IRS Audit Techniques – Expatriation
The information featured on this blog is designed to orient U.S. citizens (“USCs”) and U.S. lawful permanent residents, i.e., “green card” holders (“LPRs”) to important U.S. federal tax consequences to them. It’s primary focus relates to those USCs or LPRs who are contemplating renouncing their citizenship or abandoning their permanent residency status.
There are many complex federal tax rules that are often overlooked in the international area. One of those is the excise tax that is payable by the USC or LPR individual, not the non-U.S. insurance company, when premiums are paid to an insurance company. The IRS takes the position that the ” . . . the Service will generally seek payment of the excise tax from the U.S. person making the premium payment . . .” See, IRS Foreign Insurance Excise Tax- Audit Technique Guide.
This is a 1% excise tax on the premiums paid for each life insurance, sickness or accident insurance or contracts. See, IRC Section 4371. If you reside in London and buy life insurance with a UK life insurance carrier (or Paris with a French insurance company, Toronto with a Canadian insurance company, etc.) in your home country, you are probably not thinking that you need to pay Uncle Sam a tax on what you perceive as a “run of the mill” insurance coverage.
Indeed your life insurance company in your country of residence will not be advising that as a USC or LPR, you should be paying Uncle Sam.
If the insurance contract is a casualty policy, the excise tax is 400% greater than the 1% tax on life insurance premiums; i.e., a 4% excise tax. The payment of the tax is made on IRS Form 720, Federal Excise Tax Return.
In my experience, I never find that any individuals who are USCs and LPRs living around the world are aware of this obscure tax. When the tax is not paid the IRS has unlimited time to assess tax and penalties, including late payment penalties, late filing penalties and negligence penalties. Plus, interest that accrues on the unpaid tax and penalties can grow the amounts owing over time. See, When the U.S. Tax Law has no Statute of Limitations against the IRS; i.e., for the U.S. citizen and LPR residing outside the U.S., posted March 24, 2014.
The excise tax amount may not seem too significant. However, if it is not timely paid, there will be late payment and late filing penalties (e.g., for failure to file the excise tax return). This 1% or 4% excise tax is on the gross premium payment. This tax amount can certainly add up when insurance premiums are paid annually and over many decades.
Finally, be aware that the IRS is focusing on this excise tax on insurance contracts, at least within its OVDP program where IRS revenue agents are asserting that 25%, 27.5% or 50% of the value of the entire asset (e.g., the cash surrender value of the insurance policy) is subject to the “in lieu of penalty”.
U.S. Citizens Overseas are Often Ill Advised to go into the (1) OVDP and sometimes even the (2) the Streamlined Filing Procedure
There have been prior posts discussing what is referred to as the offshore voluntary disclosure program (“OVDP”) and what the IRS later created – the so-called “streamlined program” filing procedure.
For more background, see, GAO Yr2014 Report on Offshore Voluntary Disclosure Program Indicates Less Than 4% of Taxpayers Lived Outside the U.S., posted March 11, 2014.
Importantly, these OVDP and streamlined programs created by the IRS are not creatures of any statutory law, for instance Title 26 (the Internal Revenue Code) or Title 31 (the so-called Bank Secrecy Act); or any law for that matter. There are no court cases or Treasury Regulations that spell out the terms of these programs as part of any legal framework.
I like to say they are similar to the Hasbro rules of “Monopoly”; a game I was fond of as a child. The IRS is like Hasbro in that they can change the rules of the game as they wish, and often do in the form of publicized frequently asked questions (“FAQs”). The IRS submits these rules of their game and ask, encourage and in some cases (in my view) browbeat taxpayers, often times through their advisers, into participating. See some of the various rule changes below –
- IRS OVDP FAQs and Answers 2012
- Transition Rules: Frequently Asked Questions (FAQs)
- IRS 2011 Offshore Voluntary Disclosure Initiative
- January 8, 2010 — added Q&As 53-54
- August 25, 2009 — added Q&A 52
- July 31, 2009 — modified A6, A21 and A22
- June 24, 2009 — modified A26 and added Q&A 31-51
- May 6, 2009 — posted Q&A 1-30
The above reflect just some of the modifications and rules the IRS has made, and keeps making to their rules of their proposed OVDP structure; which again, I repeat, is not part of the law.
