Secrecy versus Privacy

Some subscribers who have talked to me by phone have asked why I don't devote much space to the subject of privacy. That's gotten us into a discussion of the difference between financial privacy strategies and asset protection strategies. Sometimes the two goals can be achieved with the same device, but most of the time, the use of some asset protection entities will reduce your privacy and create more exposure of your financial affairs. Most of the lawyers who actually do a lot of asset protection work advocate full disclosure to the various tax agencies and any other regulatory agencies. (I believe the other lawyers are living on borrowed time.) 

Partnerships, limited liability companies, corporations and private foundations are entities authorized by law. Individuals have certain rights and powers without the consent of the state. A corporation or partnership only exists as a creature of the law. Without virtually full disclosure of the financial affairs of the partnership or corporation, the state won't grant the entity the benefits of a separate entity with it's own rights under the law. Trusts do not require registration with any government agency because they are simply agreements between the grantor/creator of the trust and the trustee. While revocable trusts don't provide any asset protection, an irrevocable trust might provide some protection. 

Certain aspects of the concern for privacy make a lot of sense. You just never know whether some innocent remark might be misconstrued. If you brag about saving taxes, someone might think you are doing something illegal and turn you into the IRS. If everyone knows you are out of the country for three weeks, will one of those people be a burglar? If you have a lot of money and make sure everyone knows it, aren't you inviting a lawsuit? 

Although the use of asset protection devices may be entirely legal, why tell everyone about it? It's one thing to make the necessary disclosures to the regulators, but why let everyone else know what you are doing? Those who set up family partnerships or offshore trusts sometimes seem to feel that using these devices is a mark of success and they have to brag about it at every party or social gathering. It's like the person who is "complaining" about his high tax bracket. It sure sounds a lot like bragging to me. 

But there are some forms of asset protection that rely on secrecy and evasion rather than on openly making use of the law. When that happens, the desire for privacy can overlap into a potential felony. If secrecy, subterfuge or fraud are essential to the success of an asset protection device, the odds are that it's illegal. A concern for privacy is reasonable, so long as it's also legal. 

Keeping a low profile and keeping your financial affairs private is the first and most important step in avoiding potential lawsuits or even some opportunistic civil forfeitures.

There are many legitimate reasons for wanting to keep your financial affairs to yourself and to not have those affairs easily accessible to any potential plaintiff, private investigator or lawyer who may be curious as to your net worth. In the U.S., such privacy is extremely difficult to secure. The ownership of real estate, corporations, partnerships and limited liability companies is a matter of public record. With nothing more than your name and address or phone number, an experienced investigator can quickly discover your social security number and can then get access to your credit history and even some of your insurance records. Extensive details about your bank transactions and credit card transactions can also be obtained. Getting a copy of your tax return is usually more difficult, but if the price is right, I'm told that it can be done. In some cases, I'm told that a potential plaintiff can get a court to order you to disclose this information even prior to a lawsuit.

None of this kind of transparency has been available through offshore financial institutions. By having an offshore bank account, securities custodian, corporation, LLC or trust, you can shield a lot of your financial affairs from prying eyes. But some people are wondering if the recent assault on financial secrecy by the U.S. and other high tax countries against the tax havens means that offshore financial privacy will also be a thing of the past. If you are looking for secrecy to keep your income hidden from the government, it seems to me that your days are numbered. But if you merely want financial privacy, I don't think you have anything to fear at this time. Right now, it seems to me that the main focus of the U.S. and the OECD is to be able to pursue their own tax evaders without getting stone-walled by bank secrecy laws.

Tax evaders need a lot more than privacy.They need secrecy to hide their unreported gains. I may be mis-reading what is happening right now, but I sense no effort by the big governments to force the financial havens to become as financially transparent as we are in the U.S. Those of you who are reporting your foreign accounts on Treasury Form TD F 90-22.1 and checking the box on Schedule B-III of your 1040 tax return and filing other required tax forms should not have anything to fear from the changes that are going on in the financial havens. If you are contacted by an IRS agent because you have an offshore account or even an offshore credit card, you should be able to avoid a full scale audit by showing the agent that you have been filing these documents.

As I indicated above, I've been told that if someone has enough money and the right connections, then it is possible to get tax return information. But in most cases, that information is very difficult to secure and it's not readily available to potential litigants. There are no meaningful laws in the U.S. to prevent commercial establishments from sharing customer information as there are in many foreign countries. Disclosing information to the IRS is not the same as disclosing it to a local loan broker or credit card company.

Maximum privacy from potential plaintiffs can derail or deter a lot of predatory lawsuits. But when a concern for privacy turns into a paranoid need for secrecy, it begins to look like you are a criminal. If you act and look like a criminal, the authorities will conclude that you are one. Then you have to work much harder to convince them you are not engaging in any crime.

If the IRS believes you are not reporting all your income they will perform a "life style" audit in which they try to measure how much you are spending each year. Then they compute how much income you would need before taxes in order to have that much available to spend after taxes. If your reported income and taxes are substantially less than their computed amount, they will assess you for back taxes, penalties and interest and may even pursue criminal charges. You then have to prove you are innocent. The most effective way to do that is with an annual balance sheet that is tied to your total income and by having an "audit trail" to connect your total income to your bank deposits and then to your tax return and your personal balance sheet. You also need to be able to explain any unusual spending by showing the receipt of non taxable gifts, inheritances or loans that were used to pay for those expenses.

The dividing line between privacy and secrecy is simple. File the required government reports for your offshore financial accounts, trusts and companies. Leave an "Audit trail" to show that you have reported all your income. You may even want to be prepared for a life style type of audit by having an annual personal balance sheet that is connected to your personal income the same way a business balance sheet is connected to the income of the business.

But I really see no reason at this time to close out your private foreign accounts, companies and any trusts if you have been reporting the income from your offshore assets to the tax authorities.

I can't count how many people call me or send me email messages wanting to know if some ''plan" they have concocted to hide their assets in some bizarre manner will work. Often, they want to use a foreign corporation that is "managed" by a nominee and their ownership is evidenced by bearer shares. My answer is always the same. Even if it were legal, secrecy is not a solution because there are too many ways that a plaintiff's lawyers can uncover assets that have been hidden. 

By itself, secrecy isn't enough to protect your assets from future lawsuits. 

As a practical matter, secrecy is useful in making it difficult for a lawyer to easily find out how much you are worth before the lawyer decides whether to sue you. But if you are sued, the lawyer is then able to use discovery proceedings to require you to disclose some information under oath even before there is a trial. And if you lose a lawsuit, the courts will require you to disclose the extent of your holdings. 

You can't make a transfer of real estate without leaving tracks. The same is true for an interest in a corporation, limited partnership or limited liability company. If you make gifts of more than $10,000 to any one person in any year, you are required to file a gift tax return. If you have listed securities, you have to convert them to cash to avoid leaving tracks. When you convert to cash, you leave a record. If you have a gain from selling securities, you have to report that on your tax return.

Whenever there is an inheritance, there are usually some probate records or a federal estate tax return. Any tax return information can be obtained by a creditor/plaintiff unless you claim the 5th and that's almost certain to be passed on to the IRS. I'm told that a bankruptcy trustee has nearly unlimited access to tax information. Any half competent auditor can look at a tax return for two years in a row and quickly identify any assets that haven't been accounted for in the second year.

And, there is always the requirement to report any cash or currency that you take offshore in excess of $10,000. If you use a foreign trust, there are extensive reporting requirements with heavy penalties for not reporting. Ditto for a foreign corporation or foreign partnership. Using a non-profit entity isn't a solution because their records are seldom protected. The list goes on and on. 

For those who are greatly frustrated by the growing lack of privacy in the U.S. and most other major countries, the only "solution" I can think of is to expatriate if you have the resources to live elsewhere. If you are self employed and can work anywhere in the world, then you have an ideal situation. Or, if you have ample assets and can live off your investments, you are also in an ideal position to change your country. Of course, you will most likely have to leave some family and friends behind, which is what makes it a difficult choice for most people. As for the prospect of ever regaining any significant personal privacy in the U.S., I'm extremely pessimistic. And, the lack of financial privacy is growing in most other major countries. 

Even so, it's foolish to make your financial affairs public any more than is required to avoid problems with the law. If you have assets in an offshore trust, it won't show up on a routine financial investigation by a lawyer who is considering taking on a suit against you on a contingent fee. Assets in the name of a family partnership won't disclose the extent of your financial resources if a trust is the limited partner. (Global Asset Protection, 7/99)

This report is a compilation and update of various articles and correspondence I have written or received in the past few years on the subject of privacy and secrecy. Portions of this report are articles by contributors to previous issues of Global Asset Protection or from Offshore Tax Strategies. 

Tax Avoidance or Tax Evasion?

What's the difference between tax avoidance and tax evasion?

The short answer is five years and $10,000. (For a corporation, the penalty is $100,000.) 

The serious answer is that the real difference is secrecy and deception. 

Legal methods of tax avoidance do not require the use of bearer shares, unregistered trusts or secret bank accounts. Legal methods of saving taxes offshore do not require a U.S. taxpayer to commit perjury on his tax return. 

