You most certainly have seen the ads and heard the promoters touting the incredible benefits of offshore asset protection: Privacy, anonymity - and the big one - no taxes ever.

But there is a wrinkle in all their chatter. Uncle Sam taxes U. S. citizens on their worldwide income. So in another one of those too good to be true scenarios, setting up offshore won't get you off the hook for federal income and capital gains taxes.

Of course, this is not enough of a deterrence for some. They will listen to the promoter and not to their U.S. advisors, who the promoters successfully argue don't "understand" the benefits of offshore strategies. The promoter will tell them once you are set up offshore there are no filing requirements ever again for U.S. taxation purposes.

This is not the case. And the failure to file the proper form has just gotten very expensive.

The form in question is I.R.S Form 5471. All U.S. citizens who have equity in, or a controlling interest in a Controlled Foreign Corporation ("CFC") must file one. Most offshore asset protection promoters put their U.S. clients into entities that are considered CFCs.
As of January 1, 2009, the IRS will now assess an automatic penalty of $10,000 for each CFC filing that is missed. That is $10,000 for each entity in each year that is not filed.

So let's review an example of what can and now does happen in the offshore world.

Joe listens to an offshore promoter in Nevis about the benefits of offshore asset protection. The promoter never mentions the need to file Form 5471 each year. Joe spends tens of thousands of dollars to set up five CFCs in 2009.

In 2012, the Nevis promoter's mistress realized the promoter won't leave his wife. She is spiteful and turns all of the promoter's files in to the IRS. Very quickly, the IRS is calling on Joe demanding $200,000 in penalties for the five entities for which no Form 5471 was filed for four years. And that's just the start. Joe will have penalties, interest and taxes due on all the income he made over those years.

If you think it is unlikely the IRS could ever receive information in such a way, think again. If it is not from the promoter's mistress, it may be from your own spouse or mistress or other aggrieved party. The IRS counts on domestic troubles as one of its best sources of information. But even if your life is trouble-free you can count on the authorities to be monitoring your wiring instructions and banking activities for offshore violations. And with this new $10,000 automatic penalty they have ever more incentive to do so.

You can complain about Big Brother and Big Government if you want (and you should; it's healthy and to be encouraged). But it is important to know that certain offshore promoters will never tell you about these crucial requirements, to your great financial detriment.