Many taxpayers and their advisers, in my view have not thought carefully about the law and its application; but rather have focused on the “Monopoly” rules. They cite and read the FAQs if that is somehow the law! See How is the offshore voluntary disclosure program really working? Not well for USCs and LPRs living overseas posted May 10, 2014 and The 2013 GAO Report of the IRS Offshore Voluntary Disclosure Program, International Tax Journal, CCH Wolters Kluwer, January-February 2014. PDF version here.
Similarly, the streamlined filing procedures is not part of the law, and also has been modified several times by the IRS. Fortunately, the IRS realized that U.S. taxpayers residing outside the U.S. are not the same as those who reside in the U.S. when they created two separate programs last year in 2014.
See, U.S. Taxpayers Residing Outside the United States: The following streamlined procedures are referred to as the Streamlined Foreign Offshore Procedures. Eligibility for the Streamlined Foreign Offshore Procedures
The point of this post is that I have seen numerous cases where U.S. citizens residing around the world were ill advised to participate in the OVDP. In short, if an individual has no criminal tax liability, I think there is little purpose or reason for almost all USC overseas to participate into the OVDP. Analyzing thoughtfully the facts of each case and the law (not the Monopoly rules) is what is important for each individual.
Finally, a clear understanding of what are the Monopoly rules compared to the law is crucial when advising USCs residing overseas. Sometimes, filing through the streamlined procedure might be well advised for a particular taxpayer; e.g., if they would otherwise have substantial late payment and late filing penalties. However, there are plenty of cases where simply filing tax returns pursuant to the law will be preferable in a particular case. This is a process that needs to be thoughtfully considered in each case with a clear understanding of the law – not just the Monopoly rules.
For some related commentary on this topic, see the following posts:
Part I: New TIGTA Report to Congress (Sept 30) Has International Emphasis on Collecting Taxes Owed by “International Taxpayers”: Treasury Inspector General for Tax Administration (TIGTA)
TIGTA’s Semiannual Reports – Today’s Report with International Considerations – Part I
The Internal Revenue Service and U.S. Department of Justice (Tax Division) are the “soldiers” on the ground used to enforce U.S. federal tax law. They interpret the law, in no small part based upon the expertise and input of the myriad of experts in the U.S. Treasury, IRS and DOJ.
However, there are outside forces which oftentimes seem to have an “over-sized” influence on how, when and what priorities are identified in the IRS and DOJ. One of those powers of course is the Administration which makes up the Treasury Department and the very Department of Justice. The green book proposals of the Treasury and different policy proposals are an example. The other organization, within the Executive Branch is the Treasury Inspector General for Tax Administration (TIGTA).
TIGTA is the sort of “watch dog” over the IRS that independently reviews the work undertaken and often times questions that work and the IRS’ efforts. Per its own website it describes itself as:
The Treasury Inspector General for Tax Administration (TIGTA) was established in January 1999 in accordance with the Internal Revenue Service Restructuring and Reform Act of 1998 (RRA 98) to provide independent oversight of Internal Revenue Service (IRS) activities. As mandated by RRA 98, TIGTA assumed most of the responsibilities of the IRS’ former Inspection Service.
Another important influence is the Congress. See a prior post from September 2014 on this topic: How Congressional Hearings (Particularly In the Senate) Drive IRS and Justice Department Behavior
Does the IRS have access to the USCIS immigration data for former lawful permanent residents (LPRs)?
Information about former LPRs, such as the individuals names, is not published under the statute, IRC Section 6039G, which only covers former U.S. citizens.
This raises the question of whether the Department of Homeland Security tracks former LPRs – names and addresses overseas and provides that information to the Internal Revenue Service?
