The United States taxes its citizens and residents (“U.S. persons”) on their worldwide income. U.S. persons commonly used foreign financial accounts to evade U.S. income tax. Unlike U.S. financial institutions, foreign financial institutions do not report to the U.S. Internal Revenue Service income paid or credited on accounts. Some U.S. persons interposed shell companies to mask their beneficial ownership of foreign accounts. The United States government responded by enacting laws requiring U.S. persons to report their foreign income and their interests in foreign financial accounts and foreign entities. A noncompliant U.S. person is subject to being assessed income tax for as many as five years, and heavy penalties. To impose such penalties, the U.S. government must first discover the U.S. person’s foreign income, accounts, or entities.
The U.S. government has available three legal weapons for discovering U.S. Persons’ foreign accounts. First, a foreign financial institution that has entered into a “foreign financial institution” or “FFI” agreement with the United States under 26 USC § 1471(b) must annually report its U.S. account holders’ identities, account balance(s), and account income to the U.S. Treasury. Such an FFI must identify its U.S. accountholders and report their account information, without request by the U.S. government. If an account has indicia of U.S. person ownership, and the account holder refuses to answer the FFI’s inquiry about the holder’s nationality, the FFI must close the account.
Second, if the United States suspects that a U.S. person has used one or more financial accounts in a foreign country to evade U.S. income tax, and the U.S. government has an income tax treaty in force with that country, the U.S. government can make a request under the treaty to the foreign government for the U.S. person’s bank records. The United States has 69 income tax treaties in force. Treaty requests are ex parte—the target learns of the request if at all when the U.S. government notifies him of it. But the U.S. government must be aware of U.S. persons’ foreign financial accounts, and have reason to suspect that the accounts have been used to perpetrate tax fraud against the United States, before it can make a treaty request concerning the accounts.
Third, and most recently, 31 USC § 5318(k)(1)(3)(i), as added by the National Defense Authorization Act for 2021, and effective January 1, 2021, authorizes the Secretary of the Treasury or the Attorney General to—
issue a subpoena to any foreign bank that maintains a correspondent account in the United States and request any records relating to the correspondent account or any account at the foreign bank, including records maintained outside of the United States, that are the subject of—
- any investigation of a criminal law of the United States; [or]
- any investigation of a violation of this chapter [the U.S. Bank Secrecy Act.]
A correspondent account is an account established in the United States by a foreign financial institution to make payments for the foreign financial institution, receive deposits from the foreign financial institution, or handle other financial transactions for the foreign financial institution.
Thus, if a foreign bank has a correspondent account with a U.S. bank, the U.S. government now claims the authority to subpoena records of any account at the foreign bank, including records maintained outside the United States. It appears that such a subpoena must request records of a specific account or accountholder. Thus, the U.S. government must be aware of a U.S. person with suspected accounts at the foreign bank. The new law does not appear to authorize a “John Doe” summons for the records of a foreign bank’s accounts generally, or classes thereof.
The new law forecloses account holders’ due process as to subpoenas. Subpoenas issued in a criminal investigation are shrouded in secrecy. Prosecutors, grand jurors, and court personnel are bound to secrecy as to the investigation. Traditionally, other persons are not bound to secrecy. The new law, however, specifically forbids an officer, director, partner, employee, shareholder of, or an agent or attorney for, a subpoenaed foreign bank from directly or indirectly notifying any accountholder or person named in a subpoena about the existence or contents of the subpoena. Disclosure of a subpoena or its contents in violation of the new law subjects the violator to a civil penalty equal to double the amount of “suspected” criminal proceeds sent through the foreign bank’s correspondent account under investigation, or, if no such proceeds can be identified, not more than $250,000. The potential penalty is draconian. “[C]riminal proceeds sent through the foreign bank’s correspondent account” would include the proceeds of tax evasion or other crimes processed through correspondent account by all U.S. persons, not just the U.S. persons under investigation. The United States District Court under authority of which the subpoena was issued imposes the penalty, upon application of the Attorney General. Presumably, the alleged violator would be afforded due process as to the penalty.
Voluntary disclosure programs are available by which U.S. persons can minimize their cost of coming into compliance with the law. Under such programs, a U.S. person may have to file U.S. income tax returns or amended income tax returns for only three years, and may incur little or no penalty. But such programs are available only so long as the Internal Revenue Service has not become aware of the taxpayer’s delinquency. So it behooves a taxpayer to avail of a voluntary disclosure program and become compliant as soon as possible.