There are a proliferation of phony tax schemes, scams and myths that involve some aspect of "going offshore". Although both of us (Richard Duke and Vernon Jacobs) are eager to find ways to help our clients to minimize their tax burden, we sense that a great many people simply don't how really difficult it is to evade taxes with illegal schemes without being caught. We also sense that many people (including some of the promoters of these schemes) just don't understand the various ways in which the tax law gives the IRS the power to penetrate and ignore many intermediate entities in a complex web of offshore structures. We also suspect that a lot of the people who think they can avoid taxes with a secret bank account, secret trust or secret corporation don't have a clue as to how difficult it is to avoid getting caught. 

Most likely, those who are tempted to evade taxes aren't even aware that there is no statute of limitations on back taxes, penalties and interest for an intentional failure to report and pay any taxes.

This is just one of many complicated traps in the tax laws that make it difficult to avoid U.S. taxes with offshore entities. Promoters and hustlers can easily persuade an eager prospect that he has found the "holy grail" of tax avoidance with some scheme by merely failing to disclose the obstacles and pitfalls that await the unwary and uninformed. 

Vernon Jacobs & Richard Duke

Secret Bank Accounts

As far as the U.S. tax law is concerned, U.S. citizens and permanent residents are required to report any income from foreign bank accounts. The fact that the income is not reported to the IRS on an information return does not alter the legal duty of the U.S. citizen/resident. The existence of a foreign bank account is required to be disclosed on Form 1040, Schedule B, Part III and a Form TD F 90-22.1 must be filed by June 30th of each year to disclose the location and other information about any foreign "financial accounts" with an aggregate value of more than $10,000 at any time during the prior calendar year. There are substantial penalties for failing to report income from foreign accounts and for failing to file the form TD F 90-22.1.

The IRS has been trying to convince the U.S. Congress that a lot of people are evading taxes in the underground economy. It's their bureaucratic assumption that they can and should somehow uncover every dime of unreported income - regardless of what it costs.

It's also widely known that there are a lot of U.S. citizens and residents who are evading taxes by not reporting the income from their secret foreign bank accounts, trusts or corporations. We're not about to try to tell you that tax evasion isn't widespread. Frankly, the IRS may be correct in saying that almost everyone cheats on their taxes sometime or other.

Of course, we also know a lot of people who will stoutly deny that claim. The ones we've met always tell us that their tax return is "squeaky clean". But we really doubt if there are a lot of people from the U.S. with foreign bank accounts who are reporting it all to the IRS. After all, if the Swiss banker or the Austrian banker won't send an information return to the IRS, why should the taxpayer volunteer? "Who wants to be a sucker anyway?" At least that's the argument of many people for not reporting income from foreign accounts.

Let's not get derailed at this point into a discussion of the moral issues of whether it's right or wrong to evade taxes or even to avoid taxes. Our focus here is on the practical issue of what's legal and what isn't.

First, you need to know that when you fail to report income, there is no U.S. statute of limitations on your tax return for that income. If the IRS finds out about some foreign bank account twenty years from now, it's all subject to penalties and interest plus the taxes that should have been paid. 

It only takes one audit out of a lifetime to get caught.

Second, you should also know that there is no dollar threshold for tax evasion. As a practical matter, the IRS rarely tries to pursue a criminal conviction for small amounts, but that's not because there is any legal reason to ignore the small fry. They just don't have the staff or the budget to pursue more than a few tax evaders.

Now then, how can they catch you if you fail to report a few dollars of interest in a foreign bank account? For one thing, it's nearly impossible to move more than a few dollars offshore without leaving a paper trail. For now, you can move as much as $10,000 in currency offshore without leaving tracks. But that only works if the withdrawal of $10,000 is from such a large account that it won't be noticed if you are audited. If you don't have a habit of carrying around that much cash, some bank employee is likely to file a suspicious activity report on you. Basically, you would have to engage in a lot of very small transfers of money, spread out over many years, in order to avoid leaving a trail. The travel costs would far exceed the tax savings.

Transfers of large amounts (in relation to what you have) leave a trail. They even leave a trail when there is something missing. For example, you had $1 million of net assets last year, you made $150,000, you spent $100,000 (including the taxes you paid) and this year you have $900,000 of assets instead of $1,050,000. What happened to the other $150,000? Most auditors spend four or five years in college learning their craft. Then they often spend another four years with one of the big CPA firms as an auditor. Or they go to work for the IRS and get a crash course on how to find hidden money. An auditors job is to find things that don't fit a pattern. Ratios are out of whack. Financial trends change for no apparent reason. Most IRS agents are auditors. Only a few are lawyers.

Like the detectives in the movies, the books and t.v., the IRS auditors acquire a sixth sense of when something isn't in sync with everything else. They soon learn to sense when someone is lying or is nervous. They even learn to observe body language to get a feel for whether the taxpayer might be trying to hide something. The more of these clues they get, the more they want to get to the bottom of it. They ask leading questions of the taxpayer in different ways. If they are auditing a business, they ask seemingly innocent questions of the employees. They look for large deposits or withdrawals of cash from bank accounts or other financial accounts.

Frequent foreign travel without an obvious business reason tends to make the auditors suspicious. They will want to know the reason for the trips. Are you going to the same place each time? Who did you visit? What did you discuss with them? Where did you stay? When did you see them? Where did you meet? Was it a profitable trip? Did you establish new business relationships? What are you buying or selling to this new foreign contact?

If they have sufficient reason to doubt the information they are getting from a taxpayer, they can begin a lifestyle type of audit. Instead of just looking at your tax returns and supporting records, they look into every nook and cranny of your personal life for clues to unreported income. They then try to reconstruct how much income you would need to support a particular lifestyle. If you haven't reported that much income, they dig deeper.

But maybe you will win the audit lottery and not get selected for one of the random audits that occur just because yours was one of the random numbers they pulled for that year. There's a really huge problem of being reported to the IRS by someone you know. You have to resist the great temptation to tell someone about your exciting and ingenious scheme to hide some income from the IRS. A lot of people can't resist telling someone. But then they get divorced, or they have to fire the employee who knows what they did, or the business goes broke, a former partner is angry over the breakup, a lover gets mad at them and someone blows the whistle with the IRS. Did you know that most IRS informants don't want the money the IRS is willing to pay for information leading to collecting more taxes?

What about all the communications you have with your foreign banker? Will you be making monthly phone calls to Zurich? Or will you have to travel frequently in order to take care of such matters in person? How much taxes would you have to save in order to pay for the plane fare and other travel costs? Of course, you could use the internet with encrypted email messages. But first, the foreign banker has to get well enough acquainted with you to do business by email, phone or other impersonal means. With the pressure of the U.S. and other major countries to require bankers to "know their customers", it will be much more difficult to establish a new banking relationship outside the U.S.

And - if you decide to do business through someone who is willing to lie for you, to commit a felony with their own government, to sign documents that are false, how can you be sure this person will be honest with you? Secret bank accounts may sound easy in the movies and the novels, but they actually require a lot of hard work and expense.

The High Cost of Secret Accounts

(The following comments were written in October of 2000.)

I've just received an email from a party who wanted me to visit their new www.sparbucks.com web site which promises a 100% anonymous offshore debit card from Austria. (As of December 11, 2001, this web site is not longer online.)

A quick look at their web site disclosed the high price of secrecy -- which they actually claim are "low costs and fees".

• The cost per Baltic Sparbuck is "only" $595 plus $60 shipping plus $40 opening deposit.
• Annual renewal fee is "only" $295.
• ATM cash withdrawal charges are a "low" 1.5% of the amount withdrawn.
• There is a 5% charge for wire transfers and a 10% charge for e-gold transfers.

Is this a bargain or what?  Frankly, if you don't have funds earning any interest, there is no problem with tax evasion because there is no income and hence no tax to evade.

So why does anyone want to pay these fees to have an anonymous (secret) offshore debit card?  Maybe they want to use it to hide some transactions from a spouse?

Well, I do understand that if you are a drug dealer or engaged in some other kind of illegal activity, this might be an appealing way to launder money out of your illegal activity.

Can anyone think of any legal reason why it would make sense to forgo all income from interest for any funds on deposit and to also pay almost $700 to sign up and $300 a year, plus up to 11.5% of the funds put into the account and later withdrawn?

Perhaps the fees would not be a problem if you had a large amount on deposit, but then your lost income and transfer fees would be pretty costly -- it seems to me.

Is secrecy really worth this price?

Perhaps not, since their web site is not longer online.

Why Can't You Just Hide Your Assets?

A common assumption about protecting your assets from judgment creditors is that you can somehow just hide your assets somewhere. First of all, that clearly won't work for immovable assets such as your home, your business, your pension plan and any investment real estate. Secondly, if you attempt to hide movable assets such as cash, stocks, bonds or other securities, you will have to commit perjury under oath. The judgment creditor will be able to engage in a fact finding process (which includes taking a deposition, reviewing any financial statements and even looking at your tax returns) to identify and locate your assets. If you have reported the interest, dividends, rent or related tax deductions for any movable assets on your tax return, it will show up and you will be asked what happened to the assets. The creditor will also ask for any financial statements you have used to secure credit - and those statements may disclose the existence of the assets you are trying to hide. Basically, you have to be prepared to convincingly lie under oath, and to be able to cover your tracks through all of the various paperwork that may identify any assets you have ever owned. You also have to able to resist the temptation to tell someone about your "secret" stash. 