A prior post discussed the newly published USCIS immigration form I-407 for LPRs who must now use it when formally abandoning LPR status. See, More Information and More Information: USCIS Creates New Form for Abandonment of Lawful Permanent Residency
The new I-407 Form requires much more information and is 2 pages in length. The old form had only 6 lines and was less than 1/2 of a page in length. These forms are set forth here. The new form requires the address overseas of the individual.
As readers here know, the names of former U.S. citizens are published quarterly by the U.S. federal government for the world to see. See a prior post, The 2014 Third Quarter Renunciations Is probably the New Norm –
The complete set of lists going back to the mid-1990s can be reviewed here. Quarterly Publications.
Of course, the IRS can easily select and identify individuals for audit, by simply drawing from the published names of former U.S. citizens, which is currently tracking at an average of about 850 former USCs quarterly. In contrast, the number of former LPRs who have filed USCIS Form I-407 is tracking at an average of about 4,000 to 5,000 individuals quarterly.
While citizens are often the focus of the public press and Congress regarding “expatriation taxation”; the statute also wraps in so-called “long-term residents.” These are individuals who had or continue to have “lawful permanent residency status.” There are numerous technical considerations in this area, but needless to say, the number of former lawful permanent residents who have simply filed Form I-407 – Abandonment is far in excess of those U.S. citizens who have filed for and received a Certificate of Loss of Nationality (“CLN”) – Form DS-4083 (CLN). The graph reflects the enormous difference.
On a related post, the question was raised –What are the Number of LPRs who Leave U.S. Annually without filing Form I-407 – Abandonment?
This is important, since many LPR individuals will have “expatriated” without actually having filed USCIS Form I-407. See, Oops…Did I “Expatriate” and Never Know It: Lawful Permanent Residents Beware! International Tax Journal, CCH Wolters Kluwer, Jan.-Feb. 2014, Vol. 40 Issue 1, p9
While the IRS has specific information about U.S. citizens, it is not clear whether the Department of Homeland Security via the USCIS provides data to the IRS regarding lawful permanent residents who have filed Form I-407? If such an individual becomes a “covered expatriate” under the U.S. tax law, the range of adverse tax consequences can follow them and their future beneficiaries and heirs, including as follows:
- “mark to market” taxation on their worldwide assets,
- 40% inheritance tax to U.S. beneficiaries,
- 40% tax on gifts to U.S. beneficiaries,
It seems fairly easy, from a legal perspective, that the IRS can request the names, addresses (and indeed the newly completed form) from the USCIS of all individuals who have filed USCIS Form I-407. From the USCIS records, the IRS will be able to determine if the individual was a “long term resident” based upon the number of years the individual had such status.
Assuming the IRS determines the individual is a long term resident, they can then simply check to see if the they have received IRS Form 8854 from the former LPR; in order to determine if she or he satisfied the certification requirement of Section 877(a)(2)(C). If not, the IRS will necessarily know the individual is a “covered expatriate.”
The Information in DHS/USCIS Database (A-Files, EMDS, CIS, PII, eCISCOR, PCQS, Midas, etc.) on Individuals is Extensive and Can be Shared with Internal Revenue Service
A prior post discussed the new USCIS Form I-407 that must be filed by a lawful permanent resident (LPR) who wishes to formally create a record of their abandonment of LPR status. See, More Information and More Information: USCIS Creates New Form for Abandonment of Lawful Permanent Residency
This raises many questions regarding how information maintained by the Department of Homeland Security (DHS) and the United States Customs and Immigration Service (USCIS) can be shared with
and provided to the IRS.
Former “long-term residents” have extensive U.S. tax compliance obligations, including certification requirements under Section 877(a)(2)(C) to avoid “covered expatriate” status and the various adverse tax consequences.
