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Journal of Multistate Taxation and Incentives

Volume 13, Number 10, February 2004

Department: PROCEDURE

The New Federal-State Tax Enforcement Alliance: Carrots, Sticks, and Implications for Taxpayers

In their new alliance, the IRS and the states (as illustrated by Florida) will fully use all available tax-enforcement "sticks," which should make noncompliant taxpayers extremely uneasy.

Author: HALE E. SHEPPARD

HALE E. SHEPPARD, LL.M., is an attorney with Chamberlain, Hrdlicka, White, Williams & Martin LLP in Atlanta, Georgia. Copyright © 2004 Hale E. Sheppard. This article appears in and is reproduced with the permission of the Journal of Multistate Taxation and Incentives, Vol. 13, No. 10, February 2004. Published by Warren, Gorham & Lamont, an imprint of Thomson Reuters.

The reasons given for avoiding or evading taxes are numerous, including social or religious objections, professed inability to pay, disapproval of the manner in which the government allocates the tax revenues that it collects, rejection of the progressive tax system whereby those with greater incomes pay proportionally larger sums than their less prosperous compatriots, and general condemnation of the perceived high tax rates. Regardless of the rationale for doing so, one thing is clear: most high-income U.S. taxpayers make significant efforts to minimize their overall tax burden. In their quest to reduce tax liabilities, a growing number of taxpayers have crossed the line, going from tax avoidance (which may be legal) to tax evasion (which is clearly illegal). One of the common tax-evasion methods used in recent years involves U.S. taxpayers' transferring assets to, and establishing corporations or trusts in, nations that impose little or no income tax—i.e., nations commonly known as "tax havens."

Aware of these activities, the federal IRS and state revenue agencies have each made various unilateral moves over the years designed to identify taxpayers involved in offshore operations, increase compliance with applicable tax laws, and preserve the tax base. 1 While these independent endeavors undoubtedly achieved a certain degree of success, considerable disagreement exists as to whether the federal government and the states managed to reach their primary goals. 2 Consequently, the IRS and the majority of state revenue agencies recently agreed to join forces with the hope that this federal-state synergy will enable them to more effectively deter the international tax-evasion techniques that have become pervasive in recent years.

The following discussion begins by describing one of the typical offshore arrangements used by U.S. taxpayers, including its establishment, operation, benefits, and hazards. The discussion also presents an overview of the tax laws related to these offshore activities, placing particular emphasis on the applicable civil and criminal penalties. The "carrots" used by the IRS and Florida that are aimed at enticing taxpayers to voluntarily become tax compliant are then explained. In particular, the article describes the federal Offshore Voluntary Compliance Initiative and the "last chance compliance initiative," as well as the Florida tax amnesty program. The article goes on to describe the "sticks" that the IRS and Florida have at their disposal, focusing primarily on the burgeoning federal-state alliance. Florida's intangible personal property tax and associated penalties also are discussed. Finally, the article concludes that the new federal-state alliance, together with the end of the "carrots" and the dawning of the "sticks," could have major ramifications for Florida taxpayers.

The Prototypical Offshore Arrangement

According to certain tax practitioners and IRS reports, an abusive offshore arrangement commonly used by U.S. taxpayers desirous of evading taxes develops in the following manner. 3 An individual in the U.S. identifies and retains a self-proclaimed "offshore expert" to assist with the establishment of an overall offshore financial arrangement. Perhaps more commonly, an expert (i.e., an offshore promoter) offers a U.S. taxpayer an assortment of offshore possibilities with supposed tax benefits. Either way, once hired the offshore promoter's first step is to help the U.S. taxpayer organize a corporation in a tax haven that has strict financial secrecy laws. This foreign corporation appears not to be owned by the U.S. taxpayer since various "nominees" (who usually are employees of a local law firm or financial management company) officially control the entity. These nominees typically execute an agreement clarifying that they hold the shares of this newly formed foreign corporation on behalf of the U.S. taxpayer, who is referred to as the "beneficial owner." In this manner, the U.S. taxpayer's ownership of the foreign corporation is not mentioned in any of the official corporate documents or government filings. Next, the offshore promoter aids the taxpayer or the foreign corporation in establishing local financial accounts, such as interest-bearing savings accounts, certificates of deposit, and security accounts through which trading in stocks, bonds, and other financial instruments is conducted. 4

As explained in official IRS studies, after the foreign corporation and foreign financial accounts (both with their stealth ownership) are established, the offshore promoter then works with the U.S. taxpayer in identifying inconspicuous methods to transfer money or other assets to the new corporation and accounts. 5 Once this is accomplished, the promoter designs techniques through which the taxpayer can access the funds and accounts without the IRS's knowledge. One of the most common tactics for doing so involves the use of an offshore payment card (i.e., a credit or debit card), which is likely issued in the name of the foreign corporation. As with domestic payment cards, whenever the U.S. taxpayer wants to access the funds in the foreign accounts, the taxpayer simply makes cash withdrawals or purchases an item on credit. 6 To further insulate the taxpayer from IRS scrutiny of the offshore activity, the foreign financial institution that issued the payment card, the law firm that established and maintains the foreign corporation, the local management company charged with handling all of the investment activities, and the offshore promoter all agree to institute ultra-discreet billing methods. Such cautious billing practices commonly include not sending any documentation to the taxpayer in the U.S. 7