Asset Protection By Giving Your Assets Away

Another common attempt to hide assets from judgment creditors at the last moment is to make gifts of the assets to a spouse, children or other relatives. Sometimes, you might attempt to put the assets into a family corporation or even into an irrevocable trust. 

Assuming that these transfers are disclosed during the discovery process, the creditor can ask the court to have the assets transferred back to the control of the court for the benefit of the creditor. To do this, the creditor only needs to show that the debtor transferred the assets in order to "delay, hinder or defraud" any of their creditors. All of the states have some form of fraudulent transfer or fraudulent conveyance law to protect the rights of creditors. Property transferred without sufficient consideration (payment) can be recovered by the creditor from the person or entity to whom the property was transferred if the creditor can convince the court that the transfer was intended to hinder, delay or defraud any creditors. It's possible to rebut this claim by showing that you were technically solvent at the time of the transfer. An in-depth discussion of solvency in connection with asset protection is available on our subscriber's restricted web site. 

The Secret Foreign Bank Account Scheme

Some "advisors" will tell you that money in a foreign bank account is protected from any creditors, but they often fail to point out that this only works if you are able to keep the existence of that foreign account a secret and are willing to commit perjury on your tax return. These advisors allude to the well publicized "numbered accounts" of Swiss banks and Austrian banks, whereby there is no record in the U.S. of the ownership of these accounts. 

But first, you have to find some way to get the money out of the country without leaving a paper trail of any kind - and that's extremely difficult. You can take up to $10,000 out of the country with you on a trip. If your spouse travels with you, he or she can take another $10,000. As I understand it, each child could take $10,000 out of the country - if it's their money. But if you use this exemption too often or just use your kids as a conduit, you will be guilty of a crime called "structuring". This crime was created to prevent drug dealers from laundering money through multiple smaller transactions, but it's a crime without regard to whether you are a drug dealer and without regard to whether you are even engaged in money laundering. As a practical matter, if you, your spouse and each of your five children are searched (or questioned) when you depart from the U.S. or when you enter another country, the fact that each of you are carrying $10,000 in cash is likely to be viewed as a crime by the customs official and you will then have to spend a lot of time to try to prove you haven't committed any kind of crime. It's also highly likely that the cash will be confiscated (forfeited) by the customs personnel.

Of course, you can transfer funds to a foreign bank account with a check or a wire transfer, but that leaves a trail that could be found by a determined creditor. And you are still faced with the decision of whether to lie on the part of your tax return that asks if you have a foreign account. It may be possible to hide some of your assets in a numbered foreign bank account, but it "ain't easy". It will require a great deal of careful subterfuge - which most people are not capable of accomplishing. 

In the past year or two, it's become even more difficult because of pressure by the major countries (like the U.S., England, Canada, France, Germany, Japan and others) on other countries to adopt rules to ostensibly deter money laundering. More international banks are refusing to take funds from new customers without first engaging in an extensive review of their credit and financial records. There are fewer and fewer banks in the world that will accept deposits that are secret. 

Some commentators have argued that if you have funds in a foreign bank account, a creditor will have to pursue a court action in the foreign country in order to get a lien or attachment on the funds in the foreign account. However, if you have the legal right to draw checks or to make withdrawals from that foreign account, a creditor will merely ask the court to order you to withdraw the funds in those foreign accounts. If you refuse, the judge will hold you in contempt of court and will let you spend some time in jail to think about it. 
 

Bearer Share Domestic Corporation Schemes

Some promoters are selling packages consisting of a Nevada corporation or an international business company (IBC) as a way to protect your assets from creditors and even to "save taxes". The key to these schemes is that the ownership of the entity is evidenced by bearer shares. There is no public record of who owns the shares of the corporation and the shares can be quickly transferred to someone else without the time and delay of registering the change in ownership with the corporation. 

Basically, the protection -- and the tax savings -- rely on secrecy.

This is a legitimate way to prevent potential plaintiffs (or their lawyers) from discovering all of your assets with a quick computer search. That may deter a predatory plaintiff from suing you and it's almost certain to deter a lawyer working for a contingent fee from taking the case. If the potential plaintiff has to pay cash to hire the lawyer, that is usually the end of the matter. Thus, when properly used, the Nevada Corporation or foreign IBC can make it a lot more difficult for legal predators to find out if you are worth suing.

But most of the promoters of these arrangements claim a lot more in the way of benefits. Many of the promoters claim that a bearer share corporation provides asset protection and some even claim that it provides tax savings. 

But -- while a bearer share corporation might prevent someone from deciding to sue you, it won't protect your assets very much after you are sued. The claims of tax savings are often based on very limited circumstances that seldom apply to most people. 

If you lose a lawsuit, the plaintiff can require you to disclose all of your assets under penalty of perjury. If you have substantial assets that have been moved into a bearer share corporation, any half witted investigator can easily discover that there is an unexplained loss of assets. You will be grilled. If you refuse to disclose where the assets are, the plaintiff will then hire a really good auditor who is a specialist in forensic accounting. They will demand your tax returns and complete details of your credit files and applications for credit for the past few years. They will demand an explanation of any discrepancy in your assets from year to year. If you still refuse to explain a sudden and substantial loss of assets, they can get a judge to put you in jail for contempt of  court. 

The promoters of the Nevada Corporation often  claim that you can save income taxes because Nevada does not have a state income tax. This is true if you are doing business in Nevada and have an office in Nevada and if your corporation is making a profit. But if you don't read the fine print, you might not realize that the tax savings only apply to state income taxes -- and not to federal income taxes. 

Some promoters go a step further and claim that you can use your nevada corporation to move profits from a separate corporation in a high tax state like California into your state tax free nevada corporation. The scheme involves billing your California or other corporation for services alleged to be performed by your nevada corporation -- and at a very high markup. 

If you live in a high tax state with a corporate income tax, you need to be sure that they don't have some laws that limit the extent to which you can transfer profits from their state to another. Merely having a paper entity in Nevada that bills your operating corporation for some phony service will not stand up to a challenge by your state tax collector unless there is some substantial substance to the work that is being done in Nevada. 

But when you incur extra expenses to establish and maintain an office in Nevada, the tax savings become less attractive. For example, if you have a corporation that is making $100,000 a year in profits, and if your state imposes a corporate income tax of $5,000 on that profit, you clearly need to spend a lot less than $5,000 a year to operate your Nevada corporation. If you really like this idea, at least take the time to run the numbers before you spend your money to set up a Nevada corporation. And also check with some local tax professionals to find out if your state has some tax laws that allow them to challenge this kind of profit stripping activity. 

The Nevada corporation doesn't do anything to reduce your federal income taxes. In fact, if you are able to reduce  your state income taxes, you will incur some added federal income taxes. 

Bearer Share Foreign Corporations

If you object to the sales pitch for a secret Nevada corporation with bearer shares, the promoter may respond by telling you about how you can set up a secret foreign corporation with bearer shares. According to the promoter, there is no way anyone can find out about your foreign corporation unless you tell them. 

You have to have some help to do this, and the help is usually provided by a promoter who is merely a more devious thief than a burglar.

A non-resident alien (including a non-resident foreign corporation) can invest in U.S. stocks and any gains (or losses) are not subject to U.S. taxes. Investments in U.S. government securities or certain kinds of U.S. bank or S&L obligations do not result in any tax to the foreign investor. In addition, any income or gains from investing in any non-U.S. investments would be tax free if the corporation were domiciled in a tax haven. A great many U.S. taxpayers would like to be the owner of a foreign corporation that can generate tax free investments - but they clearly aren't aware of the complicated obstacles the U. S. Congress has put in their path.

Usually, the U.S. person who forms such an entity will fund it with cash. As with the secret bank accounts or other secret investment accounts, transfers of large amounts will leave a trail for a nosy auditor but transfers of small amounts are not adequate to offset the fees to create and to maintain this entity. All of the earlier comments about how secret bank accounts or investments can be found out apply to the secret foreign corporation. It's something that's very hard to keep secret because of the phone calls, mail and travel to visit with the managers of the foreign corporation.

One of the more popular foreign tax schemes is to create a foreign corporation (usually called an International Business Company or IBC) with bearer shares or with some kind of unsigned agreement with the person who is acting on your behalf.  You can purchase an "off-the-shelf" IBC in most foreign jurisdictions that has been formed by a local attorney (or other professional person) who merely hands you the shares to this standby corporation for a fee. Then, if you wish, the promoter/lawyer will offer to act as your agent for the company.

