The U.S. Department of Justice announced a US$100M FBAR penalty and criminal guilty plea in an international tax evasion case. The government’s press release on November 4, 2016, provided as follows:
- A Rochester, New York emeritus professor of business administration pleaded guilty today to conspiring with others to defraud the United States and to submitting a false expatriation statement to the Internal Revenue Service (IRS), announced Principal Deputy Assistant Attorney General Caroline D. Ciraolo, head of the Justice Department’s Tax Division, and U.S. Attorney Dana J. Boente of the Eastern District of Virginia, after the plea was accepted by U.S. District Judge T.S. Ellis III.
The case is extraordinary in the steps apparently taken by the business investor/professor in hiding some US$200M of assets overseas. The facts are egregious as reported and tie directly to IRS Form 8854. Hence, this seems to be a very good criminal tax case for the government. See a prior post that briefly discusses IRC Section 7206(1), see, What could be the focal point of IRS Criminal Investigations of Former U.S. Citizens and Lawful Permanent Residents?
Prior posts have discussed the importance of certifying truthfully and accurately as to all items of information requested on IRS Form 8854, Initial and Annual Expatriation Statement; which is made under penalties of perjury (like all U.S. tax statements). See, Part II: C’est la vie Ms. Lucienne D’Hotelle! Tax Timing Problems for Former U.S. Citizens is Nothing New – the IRS and the Courts Have Decided Similar Issues in the Past (Pre IRC Section 877A(g)(4))
Also, prior posts have discussed the steps taken by the government to track taxpayers and their assets globally, to help assure they comply with U.S. federal tax law. See a prior related post, 19 Jan 2014 – 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
The recent press release explains how a false IRS Form 8854 was prepared by a co-conspirator of the taxpayer, as follows:
- In 2013, the individual who had nominal control over Horsky’s accounts at the Zurich-based bank conspired with Horsky to relinquish the individual’s U.S. citizenship, in part to ensure that Horsky’s control of the offshore accounts would not be reported to the IRS. In 2014, this individual filed with the IRS a false Form 8854 (Initial Annual Expatriation Statement) that failed to disclose his net worth on the date of expatriation, failed to disclose his ownership of foreign assets, and falsely certified under penalties of perjury that he was in compliance with his tax obligations for the five preceding tax years.
The importance of a complete and accurate IRS Form 8854, is to enable a taxpayer (if they meet other statutory requirements) to avoid “covered expatriate” status. See, the Tax Court case earlier this year 2016, Topsnik v. Commissioner (2016), where the Court found the taxpayer had failed to meet the certification requirements and was necessarily a “covered expatriate.”
Whether criminally or civilly, taxpayers should never underestimate the importance of filing complete and accurate tax returns; specifically including IRS Form 8854, Initial and Annual Expatriation Statement.
Maybe most important of all, it is crucial the taxpayer understands the full range of legal and tax consequences to them regarding the important steps that might lead to “tax expatriation.” The law is complex and fraught with potential minefields. It’s always advisable to have thoughtfully analyzed and considered the consequences of “tax expatriation” long before taking specific steps (pre as opposed to post-expatriation) of renunciation of U.S. citizenship or abandonment of lawful permanent residency.
Individuals around the world are often curious about how and when the U.S. Supreme Court hears tax cases. In some countries, tax cases represent the majority or large percentage of total cases heard by their Supreme Court (e.g., Mexico).
The Supreme Court typically hears some 100-150 cases per year out of more than 7000 cases a year it is asked to review. Many of these cases deal with the constitutionality of particular laws. They rarely take up tax cases.
The 2013 term was unusual in that the Supreme Court heard three federal tax cases (U.S. v. Woods, U.S. v. Quality Stores, Inc. and U.S. v. Clarke). Similarly, in 2015 the Supreme Court issued opinions in three tax cases (although each dealt with powers of states to impose taxation – Alabama Dept. of Revenue v. CSX Transportation, