Till Offshore Do Us Part: Uncovering Assets Hidden From Spouses and Tax Authorities
Khrista McCarden*
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INTRODUCTION
Governments and individuals around the world know that offshore accounts are used to hide assets from tax authorities. However, the Panama Papers brought to the forefront a less well-known use of offshore accounts: hiding assets from a spouse during divorce proceedings. The Panama Papers contain information about offshore accounts used by public officials, drug kingpins, money launderers, and perhaps surprisingly, high net worth divorcees. The Panamanian firm featured prominently in the leak of information, Mossack Fonseca, has admitted to at least considering assisting wealthy individuals with hiding assets from their spouses who may have a claim to them in divorce proceedings.
Given the ease associated with electronically transferring funds to countries today, it has become increasingly difficult to uncover assets that have been hidden offshore. While in recent years there have been numerous efforts to combat offshore tax haven abuses, such as heavy penalties and new reporting requirements, a fundamental problem persists: the Internal Revenue Service (“IRS”) does not have the time or resources to untangle the intricate maze of corporate structures used by wealthy individuals to hide their assets offshore. The spouses of wealthy tax evaders do. In fact, the scope of divorce cases can far exceed that of federal tax investigations because they seek to “map the wealth of the some of the world’s richest people.”
The discovery process that is an integral part of divorce proceedings is conducive to the unraveling of multiple chains of corporate ownership inherent in such “offshore planning.” Under Internal Revenue Code § 7201, tax evasion is a felony that carries either a large fine, five years imprisonment, or both. The three elements of the crime of tax evasion are (1) willfulness, (2) an attempt to evade tax, and (3) additional tax due. In this Paper, I will argue that discovery devices should be modified in order to impute knowledge of reporting requirements to a spouse refusing to comply with the discovery process (a “noncompliant spouse”) given the willfulness standard required for imposing the three categories of tax penalties and that noncompliant spouses should be ineligible for voluntary disclosure programs that allow taxpayers to avoid criminal prosecution and cap civil penalties. Strengthening the tax implications of failing to disclose assets in the divorce context would incentivize noncompliant spouses to comply with discovery from an early stage in the proceedings. This would lead to two benefits: (1) more expedient family court proceedings and (2) more timely and accurate reporting of hidden offshore assets.
I. THE DISCOVERY PROCESS AND NONCOMPLIANT SPOUSES
There is a predictable pattern in high net worth divorce proceedings that involves hiding assets from both a spouse and the IRS. In fact, it is not unusual for a spouse who is hiding money offshore in anticipation of a divorce to also hide his/her assets from the IRS. Typically, a wealthy spouse opens an account under the name of a shell company in a tax haven country, such as Panama, and transfers assets into the company to hide them from his/her spouse. During the divorce proceedings, the spouse can claim that investments are tied up in the sham corporation and then later lost. At the same time, the wealthy spouse does not report the offshore account to the IRS, as required under Foreign Bank Account Report (“FBAR”) and Foreign Account Tax Compliance Act (“FATCA”) filing requirements, and engages in tax evasion. Such spouses would qualify as noncompliant spouses.
Generally today, family lawyers attempt to use the discovery process, where documents must be exchanged by court order, to gather financial and other information. Some hidden foreign assets are uncovered through an extensive court discovery process; however, the process inevitably is incomplete. A family lawyer often must resort to filing motions to compel. Even in responding to these motions to compel, a truly recalcitrant spouse will continue to fail to disclose assets and provide incomplete or inaccurate information. Ultimately, the family lawyer must subpoena financial documents of any known bank or other financial accounts.
*Associate Professor of Law, Pepperdine University School of Law; J.D. cum laude, Harvard Law School, 2003; A.B. Harvard College, magna cum laude.