The problem with that approach is that the U.S. tax law includes provisions that give the IRS and the courts the power to disregard the legal formalities of an ownership arrangement that is inconsistent with the facts and to look at the substance of the arrangement. If someone else is acting as your agent, as a nominee or an intermediary, you will still be treated as the owner of that entity for tax purposes.

Certain U.S. shareholders of a foreign corporation are required to pay taxes on the current investment income of the corporation, plus certain other kinds of "sub-part F income" if more than 50% of the corporation is owned by five or fewer U.S. persons.

The U.S. tax system requires that if a foreign corporation is a passive foreign investment company (PFIC), all U.S. shareholders are required to file an annual information return (on form 8621). And, the U.S. shareholders are required to pay taxes on the income of the corporation as it is earned - somewhat like a partnership or S corporation.

In addition, if the foreign corporation is deemed to be a foreign personal holding company (FPHC) or a controlled foreign corporation (CFC), the shareholders who own 10% of more of the company must file form 5471 each year to disclose substantial details about the financial operations and financial condition of the company.

If the foreign corporation is engaged in an active trade or business outside the U.S., then there might be a reason to operate a foreign corporation - which would be able to accumulate profits tax free until they are returned to the U.S. But even then, it is sometimes more profitable to operate a foreign business as a U.S. corporation.

The U.S. tax law imposes severe penalties for not filing various reports for this kind of arrangement. Because the corporation is more visible than the secret bank account, it will be more likely to be noticed at some point by an inquisitive auditor. Or, it will be reported to the IRS by an angry former partner, former spouse, former lover or anyone else who has a reason to be mad at you and also knows about your foreign corporation.

Worse yet, the foreign managers can take the money from your accounts and then defy you to sue them. If you do, they will threaten to notify the IRS that you have a foreign corporation. And even if you settle up with the IRS, you still have to sue in a foreign country, with foreign lawyers, under foreign laws and subject to foreign judges. How much are you willing to trust the foreign managers who will help you to break the law in the U.S.?

Secret Accounts Through IBC/Nominee Ownership

(The Following is by Richard Duke, from the October, 1999 Offshore Tax Strategies report.)

Practitioners in the international arena are aware that promoters in the U. S., and especially those in tax haven financial centers, have promoted and continue to promote "bearer share" corporations. The implementation of this structure involving a nominee entity is accomplished as follows:

A U. S. person transfers cash or other assets to an IBC that is established by a foreign person. The IBC is a "bearer share" corporation with the certificates placed in the hands of the foreign person or entity. This corporation belongs to the person who physically possesses the stock certificates with no official record of ownership. Generally, the person or entity establishing the IBC names himself and others as officers and directors of this IBC. 

The U. S. person, however, is the "beneficial owner" of the account in the name of the IBC. The U. S. person is the sole signatory on the account and generally fills out a form at a bank identifying himself as the beneficial owner of this IBC. Also, the foreign persons who are acting as directors will follow the advice of the U. S. person with respect to where to invest the money and when to make distributions.

Generally, a debit card is also issued on the account in the U. S. person's name. In such a structure, there is no question that the U. S. person is subject to tax reporting requirements and income taxation on all subpart F earnings of the IBC. Those who make claims to the contrary are either seriously uninformed or are outright charlatans.

As beneficial owner, the U. S. person is required to indicate his "financial interest in, or signatory or other authority over, a bank, securities, or other financial account in the foreign country" by checking "yes" to Schedule B, Part III of his Form 1040. In addition, the Bank Secrecy Act of 1970 requires his filing a Form TD F 90-22.1 (for the transfer of more than $10,000 in cash or assets outside the U. S.). This form requires checking a "yes" as to the transfer of assets outside the U. S. and further requires the U. S. person to "enter the name of the foreign country" to which he has transferred assets.

The Form 1040 instructions also require a "yes" to the foreign bank account questions (Schedule B, Part III) if the U. S. person: (1) at any time during the year had "an interest in or signatory or other authority over a financial account in a foreign country;" or (2) the U. S. person owns more than 50% of the stock in any corporation that owns one or more of such accounts.

Two things can occur here. First, the promoter, whether inside or outside the U. S., can be a target of the IRS. If the target is being watched, the IRS can learn about the clients who have established such a structure who are not disclosing the foreign account and not reporting income. The targeted promoter can also be indicted followed by the IRS subpoenaing the promoter's records (his clients). Secondly, a simple random audit of the U. S. person can cause extreme problems for both the U. S. person and his professional advisor or advisors.

In a random audit, the U. S. person may disclose to the professional advisor that he has a "secret" foreign account. The professional advisor, after learning the facts, then becomes aware of the fact that a false return (Form 1040) has been filed since Schedule B, Part III has not been checked "yes" (indicating an interest in a foreign account). The professional advisor is faced with a dilemma. If this fact is disclosed to the IRS, it will place the IRS on notice that a foreign account has been established and the taxes have not been paid. This can result in criminal as well as civil fraud charges by the IRS. On the other hand, if the professional advisor fails to advise the IRS of the failure of the client to appropriately answer the question on the Form 1040, the professional advisor may be subjecting himself to criminal (tax) conspiracy. If the professional advisor is not a practicing attorney, the attorney-client privilege may be lost, since there are generally legal issues outside the strict tax privilege available to accountants.

It appears that the only solution for the lawyer representing the client is to advise the client to take the Fifth Amendment privilege against self-incrimination. The client may then decline to answer the foreign bank account question by claiming the Fifth Amendment privilege. The client also has to deal with the failure to file the Form TD F 90-22.1. However, there are several courts that have rejected the Fifth Amendment privilege as a basis for the non-filing of bank secrecy act forms. 

As the above indicates, there is no "good" scenario with respect to someone who has been "caught" with an IBC/bearer share structure where income is not being reported and tax return and Bank Secrecy Act forms are not being properly completed and filed. For those who are in such a scenario and now wish they could get out, they must seek legal counsel from a tax attorney. 

Generally, a tax attorney who is a planning and structuring attorney (transactional attorney) must engage a criminal tax attorney or refer the client to such an attorney. A criminal tax attorney is one who spends most of his time handling criminal and civil fraud litigation rather than planning and structuring. It is possible that working through a criminal tax attorney, the U. S. person desiring to "come clean" can work out an arrangement with the IRS to file the appropriate tax returns, pay the taxes, penalties and interest and avoid criminal charges by the IRS. Planning and structuring attorneys do not usually understand the nuances of the Fifth Amendment privilege against self-incrimination, as do criminal tax attorneys.

There is one additional serious legal problem with respect to the IBC/bearer share arrangement (as a nominee). Financial centers have two corporate laws: (a) corporate law for residents and (b) corporate law for non-residents (IBCs). A resident cannot own an IBC. If the resident who is in possession of the stock certificate is considered the owner, a non-resident did not form and does not own the IBC. This is a legal issue, however. This legal issue is raised simply to show the "pitiful" planning of many offshore promoters.

An excellent article regarding the seriousness of this structure and of a random audit is: Scott D. Michel, "Advising a Client With Secret Offshore Accounts-Current Filing and Reporting Problems," 91 Journal of Taxation 158 (Warren, Gorham and Lamont), September 1999. Scott Michel specializes in criminal tax matters. 

Richard Duke

The Secret Foreign Trust

If the promoter can't sell you a secret foreign corporation with bearer shares, he may then tell you there is something a whole lot better -- a secret foreign trust. A corporation is a creature of the law and there are records that must be kept somewhere for every corporation. A trust is essentially a relationship and can be formed without being registered in any database of any kind. Hence, the trust is more secret than a corporation. The promoter may also inform you that a foreign trust is a foreign entity that can invest on a tax free basis until some of the trust assets are distributed to a U.S. person. 

Here's another arrangement that requires the help of a scoundrel to make it happen - and that puts it into the category of a scam.

A foreign trust that does not have any U.S. beneficiaries or that is not funded (settled) by a U.S. person is treated as a non-resident alien for U.S. tax purposes. Like a foreign corporation, it can invest in U.S. government securities and certain U.S. bank and S&L accounts on a tax free basis. Any gains on buying or selling U.S. securities are also tax free to the non-resident alien. In addition, any income or gains from investing in any non-U.S. investments would be tax free if the trust were domiciled in a tax haven. Even if some U.S. persons are beneficiaries of the income in the foreign trust, the assets in the trust are not subject to any estate taxes when a beneficiary dies - unless the beneficiary has some kind of measurable interest in the trust. If it's a discretionary income interest, the assets are not subject to U.S. estate taxes.

Obviously, a lot of U.S. taxpayers would like to have one of those foreign trusts. On the surface, it's fairly easy to create a foreign trust. Before 1976, it was becoming a very popular thing to do. Since 1976, it seems a lot of U.S. taxpayers have created foreign trusts but have not complied with the tax laws. So the Congress changed the reporting obligations in 1996 for U.S. grantors and U.S. beneficiaries of a foreign trust.

