The elderly British widow had been living in California for years. "She brought me a list of her accounts, and everything was in dollars - except for one item at the end of the list: 98,000 pounds sterling," says Delia Fernandez, a financial planner in Los Alamitos, Calif.

"I asked her if she reported that account to the IRS, and she said no. Why, she wondered, would she need to report a British bank account on her American tax return?"

Why, indeed? Most countries tax only the income earned within its borders - but not the United States. Federal law requires that U.S. citizens and legal residents declare any foreign account and pay taxes on the income it generates. Fines for not filing a Report of Foreign Bank and Financial Accounts disclosure form can total $100,000 per year for each account, or half an account's balance on the June 30 filing deadline for each year a violation occurred, if the IRS concludes that the failure to file was deliberate. On top of the penalties, account holders must pay the taxes due, plus interest.

That's among the reasons financial planners need to ask clients whether they hold money outside the U.S. and advise them on the proper steps. Many clients clearly don't know the law.

WHO KEEPS MONEY OFFSHORE?

Overseas accounts have a reputation - not entirely unearned - as a way Americans hide money to help avoid taxes or deceive a spouse or business partner. "Every once in a while, someone will tell me that they want an offshore account in order to save on taxes," says Matthew Tuttle, CEO of Tuttle Wealth Management in Stamford, Conn. He tells clients they can't do it.

More often, people have foreign bank accounts for innocent reasons, says Troy Thompson, a financial planner and attorney at Thompson Advisory Services in Portland, Ore. They may have come to the U.S. for education or business, and later became permanent residents or citizens. "They leave behind foreign holdings and more or less forget about them, or run them with the help of family members," Thompson says.

Americans who go abroad for work also often have international accounts. "People tend to go overseas on a three- or five-year contract. They're subjected to the expatriate lifestyle and run in circles with other expats, some of whom are not U.S. citizens. They hear about what other expats do with their money, which may involve investing outside the United States, and there is no 1099 telling them what they should declare on their taxes," says James Barnette, a financial planner with Raymond James Financial Services in Sterling, Va., who specializes in helping clients with international holdings.

Still other clients and their families may be trying to hide money, but not from the U.S. government. "Sometimes people come here as refugees or for political reasons, and they move assets somewhere else to [keep] them from being seized by their home country," Barnette says. "There are people today who still have accounts that were established in the 1930s by Jewish families in Germany or France who were concerned about seizures." An overseas account could also be part of a client's inheritance, or might have been set up by others - for example, when Jewish Holocaust victims or survivors receive reparations in accounts created by the German government.

Some account holders don't think they could owe U.S. taxes because they don't live in the U.S. Geoffrey DeHaven, an enrolled agent with the IRS who's based in Brussels with US Tax Abroad, a network of tax and accounting firms, says he sometimes meets clients who were born in the U.S. but moved out of the country at a young age.

"They don't think of themselves as U.S. citizens," he says, although they still have U.S. tax obligations. Even people with expired green cards who left the U.S. many years ago may owe U.S. taxes on foreign income. "You see that all the time with people who leave the U.S. without going through the process of formally giving up the green card," DeHaven says.

Decades ago, such people may never have learned about delinquent tax bills. But the IRS has gotten much better at finding all kinds of foreign accounts and their owners, DeHaven says. "There's a trend worldwide toward greater transparency in banking, and the international pressure to comply with terrorism-related efforts has also produced information that is of interest to the IRS," he says.

IRS RULES

Among the laws on foreign accounts held by U.S. taxpayers: Account holders must pay taxes on all income, regardless of its source. Also, taxpayers who have more than $10,000 in an account any time during the year must file a disclosure form each June 30, even if an account generated no income.

Many people get bad advice. Thompson recalls a foreign client who moved to the U.S. and became a permanent resident. In his first few years, U.S. tax preparers and U.S. and foreign bankers "essentially told him to do nothing," Thompson says. "He had several years of unfiled foreign bank account reports."