As for the perceived benefits of using this offshore arrangement, the U.S. taxpayer may be able (albeit illegally) to earn income such as interest, dividends, and capital gains without paying any taxes whatsoever. Moreover, the taxpayer may enjoy a certain degree of asset protection by placing funds beyond the reach of the U.S. court system in situations where legal liability or bankruptcy is likely. The foreign law firm, local management company, and offshore promoter also consider themselves winners in this offshore operation since they tend to charge large fees for the services they perform. For example, establishing a foreign corporation typically costs up to $5,000, annual fees are approximately $3,000, and every wire transfer of funds into or out of a foreign account generates a bill of at least $100. 8 The obvious losers in this scenario are the IRS, which suffers an incalculable amount in lost revenues and expends tremendous resources in its attempts to stop this offshore tax evasion, and law-abiding U.S. taxpayers, who are forced to pay additional taxes to cover the shortfall occasioned by the offshore schemes.

An Overview of Relevant Tax Rules

Establishing foreign corporations, foreign financial accounts, and offshore payment cards is not per se illegal; the actions that customarily accompany the establishment of these offshore items, however, may constitute transgressions of various federal and state tax laws. 9 According to the Internal Revenue Code of 1986, as amended (the IRC), "gross income" is all income earned by a taxpayer irrespective of its source, including interest, dividends, and capital gains. 10 The U.S. government taxes the worldwide income of all U.S. persons, a category encompassing U.S. citizens, resident aliens, domestic corporations, and certain trusts and estates. 11 This ordinarily means that all income earned by U.S. persons, whether in the U.S. or abroad, must be reported to the IRS and subjected to U.S. income tax during the year in which it is earned. If a U.S. taxpayer engages in the typical abusive offshore arrangement described above to evade U.S income taxes, that taxpayer could incur any or all of the following penalties.

Civil fraud penalties. The civil fraud penalty under IRC Section 6663 may be one of the sharpest arrows in the IRS's tax enforcement quiver. While the IRC does not define "fraud," that term generally is synonymous with criminal tax evasion. Criminal tax evasion and civil tax fraud, however, have different evidentiary standards. 12 In particular, criminal tax evasion requires the government to prove its case "beyond a reasonable doubt," while civil tax fraud requires the government to prove its case by "clear and convincing evidence" (a lower legal standard). 13 If a taxpayer engages in civil fraud, the IRS may impose a penalty equal to 75% of the underpayment. Moreover, in instances where the IRS proves that any part of the understatement is attributable to fraud, the entire underpayment is treated as if it were attributable to fraud. 14

Accuracy-related penalties. If a taxpayer underpays the tax due, the IRS may impose an accuracy-related penalty equal to 20% of the portion of the underpayment that is attributable to either negligence or disregard of the tax laws. 15 This sanction also may be imposed if there is a "substantial understatement" of tax. 16

Penalties for failure to timely file or timely pay. If a taxpayer fails to file certain tax or information returns before the statutory deadline, the IRS may add to the tax required to be shown on the return 5% of such tax per month, not exceeding a maximum of 25%. 17 If the failure to timely file is due to fraud, these penalties increase to 15% of such tax per month, not exceeding a maximum of 75%. 18 A similar penalty applies if the taxpayer files the return on time but fails to timely pay the taxes owed. 19

Penalties related to foreign bank accounts. Schedule B of Form 1040 (U.S. Individual Income Tax Return) contains a question (Part III, line 7a) regarding foreign financial accounts, which reads as follows: "At any time during [the relevant tax year], did you have an interest in or a signature or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account?" The instructions to Form 1040 further clarify that a taxpayer also must check "yes" if the taxpayer owns more than 50% of the stock of any corporation that owns such foreign financial accounts. If the answer is "yes," line 7b requires the taxpayer to name the foreign country in which such accounts are located.

In addition to disclosing on Form 1040 an interest in a foreign financial account, a taxpayer must file an annual Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, commonly known as a "foreign bank account report" or FBAR). 20 If a taxpayer violates the FBAR filing requirement, the resulting civil penalty is the larger of $25,000 or the funds in the foreign account at the time of the violation, not to exceed a maximum penalty of $100,000. That is, the annual penalty ranges from $25,000 to $100,000 per account, depending on the balance of the foreign financial account at the time of the violation.

Penalties related to foreign corporations. Every U.S. person who controls a foreign corporation must file an annual information return with the IRS (Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations). 21 In this context, a person "controls" a foreign corporation if the person owns more than 50% of the stock of such corporation. 22 For each year that a person fails to file Form 5471, the IRS may assert a penalty of $10,000. 23

Potential criminal penalties. In addition to the various civil penalties described above, the U.S. government potentially may bring a slew of criminal charges against a taxpayer engaged in the typical offshore arrangement, including wire fraud, 24 mail fraud, 25 bank fraud, 26 money laundering, 27 transportation of more than $10,000 of undeclared currency into or out of the U.S., 28 failure to file records and reports of transactions in monetary instruments, 29 conspiracy to defraud the U.S. government, 30 failure to file required FBARs, 31 tax evasion, 32 and signing false documents under penalties of perjury. 33 Many of these criminal penalties involve significant fines, lengthy prison sentences, or both.