Since 1977, the U.S. tax law has included a section (IRC 679) that treats a foreign trust with a U.S. grantor and any U.S. beneficiary as a "grantor" trust. What that means is that the settlor who creates and funds the trust is treated as the owner of the assets in the trust and is taxed on any income earned by those assets - as if the trust did not exist. In most respects, it's the same tax treatment as a revocable living trust. With a domestic trust, this tax treatment occurs if the grantor retains some power over the trust assets or retains a right to recover some of the income or principal in the trust. But with a foreign trust, you could create an irrevocable trust in which you retain absolutely no powers of any kind and you are still subject to income tax on the income of the trust. We're not saying that's fair. It's just part of the law that makes it difficult for U.S. investors to save taxes with a foreign trust. The U.S. congress does not want you to quit paying taxes on your investment income just because you put the assets into a foreign trust.

Because of the rule that the foreign grantor trust must have a U.S. grantor and a U.S. beneficiary, many seemingly clever people have tried to find ways to create a foreign trust through nominees, agents, foreign corporations or other deceptive arrangements. Most of these arrangements fail because the tax law looks through these intermediate parties to the person who has the real influence. In the case of a foreign trust, if you are the person with the money, the IRS will treat you as the trust grantor no matter how many intermediate entities you interject in the arrangement.

For exempla, one popular arrangement is to have a foreign person (usually a promoter) create a foreign corporation (IBC) and to then have the corporation form a foreign trust. Since the corporation is a non-resident alien, the promoter argues that the trust does not have a U.S. grantor. That won't fly with the IRS or the U.S. tax courts. 

In the first place, the foreign person (promoter) is a mere agent, alter ego or nominee for the U.S. taxpayer. The corporation formed by that foreign person on your behalf will be treated as if it were formed by you. Thus, it is a controlled foreign corporation. The trust formed by the CFC will be deemed to be a foreign grantor trust, funded (indirectly) by you. 

Or, the trust may be treated by the IRS as an agent of the foreign corporation and the U.S. grantor would be treated as the sole shareholder of a  controlled foreign corporation that is a Passive Foreign Investment Company and a Foreign Personal Holding Company. No matter how you cut it, the income belongs on the tax return of the U.S. person who put up the cash or whatever assets were used to fund the trust.

There are many variations on the ways in which promoters or "consultants" try to help you to bypass the rules relating to a foreign trust. One such  arrangement that strikes us as rather ghoulish is to pretend that the taxpayer's parents are the grantor's of the trust. Assuming the parents aren't well to do, they are given the funds to create the trust, but not enough to create any gift tax problems. Then, the taxpayer basically waits until the parent dies, at which time there is an ostensible foreign trust without a U.S. grantor. At that point, the taxpayer engages in a variety of financial transactions with the trust that is intended to transfer profits or equity into the trust and out of the U.S. tax system. In the event that the IRS were to investigate such an arrangement, it's very likely that they would argue that the real grantors were the taxpayers who provided the funds to the parents. 

Is It Really Worth the Hassle?

Whether the IRS is really able to find out about a secret corporation being operated out of the Bahamas, Cayman Islands or Switzerland is not the critical issue for Americans unless they are prepared to drop out of the system and try to work in the underground economy. (As a practical matter, the only people who can do that are those who have converted all of their assets into liquid savings and can easily move to another country.) Most people of some financial substance have ties to their community and can't (or won't) just carry assets with them and become a legal vagabond. The vast majority of Americans own businesses or real estate or have retirement plans from U.S. companies, etc.  Even if they changed their citizenship, they couldn't avoid taxes on much of their income.

The critical issues (apart from whether you are willing to ignore the law) is the time and the cost and hassle of trying to avoid being discovered. 

First and foremost, you have take steps to ensure that your foreign bank account, foreign corporation or other secret stash is kept secret. That means you really can't tell anyone -- including your spouse, your children, your mistress, your business partner, your faithful bookkeeper, your golf buddies or even your tax accountant. But if you do manage to keep this foreign stash a secret, it will be lost after you die. That's the equivalent of a 100% estate tax on those assets. (If you leave a note to one of your children or to your spouse to be opened after your death, you are creating a huge and costly problem for them. They will curse you for it. You will be remembered with more fondness if you don't tell them about your secret stash.) 

Second, everything connected with the hidden money must be "off the books". The money has to come from sources that won't leave a trail when you move it offshore. To do that, you have to commit tax evasion. You have to keep two sets of books. You have to hide this activity from everyone in your business and from your family. To move the money offshore, you need to move it in small amounts over a period of time. That will require a lot of trips to your offshore bank and you will need some plausible reason for making so many trips offshore. You soon find yourself lying to friends, family and business associates about your activities. When some of your lies don't make sense and you are questioned, you have to cover up with another lie, and soon you are having trouble remembering what you said to whom. 

Third, hiding money and evading taxes are serious crimes in the U.S. I'm not arguing that it should be a crime to have hidden assets or to not pay taxes. In many countries of the world, tax evasion is not a crime. It's a mere misdemeamor. Having secret bank accounts is not a crime in many countries. However, that is rapidly changing. More and more countries are adopting the approach of the U.S. Even those that are not copying us are willing to pass laws to prevent money laundering. It's virtually impossible to hide any money anywhere without engaging in some form of money laundering. 

Thus, when you embark on the seemingly simple procedure to have some assets that are hidden from prying eyes or to have some income that is not being consumed by taxes, you are beginning a journey that will eventually lead you to a lifestyle that is hard to distinguish from a professional crook, a drug dealer or even a terrorist. 

Multi-National Pressure to Eliminate Banking Secrecy

(From our Special Report on Harmful Tax Competition.)

In October, 1997, the European Commission adopted a proposal from their Taxation Commissioner to curb "harmful tax competition" -- within the European Union (EU). The proposal calls for (1) a code of conduct for business taxation, (2) an EU system for the taxation of income from savings and (3) measures to eliminate withholding taxes on cross-border interest and royalty payments between companies. At the time the phrase "harmful tax competition" referred to the kind of competition that was inconsistent with the goal of free trade within member states of the EU. 

However, it seems that this catchy sound-bite was picked up by others in various international groups and has taken on an expanded definition. As we like to say in the U.S., "It grew legs." 

The Organization for Economic Cooperation and Development (OECD) is an international organization of 29 of the world's most industrialized (and generally most highly taxed) countries. The OECD includes most of the members of the Economic Union (EU), the U.S., Canada, the U.K., Japan and many other major countries. The OECD is like a "think tank" that studies various issues and develops recommendations. A recommendation made about two years ago advocated the elimination of "harmful tax competition" (HTC). Without reading their report, many people jumped to the conclusion that HTC was synonymous with low tax rates. However, as defined in the report, HTC really aimed to eliminate banking secrecy and to encourage a greater exchange of information between countries regarding financial matters. The goal of their recommendations is to make it easier for the country where a person or company is resident to find out if the person or company is evading taxes. According to the OECD, 

Harmful tax practices may exist when regimes are tailored to erode the tax base of other countries. This can occur when tax regimes attract investment or savings originating elsewhere and when they facilitate the avoidance of other countries’ taxes.

Andorra, Anguilla, Antigua and Barbuda, Aruba, Bahamas, Bahrain, Barbados, Belize, British Virgin Islands, Cook Islands, Dominica, Gibraltar, Grenada, Guernsey, Isle of Man, Jersey, Liberia, Liechtenstein, Maldives, Marshall Islands, Monaco, Montserrat, Nauru, Netherland Antilles, Niue, Panama, Samoa, Seychelles, St. Lucia, St. Kitts and Nevis, St. Vincent and the Grenadines, Tonga, Turks and Caicos, US Virgin Islands and Vanuatu.

The U.S. is conspicuously absent from the list of tax havens despite the fact that the U.S. is the major tax haven of choice for non-resident investors from other countries. The U.S. offers substantial tax exempt interest and tax free capital gains to non-resident alien investors who invest in certain U.S. debt securities or U.S. based stocks. (The specific rules are actually quite complicated and have been discussed in our Offshore Tax Strategies newsletter.) 

In addition to identifying the 35 countries that are tax havens, the OECD report identified 47 preferential tax regimes (statutory exemptions, exclusions, deductions or credits) that are deemed to be "harmful tax competition" among member countries. The U.S. foreign sales corporation (FSC) tax exemption is on the list and the World Trade Organization has already demanded that the U.S. end the FSC tax break by October, 2000. (Which the U.S. did repeal, but immediately replaced it with a new law that provides tax benefits fro exporters.)

Close behind the release of the OECD report on Global Tax Cooperation, the G7 nations (the seven most powerful countries in the world) announced an initiative to tackle harmful tax competition. The focus of the agreement was on the exchange of tax information to curb international tax evasion and avoidance through tax havens and preferential tax regimes. This is the first reference I have seen where tax "avoidance" is included within the concept of harmful tax competition. As indicated above, the meaning of HTC is being expanded with each new report. 

However, As Christopher Riser pointed out to me after seeing a draft of this report, 

"… the US and European countries (particularly Germany and France) look at tax "avoidance" (as opposed to outright tax evasion) from very different perspectives. Basically, tax avoidance has a long history as being acceptable in the US, whereas tax avoidance and tax evasion are basically considered the same thing in Europe. I think this is a MAJOR driving factor behind all of these initiatives. When clever U.S. tax advisors come up with a legal tax avoidance maneuver, Congress either accepts it or changes the tax law. When European tax advisors come up with a tax avoidance maneuver, they and their clients are likely to face jail time. I think this is what is behind the reference to tax avoidance through tax havens that shows up in the G7 initiative." 