Correcting a mistake can be expensive and complex. One of DeHaven's clients, a British lawyer working in Belgium, left the U.S. in infancy and claimed she never knew she was legally a U.S. taxpayer as a dual citizen. When she learned she owed back taxes, she paid them along with interest and penalties.

The attorney considered renouncing her U.S. citizenship - which isn't allowed for citizens who've fallen behind on their taxes - or simply ignoring the law. That would have been a difficult matter as she had already paid taxes on the accounts in question. Ultimately, she filed the disclosure form and paid a $50,000 penalty, amounting to 20% of the top balance in all her accounts, including retirement savings.

"I gave them the deposit I've been saving to put down on a house," she says. "I decided that I wanted to get on with my life, and I paid up."

Financial planners need to think about international accounts whenever they see clients who are new immigrants, U.S. citizens who work abroad or have family outside the country, or those with dual citizenship. "I have to remind myself to ask clients about their lives," Fernandez says. "I met a new client the other day who is a quintessential California girl, with blonde hair and no accent, and it turns out that she married a Japanese man, has dual citizenship in Japan, and does voice-overs for Japanese television and videos."

Foreign investments are another area of concern. "The majority of my career I have spent trying to convince people to repatriate their money," Barnette says. But some overseas accounts, particularly those in passive foreign investment companies, may have surrender fees of up to 50%. "Many of the accounts we run into have those fees up to retirement age. Some of these funds also require people to keep making contributions up until retirement age," Barnette says. He advises clients to keep these types of accounts overseas, making the required declarations and tax payments, then move the money to the U.S. at retirement.

IRS AMNESTY

Clients who haven't followed the law may take advantage of the IRS' voluntary compliance initiative. The last amnesty program was in 2009; a new amnesty was announced in February and runs through Aug. 31. Those who voluntarily comply will pay mitigated penalties, DeHaven says, and wade through expedited paperwork. They won't be prosecuted for criminal tax evasion, but will still likely pay a significant sum: as much as 25% of the accounts' top balance from 2003 to 2009, plus taxes, penalties and interest.

The amnesty program has generated interest, DeHaven says, but little commitment. "As the clock ran out on the first voluntary disclosure deal, I heard from a lot of people. Now there's a new deal and I'm seeing some increased activity. I'm expecting to see more through the summer, especially if the program gets an extension," he says. But the prospect of paying up to 25% has scared many clients away. "When we tell them what's in store for them, they just walk away," he says.

NEGOTIATING WITH THE IRS

Some clients may take the amnesty deal and hope to negotiate with the IRS. Thompson's client who received bad advice owed U.S. taxes on his foreign retirement accounts; he can't move the money into a U.S. account without being subject to penalties in his home country.

Thompson said he helped him successfully argue that the rules in his case ran counter to common sense by requiring tax and reporting obligations on a tax-deferred retirement account, and noting that the client had previously relied on erroneous professional advice. The penalties were reduced.

The IRS may choose to be lenient in other circumstances, as well. "I've had clients who were able to negotiate a very good deal - pennies on the dollar, with penalties reduced or eliminated completely," DeHaven says, "even though the IRS found them first and there was no voluntary disclosure program in place, because they had very sympathetic personal histories. They were fleeing from a country we don't get along with, or they have histories of family persecution." He adds that, in his experience, the IRS has reduced penalties to 5% from 25% for amnesty participants who only recently discovered their U.S. citizenship, and to 12.5% for those with less than $75,000 in foreign accounts.

As for Fernandez's British client? "First I got her a tax attorney, so there would be client-attorney privilege," she says. "I felt the most responsible thing was to get her some legal advice about her options." The client's accountant worked with her to file amended tax returns, and the client reached a deal without significant penalties. Perhaps the old saying should be updated: You can't escape death and taxes, but sometimes you can escape a big fine.

Ingrid Case is a freelance financial writer in Minneapolis.