermuda for tax years 2003—2008. Additionally, for those years, he represented on his

Schedule B, 1040, that he didn‘t have an interest in a foreign financial account and failed to report

his income from the partnership, or the interest that accrued on the Bermuda account.

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Voluntary Disclosure - Silent Disclosure

On Oct. 6, 2009, following news of UBS‘s disclosure to IRS of undeclared accounts

held by U.S. taxpayers, Schiavo made a quiet (but partial) disclosure by preparing and

filing FBARs and amended tax returns for the 2003—2008 tax years. He did not

participate in the 2009 OVDI, although his disclosure was made nine days prior to the

end of the amnesty period. In his October 6 disclosure, he revealed to IRS that he had

an interest in an HSBC account in Bermuda, but failed to report his income on his

2006 tax return from his partnership.

Subsequently, an IRS Special Agent attempted to interview Schiavo at his home on

Oct. 27, 2009.

Thereafter, Schiavo prepared and executed a second amended return for the 2006

year where he reported the income he earned from his partnership that was ultimately

deposited into his then-undisclosed HSBC account in Bermuda.

According to the Department of Justice (DOJ), a plea agreement has been reached

under which Schiavo agreed to pay a civil money penalty of $76,283, half the value of

high balance of the HSBC Bank of Bermuda account, for failing to file the FBAR. He

faces up to five years in prison, followed by three years of supervised release and a

$250,000 fine. He was charged separately with failing to disclose a secret UBS AG

bank account and is awaiting sentencing.

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FBAR Penalties Failure to properly report the foreign account on Schedule B and to file an FBAR may

warrant civil and criminal sanctions. The two primary civil FBAR penalties are referred

to as ‗‗non-willful‘‘ and ‗‗willful.‘‘

The non-willful penalty is up to $10,000 for each negligent violation of the FBAR filing

or record-keeping requirements, and it may be waived if the violation was ‗‗due to

reasonable cause‘‘ and the amount of the transaction or the balance in the account at

the time of the transaction was properly reported.

Willfully failing to file an FBAR can warrant both criminal sanctions (imprisonment) and

civil penalties equivalent to the greater of $100,000 or 50 percent of the high balance

in an unreported foreign account per year — for each year for which an FBAR was not

filled.

Willfulness is generally determined by ‗‗a voluntary, intentional violation of a known

legal duty.‘‘ The Internal Revenue Manual provides that willfulness is demonstrated by

the person‘s knowledge of the FBAR requirements coupled with his conscious choice

not to comply with them.

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NOISY DISCLOSURE

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Voluntary Disclosure – Noisy Disclosure

• Regular Voluntary Disclosure Program

• 2009 Offshore Voluntary Disclosure Program

• 2011 Offshore Voluntary Disclosure Initiative

• 2012 and further

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Voluntary Disclosure -

The 2009 Offshore Voluntary Disclosure Procedure (―2009 OVDP‖)

No criminal prosecution and civil settlement if:

• File amended or original returns for 2003-2008;

• File amended or original FBARs; and

• Pay tax, interest and civil penalties including 20% of the highest balance in

the undeclared bank accounts.

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Voluntary Disclosure

The IRS considered the 2009 OVDP a great success:

• 14,700 taxpayers participated in the program while the IRS estimated receiving

approximately 1,000 voluntary disclosure requests based upon the 2003 OVDI.

• IRS collected over $2 Billion.

• IRS investigators received wealth of data regarding foreign banks and their

employees, lawyers, accountants and other third parties assisting Americans hiding

money abroad .

• As a result, the IRS established the Voluntary Disclosure Analysis Capability System

which enables the Criminal Investigation Department to scan and electronically search

OVDP documents for patterns relative to financial institutions, promoters and countries

and is used for data mining to identify banks, financial institutions, promoters, and

other professionals that have helped taxpayers hide income, assets, and foreign

accounts overseas.

