by Asher Rubinstein, Esq. and Julie Otton[1. Asher Rubinstein is a partner at Rubinstein & Rubinstein in New York City. His legal practice is in the areas of asset protection, wealth preservation, tax compliance and tax controversy. Julie Otton is a law student at New York Law School. They may both be reached at (212) 888-6600 and via www.assetlawyer.com.]
As part of the expanding global scrutiny of offshore bank accounts, the IRS and the criminal tax division of the U.S. Department of Justice (DOJ) have now focused attention on three of Israel’s biggest banks: Bank Leumi Le-Israel, Bank Hapoalim and Mizrahi-Tefahot Bank, to see if they helped U.S. citizens to evade taxes. We believe that additional Israeli banks, not publicly named, are also under investigation.
Investigation of Israeli banks follows the erosion of Swiss banking secrecy and U.S. legal action against multiple foreign banks including UBS, Credit Suisse, Wegelin and HSBC. The IRS is now scrutinizing banks outside of Switzerland, including Liechtenstein, India and other countries. In the case of Israeli banks, American authorities are concerned with the flow of non-complaint money from Switzerland to Israel in recent years. As Swiss banking secrecy faded over the past few years, and the U.S. extracted once-“secret” Swiss account details, many taxpayers transferred assets from Switzerland to Israel to avoid detection by the I.R.S. Now, the IRS has caught up with them. The IRS and the DOJ have recently been targeting American taxpayers with accounts in Israel. In addition, there are reports that the IRS is auditing American expats living in Israel.
Many Americans maintain bank accounts in Israel for various reasons: business ties, costs associated with owning real estate in Israel, accounts to assist family members, etc. It is completely legal to have an account in Israel, provided that (1) the account is disclosed to the IRS on (a) IRS Form 1040, Schedule B, (b) the “FBAR”, Report of Foreign Bank and Financial Accounts, Form TD 90-22.1, (c) new IRS Form 8938, Statement of Specified Foreign Financial Assets, and (2) income earned in the account, including interest, dividends and capital gains, is reported to the IRS and taxes paid on this income. (Taxes paid in Israel on such income may offset U.S. taxes.) So long as these conditions are met, the account is tax compliant. If the account is not tax compliant, a U.S. taxpayer who owns or has beneficial interest in an Israeli account can be prosecuted for civil and criminal tax fraud.
Whereas until recently, Swiss bank secrecy laws presented a formidable challenge to the IRS, pursuing undisclosed accounts in Israel will not require nearly as much effort. The tax treaty between the U.S. and Israel enables both countries to “exchange such information as is pertinent to . . . fraud or fiscal evasion in relation to the taxes which are the subject of this Convention.” Cooperation between the U.S. and Israel is routine in many matters, tax and otherwise. In addition, the U.S. and Israel currently grant legal assistance to each other in criminal matters via a Mutual Legal Assistance Treaty (MLAT). The MLAT states that the U.S. and Israel “express their understanding that this treaty applies to . . . criminal tax offenses . . . .” It is noteworthy that the treaty provides for the exchange of bank records.
In addition to the criminal tax investigations and prosecutions, a recent U.S. law called FATCA (the Foreign Account Tax Compliance Act), passed by Congress in 2010 and signed by President Obama, will come into effect in 2013 and mandate greater disclosure of Israeli account information to the IRS. FATCA requires foreign banks to report to the IRS all names and account information of U.S. beneficial owners of foreign accounts. If a foreign bank fails to make a FATCA disclosure to the IRS, the bank will incur a 30% withholding penalty on its U.S. sourced income. Because banks like Leumi have a substantial U.S. presence and U.S. investments, Leumi will begin FATCA reporting to the IRS. It has recently been reported that all Israeli banks, even those without a U.S. presence, intend to become FATCA-compliant because they do not want to be branded as non-compliant and subject to the 30% withholding.
