When it comes to unreported foreign bank accounts, there is good news and bad news. The good news is that a previously unreported foreign bank account can dramatically increase the value of a divorcing couple’s marital estate and may even make it easier to divide the assets and resolve the divorce. The bad news is that an unreported foreign bank account can result in large amounts of tax, tax penalties, and interest due to the IRS; can trigger large civil monetary penalties apart from taxes; and can even lead to criminal prosecution for this failure. Sometimes the risk that an unreported foreign account will explode into a huge problem is so high that nobody wants to admit having any connection to the account, but it nevertheless is something that must be addressed directly.
It is surprising how many people have an unreported foreign bank account, often without intending to hide assets from the IRS. Maybe they inherited it from a relative, maybe they worked abroad in the past, or maybe they just like to have a bank account while on vacation. Unreported foreign accounts often surface during a divorce as the spouses inventory the marital estate. The primary issue that must be considered is whether one or both of the spouses “willfully” failed to report the account and whether criminal prosecution or huge civil money penalties are likely. Divorce lawyers with high net-worth clients must be sensitive to the issues and risks surrounding foreign accounts and know when to bring in a tax specialist.
Part I of this article summarizes the reporting requirements for United States taxpayers who have an interest in one or more foreign bank accounts, and describes the issues regarding criminal and civil penalties that are presented by unreported foreign bank accounts. Part II reviews case law which suggests that courts are inclined to rule in favor of the government when it seeks to collect civil penalties assessed by the IRS for failure to report a foreign account. Part III examines two recent cases that addressed these civil penalties in the context of a divorce. Part IV explains how these civil penalties do not apply jointly and severally even if spouses filed joint income tax returns, but also how the same penalties may apply separately to each spouse. Part V reviews the alternatives that spouses with unreported foreign accounts should consider when deciding how to proceed. Finally, Part VI sets out a simple, straightforward framework for deciding what to do when an unreported foreign account surfaces during a divorce proceeding.
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