• The IRS trained over 1300 agents to assist with examining over 55,000 filed tax

returns under the 2009 OVDP

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Voluntary Disclosure –

The 2011 Offshore Voluntary Disclosure Initiative (“2011 OVDI”)

Under the terms of the 2011 Offshore Voluntary Disclosure Initiative, taxpayers must:

First file application with CID and upon clearance :

• Provide copies of previously filed original income tax returns for tax years;

• Provide complete and accurate amended federal income tax returns

• File complete and accurate original or amended offshore-related information returns and

Form TD F 90-22.1 (a/k/a ―FBAR‖);

• Cooperate in the voluntary disclosure process, including providing information on offshore

financial accounts, institutions and facilitators, and signing agreements to extend the period

of time for assessing tax and penalties;

• Pay 20% accuracy-related penalties on the full amount of underpayments of tax for all

years;

• Pay failure to file and pay if applicable;

• Pay, in lieu of all other penalties that may apply, including FBAR and offshore-related

information return penalties such as Forms 5471 and 3520, a penalty, equal to 25% (or in

limited cases 12.5% or 5%) of the highest aggregate balance in foreign bank

accounts/entities or value of foreign assets during the period covered by the voluntary

disclosure;

• Submit full payment of all tax, interest, and or make good faith arrangements with the IRS to

pay in full, the tax, interest, and these penalties

• Execute a Closing Agreement on Final Determination Covering Specific Matters, Form 906.

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2011 OVDI - 5% Penalty

Under the 2011 OVDI, taxpayers who are foreign residents and who meet all three of the following conditions

for all of the years of their voluntary disclosure would pay only a 5% information return penalty instead of 25%

penalty:

(a) Taxpayer resides in a foreign country;

(b) Taxpayer has made a good faith showing that he or she has timely complied with all tax reporting

and payment requirements in the country of residency; and

(c) Taxpayer has $10,000 or less of U.S. source income each year.

For these taxpayers only, the offshore penalty will not apply to non-financial assets, such as real

property, business interests, or artworks, purchased with funds for which the taxpayer can establish that

all applicable taxes have been paid, either in the U.S. or in the country of residence. This exception only

applies if the income tax returns filed with the foreign tax authority included the offshore-related taxable

income that was not reported on the U.S. tax return.

Example: The taxpayer is a U.S. citizen who has lived and worked as a corporate executive in

Israel. His income has included earnings in excess of $250,000 in each year, as well as bank interest

and investment income on financial accounts that had a high aggregate balance of $1.2 million in

2009. He has paid all required taxes on his earnings and investment income in Israel in every year, but

has filed no U.S. income tax returns since moving out of the United States. In addition to his financial

accounts, the taxpayer has acquired a personal residence in Israel with an equity of $900,000 and an

automobile worth $85,000, both financed with previously taxed savings from the U.S., as well as his

salary and investment earnings in Israel. Because the taxpayer was fully tax compliant in Israel he will be

eligible for a reduced offshore penalty of 5% of the value of the financial accounts, or $60,000. The

residence and automobile will not be included in the penalty base because the funds used to acquire

them were fully taxed in the Israel.

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2011 OVDI – CIVIL PENALTIES AVOIDED

Depending on a taxpayer‘s particular facts and circumstances, the

following civil penalties could apply:

• A penalty for failing to file the FBAR form. Generally, the civil penalty for willfully failing to file an

FBAR can be as high as the greater of $100,000 or 50% of the total balance of the foreign account

per violation. Non-willful violations that the IRS determines were not due to reasonable cause are

subject to a $10,000 penalty per violation.

• A penalty for failing to file Form 3520, Annual Return to Report Transactions With Foreign Trusts

and Receipt of Certain Foreign Gifts. The penalty for failing to file each one of these information

returns, or for filing an incomplete return, is 35% of the gross reportable amount, except for returns

reporting gifts, where the penalty is 5% of the gift per month, up to a maximum penalty of 25% of

the gift.