In response to the IRS/DOJ criminal tax investigations, Israeli banks are not waiting until FATCA’s 2013 start date to demonstrate their compliance. In March 2012, Bank Leumi sent letters to its U.S. customers requesting IRS Form W-9, the Request for Taxpayer Identification Number and Certification. Customers who fail to declare compliance with U.S. tax reporting requirements may have their Leumi accounts frozen. Further, an Israeli bank can no longer merely rely on an Israeli passport if the bank has reason to believe that the client is also a U.S. citizen or resident. Bank Leumi notified customers that without certification of U.S. tax compliance, the account balance will be transferred in the name of the account holder outside of Leumi Group or via a bankers draft payable only to the account holder. Bank Hapoalim made a similar customer request. The fact that the funds will only be transferred to the named account holder will prevent the account holder from transferring the funds to another “hidden” or “secret” account.
Further, the Association of Banks in Israel has urged Israel’s central bank, Bank of Israel, to ask the Israeli government to reach an agreement with the U.S. in order to minimize the procedural disruptions that FATCA reporting will cause each bank. Rather than each bank reporting directly to the IRS, Israeli banks would report account information to their government, which would then provide that information to the U.S. government. Five European countries have already signed similar agreements with the U.S. on FATCA compliance, including France, Britain, Spain, Italy and Germany, in order to avoid each individual bank reporting directly to the IRS.
Against this background of tax investigation, criminal prosecution and tougher reporting standards, the IRS re-opened its Offshore Voluntary Disclosure Initiative (OVDI) in January 2012 in order to encourage owners of non-compliant foreign accounts to come forward and clean up the accounts. The OVDI provides a means to declare the foreign account to the IRS, bring the account into tax compliance and avoid criminal prosecution. The applicant will have to pay back taxes (and interest) on the income earned in the foreign account for the last eight years, pay a 20% “accuracy” penalty on that tax, and then pay a one-time penalty on the highest value of the foreign assets, as much as 27.5%. Some taxpayers may be eligible for a lower penalty of either 12.5% or 5%, depending on the specific facts of the case. This lower penalty might apply to some Israeli accounts such as “Holocaust accounts,” accounts inherited by heirs of Holocaust survivors where tax avoidance was not the motivation behind establishing the account.
However, some people with undisclosed Israeli accounts are not prepared to pay the taxes and penalties. They have few options. Continuing to rely on banking secrecy is not prudent given the many recent breaches of banking secrecy, including even once-sacrosanct Swiss banking secrecy. FATCA will make it impossible to maintain an account “under the radar,” and Israeli banks are demanding evidence of U.S. tax compliance now, even before FATCA takes effect.
Some account holders have closed their accounts and moved the funds elsewhere. In fact, it has been reported that Americans have withdrawn more than one billion dollars of assets from Israeli banks over the past few months. However, simply withdrawing money or closing an account does not remedy the problem. The IRS focuses on non-compliant accounts and unreported foreign income even in prior years. In the UBS matter, the IRS looked as far back as 2000. As a practical matter, closing a non-compliant Israeli account and moving the funds to another bank will lead to source of funds questions and “know your client” due diligence, as well as the current reality that very few, if any, reliable banks will take funds with “no questions asked” and no tax reporting. Moreover, there is almost always a money trail to the new bank which the IRS can discover. Just as the IRS followed money from Switzerland to Israel, it will follow it to other jurisdictions. Most other jurisdictions are also vulnerable to IRS investigations, DOJ legal challenges and the reach of FATCA.
Some Israelis are considering revoking their U.S. citizenship in order to avoid the burden of U.S. taxes and reporting. However, without proper advanced tax planning, expatriation can result in an IRS “exit tax”. Nevertheless, expatriation requests are on the rise. The most recent publicized example is Eduardo Saverin, co-founder of Facebook, who gave up his U.S. citizenship on the eve of the recent Facebook initial public offering and avoided millions of dollars of U.S. tax.
American taxpayers who decide to renounce their U.S citizenship may benefit from a new Israeli incentive offering tax benefits to new immigrants and “senior returning residents,” i.e., Israelis who have lived outside of Israel for ten years. Before expatriating, consultation with a U.S. tax lawyer is recommended in order to address, and minimize, the U.S. “exit tax”.
Clearly, the world of international banking and taxation has changed considerably over the past few years, and there should be no expectation of hiding foreign assets from the IRS. The IRS and DOJ have displayed relentlessness in pursing once-secret foreign accounts and prosecuting the U.S. owners of the accounts for tax fraud. After achieving notable success against Swiss banking secrecy, the IRS appears to be focusing on Israeli accounts with similar scrutiny.