Tax Compliance by Carrot

The IRS is authorized to use summonses to compel persons to produce documents or give testimony under oath. 34 This investigative tool is quite powerful, allowing the IRS to obtain documents and statements in its attempts to determine the correctness of any tax return, the tax liability of any person, the liability at law or in equity of any transferee or fiduciary of any taxpayer, or the collectibility of any such liability. 35 In other words, the IRS is authorized to issue a summons when inquiring "into any offense connected with the administration or enforcement of the internal revenue laws." 36

In 1996, the U.S. government convicted John Matthewson, the former president of Cayman-based Guardian Bank and Trust, of bank fraud, tax evasion, and money laundering. 37 In exchange for leniency with respect to his punishment, Matthewson reportedly provided the IRS with encrypted computer files containing the identities (or at least detailed account information) of more than 1,000 U.S. taxpayers involved in illegal offshore arrangements. 38 The data provided by Matthewson has been described as a "goldmine" of information that will keep the IRS busy for years 39 and "a bonanza for federal prosecutors." 40 As for Matthewson personally, some have called him the "the most valuable source of information U.S. enforcement agencies have ever had" with regard to the manner in which offshore financial institutions facilitate tax evasion. 41

Based on the leads obtained from Matthewson and others, the IRS issued summonses to Mastercard, Visa, and American Express seeking information about U.S. taxpayers who received cards from these companies through banks in known tax havens. 42 The IRS further used its summons power to gather information from car dealers, hotels, airlines, and retail stores where the offshore payment cards had been used by U.S. taxpayers. 43 As a result of these discovery tactics, the IRS managed to identify numerous U.S. taxpayers who held or still hold offshore payment cards, a signal of possible illegal activity. 44

In addition to pursuing the potential scofflaws identified via the summonses, the IRS decided to introduce certain programs to allow noncompliant taxpayers to voluntarily disclose their illicit behavior in exchange for reduced penalties. 45 Simply stated, the IRS appears to have theorized that offering an inducement, the proverbial "carrot," would also serve as an effective method to control taxpayer behavior. 46

Offshore Voluntary Compliance Initiative. The first carrot offered by the IRS came in the form of the Offshore Voluntary Compliance Initiative (OVCI), which was introduced on 1/14/03. 47 The IRS was eager to maximize the recapture of lost revenue under this program; it did, however, limit the scope of the OVCI. Specifically, participation was restricted to those U.S. taxpayers who (1) submitted their applications before the IRS (either independently or through leads from informants or other governmental agencies) identified them as potential tax cheats; (2) did not promote, solicit, or in any way facilitate tax evasion by using offshore payment cards or offshore financial arrangements; (3) did not obtain the offshore income illegally; and (4) did not use the offshore payment cards or offshore financial arrangements to support or in any way facilitate any illicit activity. 48

In addition to satisfying these eligibility requirements, the taxpayer was obligated to supply the IRS with many items related to the 1999, 2000, 2001, and 2002 tax years, including copies of the taxpayer's previously filed federal income tax returns; copies of any relevant powers of attorney; descriptions of offshore payment cards, foreign accounts of any kind, and foreign assets in which the taxpayer has or had any ownership or beneficial interest; descriptions of any entities and nominees through which the taxpayer exercised control over foreign funds, assets, or investments; descriptions of the source of any foreign funds, assets, or investments owned or controlled by the taxpayer; copies of all promotional materials, transactional materials, and other related documentation regarding offshore payment cards or offshore financial arrangements; accurate amended or delinquent original federal income tax returns; complete and accurate Forms 5471; and complete and accurate FBARs. 49

Provided that the IRS was satisfied with these items, it would release the coveted carrot to the taxpayer. This reward was significant indeed, dictating that with respect to any unreported foreign income during the 1999, 2000, 2001, and 2002 tax years, the IRS would not impose the civil fraud penalty under IRC Section 6663, 50 the civil penalties for failure to file Forms 5471 as required by IRC Section 6038, 51 or the civil penalties for not filing FBARs. 52 Moreover, the IRS agreed to impose the failure-to-file penalty and the failure-to-pay penalty under IRC Section 6651, as well as the accuracy-related penalty under IRC Section 6662, only "in appropriate circumstances." 53

According to the IRS, the OVCI generated a "strong response." 54 In support of this claim, the IRS announced that more than 1,000 taxpayers submitted applications, the IRS collected more than $75 million in back taxes while spending only $2 million to administer the program, and more than 400 promoters of offshore arrangements were identified. 55 The IRS further noted that Florida may be a hotbed of tax evasion because, during the incipient stages of the OVCI, far more applicants were from the sunshine state than from any other. 56 The deadline for taking part in the OVCI expired on 4/15/03. 57