Importantly many LPR individuals will have “expatriated” without actually having filed USCIS Form I-407. See, Oops…Did I “Expatriate” and Never Know It: Lawful Permanent Residents Beware! International Tax Journal, CCH Wolters Kluwer, Jan.-Feb. 2014, Vol. 40 Issue 1, p9
Some of the important records that are maintained by DHS/USCIS, include the following, much of which can be helpful in the enforcement of U.S. federal tax obligations.
Alien Files (A-Files) are maintained in electronic and paper format throughout DHS. Digitized A-Files are located in the Enterprise Document Management System (EDMS). The Central Index System (CIS) maintains an index of the key personally identifiable information (PII) in the A-File, which can be used to retrieve additional information through such applications as Enterprise Citizenship and Immigrations Services Centralized Operational Repository (eCISCOR), the Person Centric Query Service (PCQS) and the Microfilm Digitization Application System (MiDAS). The National File Tracking System (NFTS) provides a tracking system of where the A-Files are physically located, including whether the file has been digitized.
The databases maintaining the above information are located within the DHS data center in the Washington, DC metropolitan area as well as throughout the country. Computer terminals providing electronic access are located at U.S. Citizenship and Immigration Services (USCIS) sites at Headquarters and in the Field throughout the United States and at appropriate facilities under the jurisdiction of the U.S. Department of Homeland Security (DHS) and other locations at which officers of DHS component agencies may be posted or operate to facilitate DHS’s mission of homeland security.
* * *
Categories of records in this system include:
A. The hardcopy paper A-File, which contains the official record material about each individual for whom DHS has created a record under the INA such as: naturalization certificates; various documents and attachments (e.g., birth and marriage certificates); applications and petitions for benefits under the immigration and nationality laws; reports of arrests and investigations; statements; other reports; records of proceedings before or filings made with the U.S. immigration courts and any administrative or federal district court or court of appeal; correspondence; and memoranda. Specific data elements may include:
- Alien Registration Number(s) (A-Numbers);
- Receipt file number(s);
- Full name and any aliases used;
- Physical and mailing addresses;
- Phone numbers and email addresses;
- Social Security Number (SSN);
- Date of birth;
- Place of birth (city, state, and country);
- Countries of citizenship;
- Physical characteristics (height, weight, race, eye and hair color, photographs, fingerprints);
- Government-issued identification information (i.e., passport, driver’s license):
○ Document type,
○ issuing organization,
○ document number, and
○ expiration date;
- Military membership;
- Arrival/Departure information (record number, expiration date, class of admission, etc.);
- Federal Bureau of Investigation (FBI) Identification Number;
- Fingerprint Identification Number;
- Immigration enforcement history, including arrests and charges, immigration proceedings and appeals, and dispositions including removals or voluntary departures;
- Immigration status;
- Family history;
- Travel history;
- Education history;
- Employment history;
- Criminal history;
- Professional accreditation information;
- Medical information relevant to an individual’s application for benefits under the INA before DHS or the immigration court, an individual’s removability from and/or admissibility to the United States, or an individual’s competency before the immigration court;
- Specific benefit eligibility information as required by the benefit being sought; and
- Video or transcript of immigration interview
Subsequent posts will discuss how and when the law allows the IRS to access these records.
Taxpayers have a distinct disadvantage under the law vis-à-vis the IRS, since the law creates a “presumption of correctness” in favor of the IRS determination of taxes owing by any particular taxpayer.
This concept is decades old and is found in U.S. Supreme Court precedence at least as far back as 1933, where the Court in Welch v. Helvering (290 U.S. 111 (1933)) explained:
The Commissioner of Internal Revenue resorted to that standard in assessing the petitioner’s income, and found that the payments in controversy came closer to capital outlays than to ordinary and necessary expenses in the operation of a business. His ruling has the support of a presumption of correctness, and the petitioner has the burden of proving it to be wrong. Wickwire v. Reinecke,275 U. S. 101; Jones v. Commissioner, 38 F.2d 550, 552. [emphasis added]
This continues to be the law to this day.