IRS Probe for Offshore Credit Card Records

(This is from the November, 2000 issue of Global Asset Protection.)

Last month, I reported that the IRS was seeking a summons to secure certain records of American Express and Master Card account holders with cards that are tied to certain offshore banks. In case you missed the news, the IRS has received approval by the U.S. District Court (Miami) for a John Doe Summons to secure the records of American Express and Master Card regarding their customers who have …

"… credit, charge or debit cards issued by or through, or for which payment was received from banks in Antigua and Barbuda, the Bahamas or the Cayman islands or issued to persons or entities in Antigua and Barbuda, the Bahamas or the Cayman Islands."

You have three choices if you have an offshore credit/debit card issued by AMEX or MC through a bank in one of these countries - and if you have not reported the income on those bank accounts. (1) You can wait to see if you are lucky and don't get picked for a visit by an IRS agent or agents. (2) You can try to beat the IRS to the punch by coming clean on your own with respect to any unreported income. (3) You can leave the country and look for permanent residence in a country that does not extradite on the basis of a tax/fiscal crime. You should not attempt to move the assets and income into the U.S. so they can be reported in future years. That does not cleanse you of any unreported income in past years. More importantly, doing that will be deemed to be money laundering and will subject you to much worse penalties than mere tax evasion. Any one who helps you to do that is also guilty of money laundering and conspiracy.

If you do decide to "fess up" (confess) before you are found, be sure to get the help of a criminal tax attorney. An experienced criminal defense lawyer can often approach the IRS on a confidential basis and inquire as to reduced penalties for voluntary disclosure. A criminal defense lawyer who does not do any tax work is not what you need. A tax lawyer who does not do any criminal defense work is not what you need. You need a tax lawyer who does criminal defense representation for taxpayers and who has been doing that for many years. A lawyer with experience in this kind of work has developed critically important working contacts with representatives of the IRS and is familiar with the appeals process. This is a very specialized area of tax law and you don't want an inexperienced lawyer to learn the ropes with your freedom at stake. Nor do you want to take this matter to your local CPA. Find a lawyer first and then have the lawyer hire your CPA for any preparation or accounting work that may be needed.

Locating Hidden Assets
By Bruce M. Peele, Esq.

Individuals often believe they can defeat creditors, spouses  and bankruptcy trustees through the use of  secret accounts, forming secret corporations or secret trusts. While such an approach may work on occasion, the results can be disastrous if the assets are located. This article will briefly describe how a professional fraud investigator goes about locating hidden assets. 

It should come as no surprise that people have often hidden their assets from creditors, governments, neighbors, thieves and even from their own families and spouses. Loose bricks in basement walls, mattresses, caves, hollow tree trunks and holes in the ground have provided places of secrecy for centuries. In recent years, hiding assets has become a much more sophisticated endeavor, often involving investments, banks and overseas financial transactions. As methods for hiding assets have grown in sophistication, the sophistication of investigators has also grown - primarily as a result of governmental agencies having to deal with the ever-growing power and wealth of the drug cartels..

Beginning the Investigation

An asset investigation may begin simply because someone is owed money and the debtor indicates that he or she doesn't have the money to pay. That claim might indeed be true - or an investigator might discover that the debtor continues to live well beyond his or her apparent means and his spending habits haven't been changed. Locating hidden assets can also be the result of the dissolution of a business or a marriage relationship where the assets are required to be divided evenly-except that one of the parties might not be truthful in listing all of their assets. So how do you know if everything is listed as it should be? 

Usually there are indicators that a person has more than they claim. The two most common indicators are lifestyle and financial analysis. Not only are lifestyle and financial analysis the two major indicators that assets are not being declared, they could be the only indicators that something is amiss.

Lifestyle Indicators

A person's lifestyle can be a symptom of hiding wealth. Knowing that, the fraud examiner uses these indicators to prove that the subject's income cannot possibly pay for the lifestyle and spending habits he or she is leading. The fraud examiner should strive to identify the subject's lifestyle and compare it to his or her sources of income. Although the following factors may not individually be an indicator of hidden assets, a combination of several of these factors, with the subjects income (or lack thereof), should lead the astute fraud examiner to look further into a person's financial affairs. 

Personal characteristics an investigator would be interested in could  include: whether the subject is known to (1) carry large amounts of cash , (2) wear designer clothes or expensive jewelry, (3) have club memberships, (4) belong to fitness clubs and spas, (5) live in an expensive house or (6) purchase expensive furnishings, artwork and vacation homes. Consideration should also be given to the type of car  the subject drives; that is, is it a luxury or exotic or does the a subject own numerous cars and are they late model vehicles? The investigator should also pay attention to be subject's leisure activities. Do they take expensive vacations, cruises or trips to exotic locations?

Financial Analysis

Another good way to determine if assets might be hidden is to analyze financial information (either personal or business) to identify inappropriate activity. The numbers are a good indication of where the money is coming from (income) and where the money is going (expenses). Financial statement analysis further points out changes in financial status. An unexplained change can mean that fraud is occurring. The three most common analysis methods performed for fraud in financial statements is: (1) vertical analysis, (2) horizontal analysis, and (3) ratio analysis. 

Vertical analysis is a technique for analyzing the relationship between the items on an income statement, balance sheet, or statement of cash flows by expressing components as percentages. In a vertical analysis of an income statement, net sales are assigned 100 percent. In the vertical analysis of a balance sheet, total assets or liabilities and equity is assigned 100 percent. All other items are expressed as a percentage of these numbers. This method is of little value in detecting small amounts of fraud in relation to the totals. 

Horizontal analysis is a technique for analyzing the percentage change in individual financial statement items, from one year to the next. The first year in the analysis is considered the base year, and the changes to subsequent years are computed as a percentage of the base year. Like vertical analysis, this technique will not work for small, immaterial frauds. 

Ratios can be helpful in detecting potential errors and other irregularities with respect to various balance sheet and income statement items. The quick ratio and current ratio assesses the liquidity of the suspect's financial resources. Accounts receivable and inventory turnover ratios assess the operational efficiency of a business. Other ratios such as debt-to-equity indicates the solvency of the enterprise. The profit margin, return on assets, return on equity, and earnings per share ratios assess the profitability. Unexplained changes in the ratios should be a signal to the fraud examiner that fraud might exist in the records. In a typical financial statement fraud, assets and revenues are overstated and expenses and liabilities are overstated. However, in the case were assets might be hidden, just the opposite can be true.

Profiles

The fraud examiner begins by profiling the subject. Two types of profiles may be developed: a personal profile and a business profile. The personal profile consists of two parts: the financial profile and the behavioral profile.

---The Financial Profile

The financial profile is essentially a financial statement with some modifications and additions. It shows what the subject earns, owns, owes and spends. The behavioral profile reveals habits-what is important to the subject in life - which would cause the fraudster to accumulate illicit funds. The first act in developing the personal profile is to prepare a financial profile of the suspect. The profile may yield either direct evidence of hidden assets, or circumstantial evidence that shows the suspect cannot possibly pay for the lifestyle he or she is leading. The financial profile is best at revealing transactions of significant amounts, such as large deposits or expenditures. It will not catch small currency transactions, particularly if they are used for concealed activities, consumables or unusual onetime expenses. 

In preparing the financial profile, an investigator would normally take the following steps: identify the assets, identify significant liabilities, identify income sources, identify expenses, and analyze the information developed. An examiner can identify the subject's assets, liabilities, income and expenses from: (1) interviews, (2) public records, and (3) non-public records. Interviews can be one of the most important steps in developing the personal profile. The information obtained can lead the fraud examiner to areas previously unknown or confirm information already known. The interview can lead to documents and to more people that could be important to the case. Interviews will normally be conducted with the subject's personal associates (spouses, friends, relatives) and business associates. Public records is another avenue to search for information regarding the subject's holdings. The information is widely available from several sources. Non-public records can also be used to develop the financial profile of the subject. These records include bank records, credit card records and credit reports. While these records are more difficult to obtain, obtaining them in United States is not impossible.

---The Behavioral Profile

The behavioral profile complements the financial profile. While the financial profile works best for large transactions, the behavioral profile is best at identifying small activities. Information gathered for the behavioral profile might provide the possible motive for fraud and it can indicate to the existence of hidden assets. Information for the behavioral profile is obtained primarily from interviews with the subject and observation. 

As with the personal profile, the fraud examiner begins with the business. The business profile lists prospective witnesses, relevant documents and suspicious transactions. The business profile should contain information about the subject's organization, personnel, money flow patterns, location of bank accounts, the subject's financial condition and record keeping systems. The subject's business banker may be able to supply the investigator with credit applications, financial statements and loan files as well as bank account information. 