Last chance compliance initiative. Despite the IRS's expectations that as many as two million U.S. taxpayers involved in offshore activities would take advantage of the OVCI, only 1,200 persons ultimately decided to participate. Consequently, the IRS recently hired and trained over 1,000 new revenue agents, whose task is to institute large-scale examinations aimed at identifying international tax abuses. Before expending all of these efforts and resources, however, it seems that the IRS has decided to offer noncompliant taxpayers another carrot in the form of the "last chance compliance initiative" (LCCI). 58

Unlike its approach with the OVCI, the IRS did not dangle this last-chance carrot amid press releases, congressional testimony, ominous announcements by high-ranking government officials, strategically placed newspaper articles, etc. Instead, the LCCI came into existence subtly, as many U.S. taxpayers whose identities the IRS had obtained (thanks in large part to its earlier summonses) received a relatively innocuous-looking letter from the IRS. Its contents, however, were anything but harmless. The letters began by stating that the IRS will give the taxpayer "one final opportunity" to minimize penalty exposure by providing the IRS with complete information regarding any unreported offshore activity. If the taxpayer fails to affirmatively respond to this "last chance" letter within 30 days, the IRS will automatically subject the taxpayer to an examination and impose appropriate penalties.

Both the OVCI and the LCCI share a common goal: to strongly encourage taxpayer compliance with U.S. tax laws related to offshore activities. The benefits for the taxpayer's becoming tax compliant under each of these two carrots, however, differ in important ways. First, participating in the OVCI relieved the taxpayer of any penalties for civil tax fraud. In contrast, approaching the IRS under the LCCI means that the IRS may assess a fraud penalty for one year. Second, under the OVCI, the IRS agreed not to impose any penalty for a taxpayer's failure to file annual FBARs disclosing the taxpayer's foreign financial accounts. By contrast, the LCCI allows the IRS to penalize the taxpayer's nondisclosure with respect to one year, which brings with it a fine ranging from $25,000 to $100,000 per account. Third, under the OVCI, the IRS expressly agreed not to solicit information concerning a taxpayer's offshore activities before the 1999 tax year. 59 The LCCI also is designed to apply only to the 1999 tax year and later. Nevertheless, the "last chance" letter expressly states that the IRS reserves the right to examine prior years (i.e., 1996, 1997, and 1998) if the information produced by the taxpayer indicates "substantial noncompliance" with U.S. tax laws during those earlier years. This broader examination, of course, could lead to the imposition of additional taxes, interest charges, and penalties. Finally, participation in the OVCI prohibited the IRS from pursuing criminal penalties against the taxpayer in connection with the offshore activities. No such assurances are included in the "last chance" letter, however. 60

Florida's tax amnesty program. Following the IRS's lead, many states, including Florida, have introduced tax amnesty programs whose objectives include collecting revenue and increasing compliance with state and local tax rules. The Florida tax amnesty program, which was enacted by emergency rule in August 2003, has generated high expectations. 61 State officials expected the program to raise approximately $75 million from overdue taxes and interest charges. 62 To ensure that it met this economic milestone, the Florida Department of Revenue launched a major public-awareness program, under which it (1) mailed over one million flyers to Florida businesses asking them to review their tax matters to determine if they "overlooked" something in the past; (2) aired approximately 9,000 radio spots alerting Florida residents and businesses of the amnesty program; (3) placed over 4,000 public service announcements on cable television; and (4) included information about the amnesty program in more than 200,000 bills, notices, and other communications. 63

The scope of the Florida tax program was quite broad. Nearly all state and local taxes were eligible for amnesty, including those pertaining to sales and use, communications services, corporate income, estates, fuel, pollutants, utilities, insurance premiums, and motor vehicles. 64

As was the case with the OVCI and the LCCI, participation in this statewide amnesty program had its benefits for Florida residents. A taxpayer that complied with the program's guidelines during the four-month amnesty period (from 7/1/03 to 10/31/03) still must pay appropriate back taxes, but interest charges are reduced to 50% of their normal amounts, and no civil tax penalties will be imposed. 65 More important, participants in the Florida amnesty program escape criminal prosecution for their actions. Lest there be any doubt in this regard, both the emergency rule that enacted the amnesty program and all of the news releases related thereto clarify that perhaps the largest "carrot" dangled by Florida was temporary impunity. 66 According to one announcement, the Florida Department of Revenue "will not refer taxpayers for criminal prosecution for [tax] liabilities disclosed under amnesty." 67

Tax Compliance by Stick

Now that the IRS and Florida have withdrawn most of the carrots offered to noncompliant taxpayers, the second major behavior-modification tool, the figurative "stick," will be put to use. As mentioned above, the federal government is authorized to use summonses to gather information both from the taxpayer directly and from third parties. With the disappearance of the carrot and the brandishing of the stick, the IRS has announced its unqualified willingness to issue innumerable summonses as a part of its so-called "battle against abusive tax avoidance transactions." 68 For example, acting IRS Chief Counsel Emily Parker stated in August 2003 that the IRS "will not hesitate to use the tools at [its] disposal to gather information about transactions, the taxpayers who invest in them, and the promoters who sell them." 69 To further clarify any misconceptions, Parker warned that after executing a summons, the IRS "will follow up with audits and litigation if we find that taxpayers and promoters are not complying with their obligations under the law." 70 Echoing this sentiment, Kevin Brown, Chief of Staff to the IRS Commissioner, warned at a recent tax conference that the IRS now plans to focus on enforcement, and is willing to "inflict some pain" in doing so. 71