• A penalty for failing to file Form 3520-A, Information Return of Foreign Trust With a U.S. Owner.

Taxpayers must also report ownership interests in foreign trusts, by United States persons with

various interests in and powers over those trusts. The penalty for failing to file each one of these

information returns or for filing an incomplete return, is 5% of the gross value of trust assets

determined to be owned by the United States person.

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CIVIL PENALTIES AVOIDED - CONTINUED

• A penalty for failing to file Form 5471, Information Return of U.S. Persons with Respect to Certain

Foreign Corporations. The penalty for failing to file each one of these information returns is

$10,000, with an additional $10,000 added for each month the failure continues beginning 90 days

after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

• A penalty for failing to file Form 5472, Information Return of a 25% Foreign-Owned U.S.

Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. The penalty for failing

to file each one of these information returns, or to keep certain records regarding reportable

transactions, is $10,000, with an additional $10,000 added for each month the failure continues

beginning 90 days after the taxpayer is notified of the delinquency.

• A penalty for failing to file Form 926, Return by a U.S. Transferor of Property to a Foreign

Corporation. The penalty for failing to file is 10% of the value of the property transferred, up to a

maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.

• A penalty for failing to file Form 8865, Return of U.S. Persons With Respect to Certain Foreign

Partnerships. Penalties include $10,000 for failure to file each return, with an additional $10,000

added for each month the failure continues beginning 90 days after the taxpayer is notified of the

delinquency, up to a maximum of $50,000 per return, and 10% of the value of any transferred

property that is not reported, subject to a $100,000 limit.

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CIVIL PENALTIES AVOIDED - CONTINUED

•Fraud penalties imposed under IRC §§ 6651(f) or 6663. Where an underpayment of

tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties

that, although calculated differently, essentially amount to 75% of the unpaid tax.

•A penalty for failing to file a tax return imposed under IRC § 6651(a)(1). Generally,

taxpayers are required to file income tax returns. If a taxpayer fails to do so, a

penalty of 5% of the balance due, plus an additional 5% for each month or fraction

thereof during which the failure continues may be imposed. The penalty shall not

exceed 25%.

•A penalty for failing to pay the amount of tax shown on the return under IRC §

6651(a)(2). If a taxpayer fails to pay the amount of tax shown on the return, he or

she may be liable for a penalty of 0.5% of the amount of tax shown on the return, plus

an additional 0.5% for each additional month or fraction thereof that the amount

remains unpaid, not exceeding 25%.

•An accuracy-related penalty on underpayments imposed under IRC § 6662.

Depending upon which component of the accuracy-related penalty is applicable, a

taxpayer may be liable for a 20% or 40%.

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2011 OVDI – CRIMINAL PENALTIES AVOIDED

• Possible criminal charges related to tax returns include:

• Tax evasion (26 U.S.C. § 7201). A person convicted of tax evasion is subject to a

prison term of up to five years and a fine of up to $250,000

• Filing a false return (26 U.S.C. § 7206(1)). Filing a false return subjects a person to

a prison term of up to three years and a fine of up to $250,000.

• Failure to file an income tax return (26 U.S.C. § 7203). A person who fails to file a

tax return is subject to a prison term of up to one year and a fine of up to $100,000.

• Willfully failing to file an FBAR and willfully filing a false FBAR are both violations

that are subject to criminal penalties under 31 U.S.C. § 5322. Willfully failing to file an

FBAR subjects a person to a prison term of up to ten years and criminal penalties

of up to $500,000.

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Voluntary Disclosure – WHY:

• Avoid severe civil and criminal penalties

• The ability of a U.S. taxpayer to maintain a ‗‗secret‘‘ foreign financial account is fast becoming

nonexistent.