Financial statements and tax returns are good sources of information for the fraud examiner. The financial data will show the overall financial condition of the subject and its financial statements can be useful to show any lawsuits or significant events. Business reporting companies such as Dun and Bradstreet or other commercial reporting companies disseminate basic information about individuals and businesses.

Business public filings also contain useful information regarding information on mortgages and leases.

Other business filing such as corporate records will give an examiner the name of the registered agent and the members of the board of directors.

On-Book And Off-Book Schemes

In on-book schemes, illicit funds are drawn from the subject's regular, known bank accounts and recorded on its books and records, in a disguised manner so as to reflect some sort of legitimate trade payable, consulting fee, brokerage fee or commission. Payments can also be made to fictitious employees. Payments are generally made by regular business checks. Cash payments are relatively small amounts that might be generated by fictitious charges to travel, entertainment, or miscellaneous amounts. Three common schemes are fictitious payables, fictitious employees and payroll kickbacks, and overall billing schemes. 

Off -book currency schemes (as used here) refer to arrangements in which funds to make illegal payments or transfers are not drawn to regular, known bank accounts of the payor. The payments do not appear anywhere on the payor's books or records. Off-book funds are usually generated by some sort of unrecorded sales or by failing to record legitimate rebates from suppliers. Off-book schemes are often employed by businesses that have significant cash sales, such as bars and restaurants. Additionally, an owner might accumulate an untraceable currency hoard by reporting only part of his cash receipts.

Identifying and tracing off-book payments is usually more difficult than locating on-book schemes. Success in detecting the off-book schemes generally depends upon identifying sources of funds, using an inside witness, or focusing on the point of receipt. 

Bank records are perhaps the single most important financial source of information available to fraud examiners to identify assets. In addition to their use as evidence to prove a violation, bank records provide leads on sources of funds, expenditures, other accounts and other personal items. In order to obtain bank records, substantial legal requirements must usually be met and banks will customarily demand a subpoena or a search warrant as a condition for disclosure.

Locating Assets Using Indirect Methods

Analysis of the suspect's financial condition can reveal much about the suspect and where assets might be hidden. In both criminal and civil investigations, indirect methods of proof reveal that the suspect has more money available than can be accounted for from legitimate sources. This method analyzes the relationship between the suspect's receipts and the subsequent disposition of funds. In addition, evidence that the suspect lives beyond his means, and therefore must have had unexplained income, is admissible in court. It can be used to corroborate the testimony of co-conspirators, provide circumstantial evidence of the underlying offense or as evidence to impeach testimony of a subject who denies the offense. 

There are three indirect methods of proof: (1) net worth analysis, (2) sources and application of funds (expenditures method) and (3) bank deposit analysis. The net worth analysis method is used when the subject has accumulated wealth and acquired assets from illicit proceeds which cause the subject's net worth to increase from one year to the next. The expenditures method works best when the subject's  illicit income is used for consumables such as travel and entertainment. If the subject spends illicit income, it will not cause an increase in net worth. The bank deposits method is a variation of the source and application of funds method - which works best when there is heavy use of bank accounts.

Sources of Information

A vast array of information is available to the fraud examiner. The primary sources of information are the workplace, public records and other sources. Other sources of public information include:

•  Voter registration records
•  Marriage license records
•  Permits
•  Workers compensation information
•  Property tax records
•  Medical records
•  Sheriff and county prosecutor records
•  County fire marshal
•  Utility company
•  Real estate property records
•  Litigation history
•  Divorce records
•  Fictitious business name records
•  Personal injury suits
•  State tax cases
•  Professional licensing boards
•  Financial suits
•  Bankruptcy records
•  Corporate registration records
•  Probate records
•  Telephone bills

Subpoenas/financial search warrants: Some investigators are granted subpoena power which allow investigators to obtain many non-public records by using subpoena duces tecum (bring with you). The subpoena duces tecum requires the production of books and documents pertinent to the investigation. 

A trash cover is defined as legally obtaining the suspect's trash and researching it for evidence in an investigation. As odd as it might sound, analyzing the subject's household refuge is often a sound investigative technique. Trash contents can provide the investigator with solid clues regarding the subject's finances and lifestyles. Valuable information that may be found in the subject's trash include bank statements, credit card bills, correspondence from accountants, lawyers, business associates and telephone bills. The courts have ruled that an investigator may shift through personal trash without a search warrant when the trash has left the subject's possession. Once it leaves the subject's possession there's no longer an expectation of privacy with the contents of the trash. 

Mail covers also offer a good source of information - although its use is limited to law enforcement investigators. The outside of a letter or package can reveal much about the suspect's spending habits. For example, letters from collection agencies might indicate financial troubles, packages from mail-order companies might reveal purchasing additional assets. Mail from a travel agency might indicate an upcoming trip. Whereas the letter or package cannot be opened, the U.S. Postal Service can make a record of the addressee and the return address. 

Informants can be a good source of information for fraud examiners. An informant is a person who has specific knowledge of an event or an interest in the investigation. The informant might be directly involved in the activity, motivated by revenge, or has been a position to hear about information of interest to the investigator.

About the Author: 

M. Bruce Peele is an attorney in Plano, Texas who is an instructor for the Association of Certified Fraud Examiners. He provides legal services with an emphasis on the recovery of assets from various asset preservation structures. His phone number is (972) 516-9884 and his mailing address is 1504 Westlake Dr., Suite 101, Plano, TX, 75075-8735 Email bruce.peele@worldnet.att.net
 
 

IRS Targets 132 Offshore Promoters

By Richard Duke

The IRS (along with the FBI, CIA and Secret Service) has been watching offshore promoters, beginning some time after January, 1996. In January, 1996, Congress required the IRS to begin training the FBI, CIA and Secret Service on "offshore" matters--trust, corporations, banking, etc. The IRS (and each time I say IRS, this includes the FBI, CIA and the Secret Service) is now focused primarily on 132 offshore promoters. These promoters have many U.S. clients who have evaded the tax laws and are guilty of tax fraud and evasion. And, don't tell me that most of the clients of these promoters are innocent. I know better. I've been in this business too long to believe this.

From the focus on these 132 promoters, this has taken the IRS into the professional network in which these promoters work. The network consists of those who are connected with the promoters: persons who establish structures (trusts, corporations, etc.), establish bank accounts with bearer shares and the banks and other investment managers. With 132 targeted promoters, the network is very, very large. And the amount of taxes to be collected is mind boggling. The IRS will indict the promoters, subpoena the records of the promoters (in other words, their client lists) and then collect huge sums of taxes, penalties and interest from these clients. So, the IRS is aware of "bad" banks and investment managers, the bad professionals, etc. who are in the network of these 132 promoters. No tax returns are being filed by these clients.

The IRS is not interested in U.S. persons who establish a foreign trust or structure and file the required tax returns. The strategy then is to set up a trust or structure that avoids the U. S. litigation system and permits investing in the global arena of investments (otherwise closed to Americans). The focus is on using competent professionals. If you required serious surgery, you would focus on finding a serious and legitimate professional, not some "cute" practitioner who tells everyone that he has found the holy grail of surgery. Serious surgery requires a serious surgeon and those working with him such as the anesthesiologist. The same is true with respect to international planning: the focus is on the professionals: the attorney, the trustee, the investment manager or managers and the trust protector.

The IRS attack on shady promoters and the breakdown of banking privacy (secrecy) offshore has no impact on those who desire to go offshore for legitimate reasons, such as asset protection or access to global investments. The reason that bank privacy is falling apart is due to the lack of tax returns being filed by so many Americans and Europeans. This has nothing to do with Americans who aren't trying to launder money or evade taxes. Banks generally will not divulge your name to anyone so long as you are not a target of the IRS or appear to be engaged in some unlawful activity. The fall of so-called bank secrecy is due to the targeting of money laundering and to a greater extent, tax evasion.

The fact that you dislike and can point out many improper actions of the government is irrelevant if the government catches you in an illegal offshore scheme. Unless you are seriously wealthy, the government is more powerful than you, irrespective of whether their actions are proper or improper. So, comply with the law and avail yourself of the services of serious professionals. As professionals, we agree that the government is often guilty of questionable actions, but we must comply with black and white laws (the gray areas are the areas of planning). If a U. S. person, directly or indirectly, transfers assets out of this country, very black and white laws require the transfer(s) to be reported. No one can legally avoid these very black and white laws.

Richard Duke

Why Secrecy Isn't The Best Strategy

By Vernon Jacobs

Meanwhile, perhaps those who have secret accounts in tax havens should begin to look for ways to either "come clean" with their own tax authorities or they should begin the process of expatriation to a more hospitable country. 

Although unreported income in secret foreign bank accounts has been a popular way to evade U.S. taxes, I have not been an advocate of that method of tax "savings". Because I'm a CPA and was an auditor (many years ago), I know how hard it is to keep substantial assets or income hidden for a long time. Any competent financial auditor can quickly identify missing assets by comparing two balance sheets or even two detailed income statements -- if the amounts are substantial. Where the amounts are not substantial in relation to the amounts that are disclosed, the cost of maintaining a secret foreign stash is usually more than the taxes that are being "saved". The recent efforts of the EU and the OECD will further raise the cost of the secrecy game. 

