Economics concepts and applications

Income Tax and Accounting for International Businesses

In the wake of the current economic crisis and increasing national debt, transparency in financial institutions and more coherent international enforcement of taxation policy has become a greater concern for the federal government. According to the Wall Street Journal, the Internal Revenue Service (IRS) has asked a federal judge to force payment-card processor First Data Corporation to disclose the names of clients suspected of evading federal taxes through the use of offshore accounts (Kendall 2009). According to U.S. tax law, any bank account must be reported as income to the IRS, even if that bank account is in the Cayman Islands, Belgium, Switzerland, or Ireland, to name just a few of the most popular countries used in offshore banking (Pollick 2003).

Still, despite this law, offshore bank accounts have been used to "hide profits from illegal activities" or underreport business or investment earnings, although the IRS is now trying more aggressively to limit such maneuvers than it did in the past (Pollick 2003). "Prosecutors allege that an unspecified number of merchants have opened offshore bank accounts and directed First Data, a privately held company in Colorado, to deposit credit-card and debit-card transactions into those accounts" (Kendall 2009). No longer can these clients hope that their privacy to do such illegal or quasi-legal deeds will be protected.

Previously, the offshore banks "were not obligated to report the existence of these [offshore] accounts, and the account holders could legally pay little to no taxes to the host country. In recent years, however, the rules governing an offshore bank account have become much stiffer" (Pollick 2003). Now enforcement is keeping pace with the more stringent laws governing these practices. The IRS has also "announced a six-month program that offers lower penalties to those who come forward and pay taxes due on the secret holdings" as an incentive for individuals using offshore accounts to step forward themselves (IRS: Offshore account? Tell us now, 2009, USA Today). But the penalties are still quite heavy, and include back taxes and interest for a minimum of six years, a 25% delinquency penalty for each year in which tax returns were not filed at all or a 20% accuracy penalty for years in which returns were filed but income from offshore accounts was deliberately not included. There is also a penalty "equal to 20% of the highest aggregate value at any point during the last six years for all previously secret foreign accounts" although "until now, the IRS could impose penalties of at least 50% for all years in which an account wasn't disclosed. In some cases, that could exceed the value of the offshore holdings" (IRS: Offshore account? Tell us now, 2009, USA Today). People or institutions already under criminal investigation for tax evasion also do not qualify for this leniency. The stringency of these penalties, which all clients should be made aware of, demonstrates the seriousness with which the IRS regards the offense.

"First Data complied with a similar IRS summons in 2004. The agency used information turned over by the company to identify taxpayers who were using offshore credit cards," and the company insists that it has always been compliant with the law (Pollack 2009). However, a related New York Times article on the story reported: "In court papers, the I.R.S. said that First Data had actively marketed and sold offshore services to American merchants, typically investment and Internet-commerce advisory shops, who in turn used the service to help their clients hide taxable income…In 2002, the unit [Cardservice International and now called First Data Independent Sales] which works with 3,200 independent sales offices and agents to sell and provide financial processing services, began marketing offshore processing services with First Atlantic Commerce, an e-commerce company in Bermuda, according to court documents" (Browning 2009). The IRS states that First Data, "clearly markets offshore merchant account services to U.S. merchants as a means of tax avoidance by advertising its services on the Web sites of foreign promoters of abusive offshore tax schemes and products" (Browning 2009).