By Lynnley Browning
September 3, 2013

FORTUNE — Americans living and working in Switzerland aren’t feeling much joy these days on strolls along the Rue du Rhone in Geneva, where luxury watch shops and Gucci and Hermes boutiques nestle amid a clutch of private banks.

Thanks to a landmark settlement last Friday between Switzerland and the U.S. designed to shut down tax evasion through secret accounts at Swiss banks, scores of expats say they’ve been unfairly branded as unsavory tax dodgers.

The picture for actual tax evaders through Swiss banks is even uglier. Under the terms of the deal, in which banks are required to disclose client data and pay fines totaling as much as $1 billion or more, such persons stand a greater chance than ever of being outed by their banks to the Internal Revenue Service and tax division of the Justice Department, where they face onerous fines and penalties, and, possibly, prosecution.

“Banks that come forward will be forced to provide a blueprint to the Justice Department, which will lead to the divulgence of countless undisclosed bank accounts,” said Jeffrey Neiman, a former federal prosecutor who once hunted Swiss bankers and now represents their tax-evading clients. For the IRS, finding tax evaders “will now be like shooting fish in a barrel.”

The settlement is unsettling to Switzerland, a complex, fiercely independent country that is home both to bank secrecy laws dating to the Middle Ages and a new drive-in sex facility in Zurich. Philip Hodgen, an American tax lawyer in Pasadena, Calif., with expatriate clients, called the settlement “21st century gunboat diplomacy” on the part of the U.S., and over the weekend Swiss newspapers called the deal “an organized surrender” akin to “swallowing toads.”

MORE: Are we ready for the next meltdown?

American clients who have not yet fessed up are feeling even more pain. While the settlement does not cover 14 Swiss and Swiss-style banks currently under criminal investigation by American authorities, it cranks up legal pressure on those banks, which include Credit Suisse AG (CS), Julius Baer, and Pictet. And it strikes at the heart of the rest of the Swiss banking industry, more than 300 banks, by offering them an ultimatum: Rat out American clients and the lawyers and advisers who help them, fork over their bank data and pay hefty fines, or risk prosecution.

Perhaps most importantly, the settlement divides those hundreds of banks into three groups — those that can avoid prosecution by outing clients; those that have nothing to disclose; and those that are complying with a separate, new and onerous anti-tax evasion law known as the Foreign Account Tax Compliance Act, or Fatca.

Apart from the 14 banks under grand jury probes, American bank clients appear to have no idea which category their banks falls into. For taxpayers with a lot to lose, that makes the calculus of deciding whether to risk continuing to hide assets; to come forward to the IRS; or to make a “quiet disclosure” by sneaking in an amended tax return even more difficult, tax lawyers said.

“People think they either have too little or too much to pay” in back taxes, fines, and penalties, said Robert Katzberg, a white-collar criminal defense lawyer with clients of Swiss banks.

With an estimated $2.2 trillion in offshore assets, more than any other global haven, the Alpine nation could find that a quarter of its storied private banks cease to exist within three years, according to a recent study by KPMG and the University of St. Gallen (located in the small mountain town where Wegelin, the country’s oldest bank, was indicted last year for serving tax-dodging Americans. The bank, which once counted Napoleon as a client, no longer exists.)

William Sharp, a tax lawyer in Zurich, San Francisco and Tampa, Fla., said that the deal “will force the Swiss banks to mandate errant American customers to undergo voluntary disclosure or walk the “exit” plank” and potentially move funds to other offshore havens like Singapore or the Cook Islands.

MORE: Handicapping bank risk to emerging markets

Americans owning or controlling foreign bank accounts holding at least $10,000 had until June 30 this year to file special disclosures known as Fbars, or reports of Foreign Bank and Financial Accounts. (Post-marking the forms June 30 doesn’t count — the Treasury must receive them by that date). As of last year, taxpayers also had to file a new, similar disclosure, known as form 8938. Failure to file Fbars can result in penalties equal to a multiple of what a taxpayer actually has in his bank account.

Since 2007, when the Justice Department first broadened its seminal criminal investigation of UBS AG (UBS), Switzerland’s largest bank, to cover other Swiss banks, some 38,000 American taxpayers with hidden accounts have come forward to fess up and fork over $5.5 billion in taxes, fines, and interest.

But American officials quietly estimate that scores of American taxpayers still have undisclosed accounts, in Switzerland and in other offshore havens such as Luxembourg, the Cayman Islands, and Singapore.

Of the IRS disclosures, “you can imagine that’s maybe 20% or 15% of the total out there,” said a senior American source briefed on the matter.

MORE: Wall Street bonuses to top 2009

From 2006, when scrutiny of Swiss private banks first began, through 2011, the number of American taxpayers disclosing offshore accounts more than doubled, to 618,134, according to data from FinCen, the U.S. Treasury branch that deals with money laundering. Still, government officials and tax lawyers say that with perhaps six million Americans living and working overseas somewhere in the world, hundreds of thousands of taxpayers, if not more, have yet to come clean.

The deal is already leaving telephones of tax lawyers ringing off the hooks from Americans with Swiss accounts.

“Any non-compliant U.S. taxpayer who can’t read the handwriting now on the wall as an emergency signal to come forward,” said Katzberg, “is legally blind.”

You May Like