Federal-state partnership. In addition to making such admonitions, the IRS recently joined forces with many state revenue agencies to further strengthen the tax-enforcement stick. In September 2003, the IRS released a Memorandum of Understanding, which was initially executed by the federal government and 40 states, including Florida. 72 Under this new federal-state partnership, the IRS has several obligations designed to halt tax evasion. Such duties include:

(1) Providing each state revenue agency with a list of participants in a particular "abusive tax avoidance transaction" (ATAT).

(2) Updating this participant list at least two times per year.

(3) Supplying the state tax agencies with all audit results from ATAT cases conducted by the IRS.

(4) Exchanging information with the state tax agencies on types of tax-evasion schemes that are identified by the IRS.

(5) Supplying the state tax agencies with audit-technique guidelines for ATATs.

(6) Partnering with the state tax agencies on training and other educational activities.

(7) Allowing state personnel the opportunity to attend ATAT training classes.

(8) Initiating communications with the state tax agencies on an as-needed basis in order to facilitate the purposes of the new federal-state alliance. 73

The state tax agencies have various duties under this new coalition, too. In particular, the Memorandum of Understanding dictates that each state tax agency will:

(1) Provide the IRS with the names of the parties that it intends to investigate based on the list of ATAT participants developed by the IRS.

(2) Assist the IRS in using state databases to further refine participant lists.

(3) Forward to the IRS the results of any completed state tax examinations of ATAT cases.

(4) Provide the IRS with information regarding types of ATAT schemes that are identified at the state level.

(5) Designate state members for the IRS cross-functional ATAT council. 74

The Memorandum of Understanding has enjoyed considerable support from various individuals and groups. IRS Commissioner Mark W. Everson, for instance, labeled the agreement "a milestone in state and federal cooperation" designed to enable various levels of government to jointly and aggressively pursue tax evaders. 75 In a separate statement, Commissioner Everson explained that the message projected by this new federal-state cooperation should be clear to noncompliant taxpayers: "We're closing in on you from all sides." 76 Other IRS officials have also praised the Memorandum of Understanding, calling it a "testament to the positive impact that partnering between the IRS and the State tax organizations can have on good tax administration," 77 and "an important new partnership" in the fight against abusive tax scams. 78 Likewise, the new federal-state initiative has been lauded by high-ranking members of the powerful Senate Finance Committee who guaranteed the support necessary to make the program effective. 79 State revenue agencies have similarly expressed their support of the new relationship with the IRS. For example, the California State Controller recently categorized the situation as a "win-win" for state and federal government, and a "lose-lose" for tax cheats. 80

Along with the rhetoric, certain states are taking affirmative steps to stop tax evasion, such as recruiting and training dozens of new tax examiners to assist with the new federal-state partnership. 81 As a manifestation of the seriousness with which the states are taking the Memorandum of Understanding, a local official in the Carolinas explained that they "held the proverbial carrot out there and had the stick ready." 82 The states appear eager to fully exploit this new federal-state alliance for one principal reason: self-interest. Recent studies by the Multistate Tax Commission indicate that abusive tax practices are costing state governments approximately $10 billion per year, and "[p]eople who cheat on federal income taxes typically also cheat on their state income, property or business taxes." 83 Moreover, as a result of the OVCI that ended earlier this year, the IRS has "a gold mine of investigative leads" to which the states crave access. 84

Florida's Intangible Personal Property Tax

To the delight of many of its residents, Florida does not impose an individual income tax. It does, however, levy a tax on the intangible personal property of Floridians.

In general, the intangible assets taxed by the state consist of personal property that alone has no real worth, yet is valuable because of what it represents. For example, common types of intangible personal property include (1) shares of stock in a corporation, regardless of whether the corporation is foreign or domestic and regardless of where the stock certificates are actually located; (2) bonds issued by corporations, or by governments (municipal, county, or state) that are located outside Florida; and (3) ownership interests in certain mutual funds, money market funds, and limited liability companies. 85

The intangibles tax is an annual levy imposed by Florida on the current market value (as of January 1 of each year) of the intangible personal property that is owned, managed, or controlled by a person who resides or is domiciled in Florida. 86 State law allows for a standard exemption of $250,000; thus, no tax is due unless the Florida resident possesses intangible assets whose value exceeds this floor. 87 If the value of a Floridian's intangible assets does surpass this limit, the taxpayer must pay the state $1 for each $1,000 worth of intangibles. 88

In terms of regulating intangibles, Florida generally requires that an annual intangibles tax return be filed by every corporation that is authorized to do business in Florida or that is doing business in the state, as well as by every individual who owns, controls, or manages intangible property on January 1 of each year. 89 With regard to timing, the tax return and corresponding tax payment must be submitted between January 1 and June 30 each year. 90

