In divorce cases where the parties have offshore assets, those assets are generally not reported to the Internal Revenue Service ("IRS"). However, California family law imposes a strict fiduciary duty of disclosure on all divorcing spouses. Throughout the pendency of a divorce case, the parties are under an ongoing obligation to disclose all material facts and information regarding income, expenses, assets and debts.
This includes unreported income and assets hidden overseas. If a spouse has made efforts to conceal income or assets from the federal government he or she may feel very conflicted about disclosing that information in a state dissolution matter. Therefore, the spouse may be torn by a desire to cooperate with the divorce process and make full disclosures yet fearful of criminal and pecuniary penalties which may be imposed by the IRS. In many cases, both spouses may be aware of the offshore assets or at least suspect they exist.
If a California family court determines that a spouse has failed to meet the strict fiduciary disclosure requirements, he or she will likely be sanctioned in an amount sufficient to deter repetition of the impermissible conduct. In high asset/high income cases, the amount of the sanction could be staggering. In addition, failure to disclose an asset exposes the non-disclosing party to the possibility of the court awarding 100 percent or an amount equal to 100 percent of the asset to the other spouse. On the other hand, if a spouse's failure to disclose offshore assets and/or reportable income to the IRS is discovered by federal authorities, the spouse will likely face time in jail in addition to substantial financial penalties.
In these cases, the client has limited options. The client could attempt to amend prior tax returns to fully comport with IRS requirements and immediately disclose all hidden assets/income in the divorce case. If a client pursues this option, there is still no guarantee of avoiding federal prosecution. If this option is no longer available, the client could enter the Offshore Voluntary Disclosure Program ("OVDP"). The OVDP was started in 2012 and allows taxpayers to voluntarily disclose offshore assets before they are uncovered by other means. Entering the OVDP can help taxpayers avoid criminal prosecution; however, they will likely still face harsh financial penalties for nondisclosure.
It is incredibly risky for a divorcing spouse with hidden assets or income to fail to make efforts to become compliant with IRS regulations. In a divorce proceeding, attorneys and clients spend substantial time and resources digging into the finances of both parties. It is unlikely that hidden assets or income will remain uncovered under such scrutiny.