Many U.S. taxpayers do get away with hiding assets and income offshore for many years because the IRS only audits a small fraction of the tax returns that are filed each year. But they are very effective at selecting those tax returns that are most likely to generate some additional revenue due to an audit. They have also become a lot more pro-active in looking for people who are likely to have unreported income offshore. They have a program to look at more of the tax returns of people who frequently travel outside the U.S.. I also hear they have full time agents working and living in the popular tax haven countries who look for clues as to U.S. travelers who may have illicit income in that country. I've also heard that they have agents who regularly travel to the various offshore seminars that are likely to discuss foreign investments and related subjects. They strike up discussions with attendees and collect business cards from the speakers. 

I've heard the IRS also has a program with the U.S. Postal Service for checking the return mail addresses from tax haven countries. If they have any reason to suspect that you might have a secret foreign account, they could easily check your phone records to see if you are making phone calls outside the U.S. Actually, it would not be a major hurdle for them to require the phone companies to disclose international phone call information to them. 

Richard Duke tells me that the IRS, the Customs service, the DEA and the FBI have been working together on a task force that has been gathering information about various lawyers and promoters who are selling tax avoidance trusts, foreign trusts, foreign corporations and such dubious deals as the "pure trust". According to Richard, we should begin to see news items any day now about sting operations where the task force has nailed one or more of the promoters and has "persuaded" the promoter to disclose the identity of his or her clients. When they have the list of clients, they will give the clients a choice between paying the back taxes, exorbitant penalties and interest or spending some time in "Club Fed". 

Last year, the U.S. government stumbled onto a situation where a banker in the Cayman Islands was nabbed for money laundering when he was traveling in the U.S. To get a lesser sentence, the banker (Mathewson) "copped a plea" and agreed to disclose the identity of his more than 1,500 U.S. customers. He went back to the Cayman's, got the bank computer tapes of his customers and turned them over the U.S. government. A few months ago, one of those customers was put in jail as part of the IRS annual propaganda program to remind the rest of us about what can happen to those who don't pay their taxes. 

Some of their audits are triggered by a "whistle blower" who is a former friend, former business partner, former spouse or former lover of the taxpayer. While the IRS does offer a meager reward for turning people in who have evaded taxes, I've heard that very few people ask for the reward. Most informants apparently do it to get even with someone. If you are going to keep some assets and income offshore without paying taxes on the income, you really need to keep it to yourself. You can't brag about your clever plan at the country club or the neighborhood bar, let alone the church social. Other people tend to have the belief that if you don't pay your "fair share", then they must somehow be forced to make up the shortfall. (It’s not really true, but it's a very widespread belief.) 

Even if you get away with it, you will have a very hard time getting that money into the hands of your spouse or your children after you are gone from this earth. You might as well instruct the offshore banker to write a check to a foreign charity because if the money comes back to the U.S., your heirs will have numerous reasons to burn you in effigy for the aggravation you will cause them. And if you let your spouse or children in on your little "secret", you had better hope that your marriage is very solid and that your kids and their spouses really, really love you. 

For these and other reasons, I do not believe secret foreign accounts or corporations are a safe or cost effective way to reduce your taxes, or even to protect your assets from lawsuits. 

Those who really want to reduce their taxes can often do better with various tax saving methods available in the U.S. or by simply expatriating to a more hospitable country. For example, with some creativity, you could probably operate a revenue producing "charity" that complies with the U.S. tax laws. Take a look at Internal Revenue Code Section 501(c). It includes 27 different kinds of entities that are tax exempt on their investment income and any accumulated income that is not paid out as salaries or benefits to the managers of the activity. A few years ago, I compiled a check list of more than 200 legal ways to defer or avoid taxes of various kinds. Most of those methods are still available. ( http://www.offshorepress.com/vkjcpa/checklist.htm ) 

And there are some legal ways to avoid or to defer taxes offshore that do not rely on secrecy to work. Richard Duke and I discuss these in our Offshore Tax Strategies newsletter each month. 

Unless you are planning to give up your U.S. citizenship in the near future, trying to save taxes with secret bank accounts, secret trusts, bearer share corporations and similar deals are likely to cause you a lot more grief than they are worth. 

For those who have been using secret foreign bank accounts and bearer share foreign corporations to evade taxes in their home country, the stakes have been raised by the recent attack on the secrecy policies of the many tax and financial havens of the world. I believe it is very likely that most of the financial havens will concede to exchange financial information with the high tax countries of the world. I also believe they will eventually concede to give up the practice of granting tax concessions to non-resident investors and corporations that are not available to their own residents. For many countries, including the U.S. and the U.K., this will require some politically difficult changes in their tax laws. But there will continue to be some rogue nations that will cater to those who are willing to pay the price for financial secrecy.

(The Cayman Islands has very recently agreed to an information sharing arrangement with the IRS.)

Is It Time To "Come Clean?"

For those who have waited until now to decide what to do with old-time offshore secret accounts, is the "handwriting on the wall?" Is it time to declare the previously secret income and pay the taxes, plus interest and penalties? Or will that merely result in spending some time in "Club Fed?"

Jay Adkisson (www.falc.com) made an interesting observation in an email message to the ABA Asset Protection Planning Committee. He basically reminded the lawyers on that list that:

So what does that imply for the taxpayer who is wondering what to do with a secret offshore account? At a minimum, the taxpayer can expect to have to pay the back taxes, plus interest and maximum penalties. It's possible that the IRS might attempt to pursue some criminal charges, but they seldom do that when a taxpayer comes forward on his or her own account without having yet been audited or otherwise "found out." The best approach is to contact a criminal tax defense lawyer and discuss your options with the lawyer. The conversation with the lawyer will be protected by the attorney-client privilege and you will not be compelled to settle up. The lawyer can advise you of the consequences of not settling and even of leaving the country but he or she will not be able to advise you how to circumvent the law.

The consequences will be much less severe if you do settle with the IRS without having been caught or found out. If you take your chances and wait to see if they find you in one of their fishing expeditions (like their subpoena of the credit card company records or the disclosure of client information by a foreign banker or promoter who is accused of money laundering), they may elect to pursue criminal charges and you will have less bargaining room.

If the cost was more than you could bring yourself to pay, could you just leave the country? Perhaps, but that would not relieve you of the tax liability and you would need to be sure you locate in a country that does not permit extradition of criminals to the U.S. With the recent international concern about terrorism, there are few countries left in the world where real secrecy is still available. 
 
 

If You Need Help In "Coming Clean"

If you have only been thinking about trying to open a secret foreign bank account, or setting up a secret foreign corporation or secret foreign trust, I hope this article will save you some grief by helping you to appreciate that you are trying to "swim up a waterfall" . 

But if you have already opened one or more unreported foreign accounts, a foreign corporation or a foreign trust, you basically have three choices.

1. 1.  You can move permanently to a country that does not have an extradition treaty with the U.S.
2. 2.   You can spend a lot of your time looking over your shoulder for the long arm of the IRS and spend many sleepless nights worrying about who is going to tell on you. 
3. 3.   You can "come clean" by filing the required back returns and amended returns, with the payment of any back taxes and interest. You should also be prepared to pay whatever penalties the IRS may impose. If you won't or can't do that, then you should reconsider option # 1, above. 

If you have a controlled foreign corporation, you will need to file Form 5471 and 926 for each year that the corporation was in existence. 

If you put money into a foreign partnership, you will need to file Form 8865 for the years the partnership was active.

If you had money in a foreign trust, you will need to file Form 3520-A for each year and you will  have to file Form 3520 for each year in which there were any transactions with the trust. 

If you had money in a foreign investment corporation (mutual fund) that was not also a controlled foreign corporation, then you will need to file Form 8621 for each fund, for each year.

No matter which form of entity you had, if you or any of these entities had more than $10,000 (in the aggregate) in any combination of foreign financial accounts, you will need to file Treasury Department Form 90-22.1 to disclose the existence and location of the accounts. 

If you had any combination of these foreign entities, you might have to file all of these forms or whichever ones apply for each prior year. 

You will also need to prepare accounting statements and income statements for each entity for each year so that the required returns can be prepared. In most cases, the accounting work is the most time consuming and the most expensive. 

Whoever you hire as your accountant will have to prepare amended personal income tax returns for each back year. Amended state income tax returns may also be required. 

The forms described above are not the kind of forms that most tax preparers work with on a regular basis. They are dramatically different from the kind of forms that most tax accountant's prepare and will require a lot of time for the accountant to read and understand the instructions. In my opinion, if a tax accountant has not prepared a number of these forms previously and does not do this kind of work on a continuing basis, either the accountant will not be able to charge enough  for the time that will be required, or the forms will be prepared inadequately or incorrectly. By way of example, hardly any of the professional tax preparation software programs include these forms. Your accountant will have to do them by hand. 

About the author:

Vernon Jacobs is a CPA who works as an international tax accountant and consultant.  He  writes a series of research reports on asset protection and offshore tax topics.    He can be reached by phone at (913) 362-9667.

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