Penalties, of course, are imposed by the state when a taxpayer violates Florida law. In particular, state tax law allows for severe civil penalties where a taxpayer fails to timely file the requisite intangibles tax return, fails to timely pay in full the intangibles tax due, omits from the return certain intangible assets, or understates the current market value of the assets. 91 Grave criminal penalties are also in the state's tax-enforcement arsenal. For instance, any person who willfully violates Florida's laws regarding intangibles may be convicted of a third-degree felony, which involves up to five years in prison. 92

Conclusion

As discussed above, the use of offshore financial arrangements for purposes of evading taxes has been on the rise during recent years. In an effort to discourage such practices by U.S. taxpayers, the IRS and state tax agencies alike have dangled various "carrots" before the noses of noncompliant taxpayers. Among these carrots are the federal OVCI and LCCI, and the Florida tax amnesty program. Although these inducements did tempt some taxpayers to voluntarily disclose their offshore interests and become compliant with U.S. and Florida tax laws, the government (both federal and state) believes that tax evaders still abound.

Accordingly, the IRS and Florida have withdrawn nearly all of the carrots and wielded their tax-enforcement "sticks." Their dedication to deterring tax evasion is evident from the recent passage of the Memorandum of Understanding, which authorizes the new federal-state tax-enforcement partnership. In Florida, further proof of the imminent use of various sticks may be gleaned from official statements. According to a recent announcement by the Florida Department of Revenue, "[i]f you have tax liabilities and fail to take advantage of the tax amnesty, you increase your chances of becoming the focus of enhanced compliance enforcement actions after the amnesty expires." 93 Moreover, upon introducing its new "SUNTAX" integrated tax-administration information system, this Florida agency again warned that "[t]axpayers who owe tax but fail to take advantage of tax amnesty will be the focus of increased Department enforcement activity after Oct. 31, 2003." 94

The figures released by the IRS suggest that many Floridians were or are still involved in offshore financial arrangements. 95 While Florida does not impose an individual income tax, the new alliance between the IRS and the Florida Department of Revenue, the agencies' willingness to fully use all available tax-enforcement sticks, and the existence of the Florida intangibles tax, should make noncompliant Floridians extremely uneasy. It is true that most carrots are no longer obtainable; nevertheless, it still may behoove a Florida resident to voluntarily approach (through legal counsel) the IRS or the Florida Department of Revenue to address any unresolved issues. The majority of the inducement programs may have officially expired, but logic and experience dictate that these agencies are more lenient in cases where the "leg work" is done solely by the taxpayer. []

Sidebar:

Practice Note: State Actions Under the Fed-State Coalition

As indicated by the "Memorandum of Understanding" between the IRS Small Business/Self-Employed Division and at least 40 state tax departments, the federal and state governments have recently joined forces in a new effort to crack down on taxpayers that the authorities believe have crossed the line in their quest to reduce tax liabilities (i.e., going from tax avoidance—which may be legal, to tax evasion—which is clearly illegal).

The state tax agencies have various duties under this new coalition, including obligations to:

(1) Provide the IRS with the names of the parties that they intend to investigate based on the list of "abusive tax avoidance transaction" (ATAT) participants developed by the IRS.

(2) Assist the IRS in using state databases to further refine participant lists.

(3) Forward to the IRS the results of any completed state tax examinations of ATAT cases.

(4) Provide the IRS with information regarding types of ATAT schemes that are identified at the state level.

(5) Designate state members for the IRS cross-functional ATAT council.

NOTES:

1

  Ostrander, "The Offshore Credit Card and Financial Arrangement Probe: Fraught with Danger for Taxpayers," 99 J. Tax'n 114 (August 2003). The article explains that the use of tax havens has been a concern of the U.S. and other nations for over two decades. In chronicling the rising concerns regarding tax havens, the article cites several major documents, including (1) a 1981 report by the IRS, "Tax Havens and Their Use by U.S. Taxpayers—An Overview"; (2) a 1984 U.S. Treasury Department report, "Tax Havens in the Caribbean Basin"; (3) a 1985 study by the Senate Governmental Affairs Committee, "Crime and Secrecy: The Use of Offshore Banks and Companies"; and (4) a 1998 study by the United Nations, "Financial Havens, Bank Secrecy and Money Laundering."

2

  See, e.g., Hamilton, "Senators Concerned Offshore Amnesty Not as Successful as IRS Claimed," 2003 TNT 146-3 (explaining that certain legislators questioned the effectiveness of the IRS voluntary compliance programs based on a report by the Treasury Department's Office of Inspector General for Tax Administration); Stratton, "Inside OTSA: A Bird's-Eye View of Shelter Central at the IRS," 2003 TNT 174-2 (examining the disparate views regarding the efficacy of certain IRS programs); Goulder, "IRS Official Reviews Offshore Compliance Initiative Progress," 2003 TNT 210-5 (increasing prior revenue estimates provided by the IRS); "Offshore Compliance Program Shows Strong Results, IRS Says," 2003 TNT 147-12 (IR-2003-95, 7/30/03, in which the IRS explains that it experienced "a strong response" to its voluntary compliance program).

