The indictment of Paul Manafort this week includes charges related to undeclared offshore income and assets and provides an opportunity to review basic concepts in offshore reporting obligations to the IRS.
First, the indictment charges that Manafort was paid fees from foreign parties (a foreign government to which he provided advice and consulting services) and he did not declare millions of dollars of this income to the IRS. The lesson here is that the U.S. Internal Revenue Code taxes income wherever earned, from both domestic as well as foreign sources. Whether a U.S. taxpayer earns income within the United States or in a foreign country, this income is reportable to the IRS and is taxable.
The indictment alleges that rather than receiving the foreign income into the United States and declaring it to the IRS, Manafort diverted the income to accounts in offshore tax havens such as Cyprus, the Indian Ocean archipelago the Seychelles, and the Caribbean nation of St. Vincent and the Grenadines. The Manafort indictment calls these foreign accounts “nominee accounts”, i.e., an account in the name of a person other than the true owner of the funds. Such conduct – – the diversion of income away from the U.S. and instead to foreign accounts – – constitutes criminal tax fraud, apart from the failure to declare the accounts themselves. Likewise, creating foreign entities like corporations (sometimes called “shell companies”), trusts and foundations for the purpose of concealing ownership of assets, is also criminal tax fraud.
U.S. taxpayers who own or control accounts at foreign financial institutions are required to report these accounts to the IRS, even if no income was earned in these accounts. For foreign accounts, there is thus a two-part requirement: First, the requirement to declare the existence of the accounts to the IRS; second, the requirement to declare income in the accounts to the IRS. The offshore accounts are reportable on governmental forms such as FinCEN Form 114 (known as the “FBAR” form) and IRS Form 8938. There are significant penalties for failure to file these forms, even if the accounts did not earn any income. In addition, having an interest in a foreign trust is also reportable on the FBAR form as well as IRS Forms 3520 and 3520A. Owning as little as ten percent (10%) of some foreign corporations also must be reported to the IRS on Form 5471.
The Manafort indictment alleges other misdeeds, such as making false statements to mortgage lenders, which is also a criminal act and doesn’t involve offshore reporting. The offshore claims against Manafort involve an additional degree of culpability. For example, Manafort is alleged to have wired funds from the foreign accounts into the United States in order to purchase homes and enjoy a lavish lifestyle, without paying taxes on the income. But it does not take such brazen acts to trigger government investigation and criminal prosecution. Even one failure to report a foreign account can result in onerous penalties where half the value of the foreign account can be seized by the IRS.
It should be noted that not all offshore financial activities are criminal. Owning a foreign bank account is perfectly legal, provided that it is properly reported to the IRS. There are many legitimate reasons to have an offshore presence, including foreign business activities, ownership of foreign real estate, asset protection, financial diversification, etc. But such legitimate reasons carry the requirement of IRS compliance.
We can assist you in bringing foreign assets into U.S. tax compliance in order to avoid significant penalties. We can also advise you on the proper use of offshore strategies for asset protection, financial diversification and legal tax minimization. Contact us for a consultation.