What this means for taxpayers, particularly United States citizens and lawful permanent residents (“LPRs”) who reside outside the U.S., is that the IRS will often make erroneous tax determinations; yet the calculation of the amount of tax owing is presumptively correct.
The individual has the burden of proving the government wrong.
As an international tax practitioner, I have seen some of the most farfetched tax assessments by the IRS in the international context. If the IRS uses bad or incomplete information and then produces a tax assessment result, it is like the old computer saying; “junk in junk out.”
The IRS almost always, by definition, has incomplete information for taxpayers residing overseas. For that reason, it is not uncommon for them to make statutory notices of deficiency that are not supported by the law or the facts. See, the IRS explanation of a Notice of Deficiency CP3219N (“90-day letter”) proposing a tax assessment. Understanding Your CP3219N Notice
This power of the IRS under the law, is also compounded by the ability of the IRS to file a “substitiute return” for those USCS and LPRs residing overseas. See a prior post from November 2014, How the IRS Can file a “Substitute Return” for those USCs and LPRs Residing Overseas.
U.S. Department of State, Starts Communicating with U.S. Citizens Overseas Regarding Tax Obligations with the IRS
The IRS is in charge of U.S. federal tax administration. It’s mission statement is set out below and is very different from the mission of the U.S. Department of State:
Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.
This mission statement describes our role and the public’s expectation about how we should perform that role.
- In the United States, the Congress passes tax laws and requires taxpayers to comply.
- The taxpayer’s role is to understand and meet his or her tax obligations.
- The IRS role is to help the large majority of compliant taxpayers with the tax law, while ensuring that the minority who are unwilling to comply pay their fair share.
The U.S. Department of State is in charge of something very different from taxes and tax policy. Below is its Mission Statement –
The Department’s mission is to shape and sustain a peaceful, prosperous, just, and democratic world and foster conditions for stability and progress for the benefit of the American people and people everywhere. This mission is shared with the USAID, ensuring we have a common path forward in partnership as we invest in the shared security and prosperity that will ultimately better prepare us for the challenges of tomorrow.
–From the FY 2014 Agency Financial Report,
released November 2014
In my career of more than 25 years as a tax professional, working in the international tax area, I have never before seen communications sent by the U.S. Department of State, directly discussing U.S. federal tax obligations.
However, there have been many changes in the last few years in how aggressive the IRS (and Tax Division, Department of Justice) has become in enforcing U.S. tax laws overseas. See, Should IRS use Department of Homeland Security to Track Taxpayers Overseas Re: Civil (not Criminal) Tax Matters? The IRS works with Department of Homeland Security with TECs Database to Track Movement of Taxpayers
This seems to be part of a bigger trend of the IRS to use other governmental agencies and their resources in identifying and locating U.S. taxpayers and their assets overseas.
One recent development is the communication sent by the U.S. Department of State via e-mail to U.S. citizens residing overseas. The following is the complete text of the tax compliance communication sent by the U.S. Department of State, which ends with a reference: “I Haven’t Filed All My Tax Returns, What Can I Do?.” It then references the IRS offshore programs (which includes the OVDP, which in my view, should be reserved for only those U.S. taxpayers who have criminal tax liability – see, How Congressional Hearings (Particularly In the Senate) Drive IRS and Justice Department Behavior):
Dear U.S. citizens,
The Internal Revenue Service (IRS) has provided the following guidance for U.S. citizens abroad preparing for the 2015 tax filing season. This IRS guidance is posted under Federal Benefits and Obligations on travel.state.gov. U.S. embassies and consulates cannot mail tax returns on behalf of U.S. taxpayers living abroad.
1. Who Must File?
All U.S. citizens and resident aliens must file a U.S. individual income tax return, even if they permanently live outside the United States and may not owe any tax because of income exclusion or tax credit.
2. When is the 2014 Federal Tax Return Due?
Due date for Form 1040: April 15, 2015
- An automatic extension to June 15, 2015, is granted for taxpayers living outside the United States and Puerto Rico. No form is required; write “Taxpayer Resident Abroad” at the top of your tax return.