3

  Ostrander, supra note 1; "Full Text: Publication 1150, Tax Havens and Their Use by United States Taxpayers—An Overview," 1993 TNT 119-22; "IRS Small Business Testimony at Finance Committee Hearing on Tax Scams," 2003 TNT 63-24 (full text of testimony by Dale Hart, Deputy Comm'r, Small Business/Self-Employed Operating Division, IRS, 4/2/03; hereinafter, "Hart testimony"). IRS officials recently named offshore transactions as one of "the dirty dozen" tax scams and schemes.

4

  Id.

5

  Id.

6

  Thorndike, "IRS Official Says Agency Will Emphasize Enforcement," 2003 TNT 110-1. According to this article, Kevin M. Brown, Chief of Staff to the IRS Commissioner, warns that a U.S. taxpayer's use of an offshore payment card could alert the IRS to the illicit offshore activity. During a recent tax conference, Brown offered a Star Trek metaphor to illustrate his position. In the television show, the Romulan enemies used a cloaking device to hide from the U.S.S. Enterprise and other Federation starships. Nevertheless, the Romulans were obligated to momentarily lower the cloaking device in order to fire their weapons. Likewise, says Brown, U.S. taxpayers become vulnerable and their offshore funds become briefly visible to the IRS when the offshore payment cards are used.

7

  Ostrander, supra note 1; IRS Publication 1150, supra note 3.

8

  "Senate Panel Presses Large U.S. Banks on Abuses, Airs New Findings," 12 Money Laundering Alert 1 (April 2001).

9

  Hart testimony, supra note 3. According to this IRS official, "[w]hile it is not illegal to have a credit card issued by an offshore bank, there is ample basis for believing that many people are using offshore credit cards to repatriate funds hidden offshore to evade paying U.S. taxes. Use of an offshore credit card, trust, or other arrangement to hide or underreport income or to claim false deductions on a federal tax return is illegal."

10

  IRC §61(a); Treas. Reg. §1.61-1(a).

11

  Treas. Reg. §1.1-1(b); IRC §7701(a)(30).

12

  IRC §6663.

13

  IRC §7454(a).

14

  IRC §6663(b).

15

  IRC §6662(b).

16

  Id. Generally, an understatement is "substantial" if it exceeds the greater of 10% of the tax required to be shown on the return for the year or $5,000 ($10,000 for most corporations). IRC §6662(d)(1).

17

  IRC §6651(a)(1).

18

  IRC §6651(f).

19

  IRC §6651(a)(2).

20

  Under the federal Bank Secrecy Act, a U.S. person with a financial account in a foreign country with a value exceeding $10,000 at any time during the year must file an FBAR. Previously, the authority to enforce the FBAR penalties resided with the U.S. Treasury Department's Financial Crimes Enforcement Network. This power, however, was recently delegated to the IRS. See "IRS and FinCEN Announce Latest Efforts to Crack Down on Tax Avoidance Through Offshore Accounts," IR-2003-48, 4/10/03.

21

  IRC §6038(a).

22

  IRC §6038(e)(2).

23

  IRC §6038(b).

24

  18 USC §1343.

25

  18 USC §1341.

26

  18 USC §1345.

27

  18 USC §1956.

28

  31 USC §5316.

29

  31 USC §5322.

30

  18 USC §371.

31

  31 USC §5322.

32

  IRC §7201.

33

  IRC §7206.

34

  IRC §7602.

35

  IRC §7602(a).

36

  IRC §7602(b).

37

  Allen, "Murky World of Offshore Banking Emerges in U.S. Tax-Fraud Probe," Wall St. J., 8/3/99, page A18.

38

  Note 8, supra.

39

  Id.

40

  Piskora and Angelo, "Pay No Attention to the Man in the Booth," N.Y. Post, 8/8/99, page 59.

41

  Note 8, supra.

42

  Ostrander, supra note 1. See also Hamilton, "Justice Advances Offshore Crackdown by Going After Individuals," 2003 TNT 50-3; U.S. Treas. Dept. Tax Shelter Fact Sheet (JS-922, 10/20/03).

43

  Ostrander, supra note 1.

44

  "IRS Unveils Offshore Voluntary Compliance Initiative; Chance for ‘Credit-Card Abusers’ to Clear Up Their Tax Liabilities," IR-2003-5, 1/14/03.

45

  "IRS Release on Offshore Credit Cards," 2003 TNT 50-8. The IRS announced in early 2003 that, as a result of the summonses, it had already identified thousands of offshore payment card holders and referred "several dozen cases" to Criminal Investigation for possible prosecution.

46

  Goulder, supra note 2. According to Rick Cadenas, a senior technical reviewer at the IRS Office of Associate Chief Counsel, the possibility of avoiding jail time is "a pretty strong carrot."

47

  Rev. Proc. 2003-11, 2003-1 CB 311.

48

  Id., §4.