• Foreign account information is flowing into the IRS through :

• The worldwide deployment of civil and criminal tax enforcement resources, e.g. in Hong

Kong and Singapore;

• The development of relationships with corresponding taxing agencies in other countries;

• Treaty-based information exchanges;

• The use of the civil summons process to seek the identification of account holders in

foreign institutions operating within the jurisdiction of the United States;

• Indictments and investigations of foreign institutions and their bankers such as UBS and

Credit Suisse in Switzerland, HSBC in India and Singapore and the branches in

Switzerland of Bank Leumi, Bank Hapoalim and bank Mizrahi;

• The receipt of information from whistleblowers and informants;

• Cooperation from taxpayers, advisers, foreign banks, and bankers who have been

criminally prosecuted; and

• Cooperation from taxpayers from OVDP and OVDI participants who identified their

banks, bankers, advisers, and others.

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Voluntary Disclosure – WHY:

FATCA

The Foreign Account Tax Compliance Act or FATCA, as it is colloquially known, was

enacted by the Hiring Incentives to Restore Employment Act on March 18, 2010.

FATCA requires non-US financial institutions ("FFIs") and non-US non-financial entities

(―NFFEs‖) to identify and disclose their US account holders or become subject to a

new 30% US withholding tax with respect to payments of US source income such as

interest, dividends, rents, salaries and gross proceeds from the sale or disposition of

US stocks and securities.

The definition of an FFI or NFFE is broad and includes among others banks,

investment banks, brokers, trust companies, investment funds and insurance

companies.

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FATCA

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FATCA

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Voluntary Disclosure – FATCA :FORM 8938

FATCA requires any U.S. person holding foreign financial assets with an aggregate

value exceeding $50,000 (determined by combining the fair market value of each

asset) to report certain information about those assets on a new form that is currently

being developed by the IRS (Form 8938).

Reporting applies for assets held in taxable years beginning on or after January 1,

2011 and Form 8938 must be attached to the taxpayer's annual tax return.

Failure to report foreign financial assets on Form 8938 will result in a penalty of

$10,000 (and a penalty up to $50,000 for continued failure after IRS notification).

Form 8938 will be in addition to other information returns such the FBAR form, Form

5471 (Information return regarding foreign corporations), Form 3520 (Information

return regarding foreign trusts and gifts) and Form 8865 (information return regarding

foreign partnerships).

The information requested will significantly increase the amount of data required to file

a tax return for those U.S. taxpayers holding foreign assets

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Voluntary Disclosure – 2012 and further

Step 1: Pre-clearance

Submit to the Criminal Investigation Lead Development Center (LDC) taxpayer‘s

identifying information:

• Name;

• Date of birth;

• Social security number; and

• Address

to request pre-clearance before making an offshore voluntary disclosure.

Criminal Investigation will then inform taxpayer or the attorney whether or not they are

cleared to make an offshore voluntary disclosure.

Step 2: Most likely along the lines of the 2011 OVDI with different penalty scheme.

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Voluntary Disclosure – 2012 and further

There are several open questions:

• What civil penalties will be imposed?

• What about accuracy-related and similar penalties, or penalties for information

returns such as Form 3520 or Form 5471?

• How many years will be involved?

• Can a taxpayer still make the type of voluntary disclosure contemplated by Internal

Revenue Manual section 9.5.11.9(6) — that is, the submission of amended returns

with a cover letter by an attorney offering to pay penalties?

• Are the reduced penalties for longtime nonresident U.S. citizens still available, and if

the 5 percent penalty is unavailable?

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Dave Wolf, ADV. Hacohen Wolf Law Offices Tel-Aviv: 12 Kaplan Street, Tel: 03-6099979 Jerusalem: 8 King David Street, Tel: 02-6222335 Beit Shemesh: 8 Nahal Maor Street, Tel: 02-9999235 New York City: 114 West 47th Street, 19th Floor, 10036 US Tel: (646) 688-5785; US Fax: (212) 658-9022 www.hacohenwolf.com Affiliate offices in London, Amsterdam and Greater China.

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