- Caution: This extension applies only for filing your tax return, not for payment. If you owe any taxes, you’re required to pay by April 15, 2015. Interest and penalties will generally be applied if payment is made after this date.
- To request an additional extension to October 15, 2015, use Form 4868.
- Caution: This extension applies only for filing your tax return, not for payment. If you owe any taxes, you’re required to pay by April 15, 2015. Interest and penalties will generally be applied if payment make after this date.
- Other extensions may be available on IRS.gov.
3. Can I Mail My Return and Payment?
You can mail your tax return and payment using the postal service or approved private delivery services. A list of approved delivery services is available on IRS.gov. If you mail a return from outside the United States, the date of filing is the postmark date. However, if you mail a payment, separately or with your return, your payment is not considered received until the date of actual receipt.
4. Can I Electronically File My Return?
You can prepare and e-file your income tax return, in many cases for free. Participating software companies make their products available through the IRS. E-File options are listed on IRS.gov.
5. What Forms May I Need?
- 1040, U.S Individual Income Tax Return
- Instructions to Form 1040
- 1116, Foreign Tax Credit
- 2013 Instructions to Form 1116 â€“ 2014 instructions will be available soon, please check on http://www.irs.gov
- 2350, Application for Extension of Time to File U.S. Income Tax Return (for U.S. citizens and residents abroad)
- 2350 in Spanish
- 2555, Foreign Earned Income Exclusion
- Instructions to Form 2555
- 2555-EZ, Foreign Earned Income Exclusion
- Instructions to Form 2555-EZ
- 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return
- 4868 in Spanish
- 8802, Application for United States Residency Certificate
- Instructions to Form 8802
- 8938, Statement of Specified Foreign Financial Assets
- Instructions to Form 8938
- 14653, Certification by U.S. Person Residing Outside of the United States for Streamlined Foreign Offshore Procedures
6. How Do I Pay My Taxes?
You must pay your taxes in U.S. dollars.
- Direct pay. You can pay online with a direct transfer from your U.S. bank account using Direct Pay, the Electronic Federal Tax Payment System, or by a U.S. debit or credit card. You can also pay by phone using the Electronic Federal Tax Payment System or by a U.S. debit or credit card.
- Foreign wire transfers. If you have a U.S. bank account, you can use the Electronic Federal Tax Payment System. If you do not have a U.S. bank account, ask whether your financial institution has a U.S. affiliate that can help you make same-day wire transfers.
- Foreign electronic payments. International taxpayers who do not have a U.S. bank account may transfer funds from their foreign bank account directly to the IRS for payment of their tax liabilities.
7. Other Reporting?
You also may have to file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR), by June 30, 2015.
8. Does the IRS Provide Help in Other Languages?
The IRS provides tax information in Chinese, Korean, Russian, Spanish, and Vietnamese. Go to http://www.irs.gov and use the drop down box under “Languages” on the upper right corner to select your language.
9. Where Can I Get Help?
Contact the International Taxpayer Service Call Center by phone or fax. The International Call Center is open Monday through Friday, from 6:00 a.m. to 11:00 p.m. (Eastern Time).
Tel: 267-941-1000 (not toll-free)
You may also contact the IRS office in London, Paris, or Frankfurt. For addresses and telephone numbers, contact my local office internationally.
10. I Received a Notice from the IRS, What Do I Do?
If you receive a notice from the IRS and need to contact the IRS, call the number listed on the notice or the International Taxpayer Service Call Center (see above).
11. Where Can I Get More Information?
For information on the IRS website about international taxpayers, see this page.
For general information about international taxpayers, see Publication 54, “Taxation of U.S. Citizens and Residents Abroad.”
For information on the Affordable Care Act and taxpayers outside the United States, see Publication 5187, “Health Care Law.”
12. I Haven’t Filed All My Tax Returns, What Can I Do?
If you have not filed all the returns required of you and want to catch up on your filing obligations, see this announcement: IRS makes changes to offshore-programs.