49

  Id., §6.

50

  Id., §1.01(1).

51

  Id.

52

  Id., §1.02.

53

  Id., §1.01(2).

54

  "Offshore Compliance Program Shows Strong Results, IRS Says," supra note 2.

55

  Id.

56

  "Early Data Show Strong Response to Offshore Initiative; Applicants Owe Millions, Reveal Scores of Promoters," IR-2003-58, 5/1/03.

57

  Rev. Proc. 2003-11, supra note 47, §3.

58

  Ostrander, supra note 1. See also "E&Y Memo Opposing Clients' Emergency Motion for Injunctive Relief," 2003 TNT 9-36 (noting that the IRS issued Ernst & Young LLP a "last chance" letter). The IRS has not officially labeled this new program as the "last chance compliance initiative"; this article refers to the program as the LCCI solely for the sake of simplicity and clarity.

59

  Rev. Proc. 2003-11, supra note 47, §8.01.

60

  Ostrander, supra note 1.

61

  Emergency Rule 12ER03-6 (Fla. Dept. of Revenue, 8/18/03).

62

  "Save Money with Tax Amnesty," Fla. Dept. of Revenue News Release, 6/23/03.

63

  "State Tax Agency Launches Amnesty Awareness Program," Fla. Dept. of Revenue News Release, 7/30/03.

64

  Emergency Rule 12ER03-6, supra note 61, §2(c).

65

  To participate in the Florida tax amnesty program, a taxpayer had to do all of the following by 10/31/03: submit a Form DR-100000 (Tax Amnesty Agreement), submit accurate original or correct amended Forms DR-601-I (Florida Intangible Tax Return for Individual and Joint Filers), and pay the full taxes and interest owed.

66

  Emergency Rule 12ER03-6, supra note 61, §1(a).

67

  "DOR Gearing Up for Tax Amnesty Implementation," Fla. Dept. of Revenue News Release, 6/5/03.

68

  "IRS Official Lists Actions Taken to Curb Corporate Tax Abuses," 2003 TNT 114-6.

69

  "IRS Chief Counsel Comments on Enforcement Petition Against Jenkens and Gilchrist," 2003 TNT 158-12.

70

  Id.

71

  Thorndike, supra note 6.

72

  "IRS SB/SE Releases Memo of Understanding on Abusive Transactions," 2003 TNT 180-27 (reproducing the sample "Memorandum of Understanding Between Internal Revenue Service Small Business/Self-Employed Division (SB/SE) and [State tax agency]"). See also "Federal and State Tax Authorities Initiate Partnership to Combat Tax Shelters; Pledge More Information Sharing," Std. Fed'l Tax Rpts. (CCH, supplement 9/25/03).

73

  Id.

74

  Id.

75

  "IRS and States Announce Partnership to Target Abusive Tax Avoidance Transactions," IR-2003-111, 9/16/03 (reproduced at 2003 TNT 180-10).

76

  "Everson Comments on Antishelter Agreement Between IRS, State Agencies," 2003 TNT 180-12.

77

  "SB/SE Commissioner Highlights Provisions of Agreement to Fight Tax-Avoidance Schemes," 2003 TNT 180-11.

78

  "New Partnership Will Restore Faith in Tax System, Olson Says," 2003 TNT 180-13.

79

  "Baucus Supports IRS/States Partnership to Fight Abusive Tax Shelters," 2003 TNT 180-31.

80

  "States, D.C. Comment on Agreement to Fight Abusive Tax Transactions," 2003 TNT 180-32.

81

  Lunan, "Carolinas Target Shady Tax Shelters; IRS Will Hand Over Its List of Names of Shelter Investors to State Examiners," Charlotte Observer, 9/29/03, page 1D.

82

  Id. According to this article, "[w]ealthy Carolinians trying to fend off a federal crackdown on suspect tax shelters will soon be fighting another foe—state agents."

83

  Donmoyer, "IRS, States to Probe Tax Shelters; Because Florida Takes No Revenue From Personal Income, Taxpayers Here Won't Be Scrutinized, but Businesses Might," Miami Herald, 9/17/03, page C4. See also "Corporate Tax Sheltering and the Impact on State Corporate Income Tax Revenue Collections," Multistate Tax Comm'n, 7/15/03.

84

  Id.

85

  Fla. Stat. §199.023(1) (2003); see also Fla. Stat. §199.175(1) (2003).

86

  Fla. Stat. §199.023 (2003).

87

  Fla. Stat. §199.185(2) (2003).

88

  Fla. Stat. §199.032 (2003).

89

  Fla. Stat. §199.052(1) (2003). See also Fla. Stat. §199.052(2) (2003). The filing requirement is waived when the tax due is less than $60.

90

  Fla. Stat. §199.042(a) (2003).

91

  Fla. Stat. §199.282 (2003).

92

  Fla. Stat. §199.282(1) (2003).

93

  Fla. Dept. of Revenue, "Tax Amnesty Program" (available at ).

94

  "State Tax Agency Launches Amnesty Awareness Program," supra note 63.

95

  IR-2003-58, supra note 56.

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