The Big Gap ? – How U.S. Citizens and LPRs Residing in the U.S. versus those Living Outside the U.S. File U.S. Tax Returns.

Posted on Updated on

The U.S. worldwide taxation system of U.S. citizens and LPRs causes much confusion.  It is unique in the world as most all other countries only impose worldwide taxation on their residents.  See, . “Tax Simplification: The Need for Consistent Tax Treatment of All Individuals (Citizens, Lawful Permanent Residents and Non-Citizens Regardless of Immigration Status) Residing Overseas, Including the Repeal of U.S. Citizenship Based Taxation,”  by Patrick W. Martin and Professor Reuven Avi-Yonah, 2013.

These U.S. citizens and LPRs living outside the U.S. have (at least prior to FATCA) little third party reporting of income directly to the IRS.  There are numerous government reports that demonstrate that when third parties (e.g., banks, tenants, securities brokers, credit card companies, real estate sales transactions, etc.) report the income of a particular transaction to the government, the voluntary compliance of taxpayers increases significantly.  See, OECD FORUM ON TAX ADMINISTRATION: COMPLIANCE SUB GROUP

and the U.S. GAO-12-342SP: General government: 44. Internal Revenue Service Enforcement Efforts   which highlights that the ” . . . where IRS can improve its programs which can help it collect billions in tax revenue, facilitate voluntary compliance, or reduce IRS’s costs. These include pursuing stronger enforcement through increasing third-party information reporting . . .  Expanding third-party information reporting improves taxpayer compliance and enhances IRS’s enforcement capabilities. The tax gap is due predominantly to taxpayer underreporting and underpayment of taxes owed. At the same time, taxpayers are much more likely to report their income accurately when the income is also reported to IRS by a third party. By matching information received from third-party payers with what payees report on their tax returns, IRS can detect income underreporting, including the failure to file a tax return.”

The current trend of worldwide reporting of assets and income via FATCA and the OECD programs is designed to accomplish just this;  increase information reporting by third party payers (e.g., principally from foreign financial institutions) directly to the IRS and tax revenue authorities around the world to deter U.S. citizens and LPRs living outside the U.S. from under-reporting or not reporting at all their income on their U.S. income tax returns.

Traditionally, there were limits on the law and the jurisdictional authority the U.S. government had to require non-U.S. institutions to report non-U.S. source income directly to the IRS.  This has changed significantly now with FATCA, which started in earnest this year, in 1 January 2014.  See,

Here is where there appears to be a “Big Gap”?  Not necessarily a gap in the amount of tax dollars collected among USC and LPR living in the U.S. versus those living outside the U.S.; but at least an apparent gap in the number of tax returns filed by overseas residents.  The level of over-all tax compliance by U.S. citizens and LPRs residing overseas is not clear, since only 334,851 total individual tax returns were filed in 2006 which incorporated the foreign earned income exclusion (IRS Form 2555) by non-resident U.S. taxpayers.27 If there are approximately 5-7 million U.S. citizens residing overseas28 (not even including LPRs who reside overseas) and 142 million total individual income tax returns filed annually29 such a small number (i.e., 334,851) indicates that only a fraction of the total returns filed are filed by persons residing overseas; i.e., only about 2 tenths of one percent (0.24%) of the total income tax returns filed were by those residing overseas with the foreign earned income exclusion.
Will the government see this as a tax gap?
These numbers for the year 2006 are even more interesting when one analyzes the foreign earned income exclusion taken. Canada had 30,067 returns filed versus Mexico with only 6,112 for the year 2006. It seems that Mexico should at a minimum have more returns filed than Canada – or at least about the same, since the State Department estimates that more U.S. citizens (approximately 1+/- million live in that country). Both seem very low, if it is true that there are probably close to 1.5 to 2 million total U.S. citizens living in these two countries.
28.  See, p. 130 and footnote 11 of Taxpayer Advocate Report referenced in footnote 29 above – “Cf. IRS website, Reaching Out to Americans Abroad (Apr. 2009), and W&I Research Study Report, Understanding the International Taxpayer Experience: Service Awareness, Use, Preferences, and Filing Behaviors (Feb. 2010) (citing U.S. Department of State data). This number does not include U.S. troops stationed abroad.”
In 2006, there were a total of 138 million total individual income tax returns filed.

This entry was posted in IRS Audit Techniques - Expatriation, Penalties, Tax Compliance.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.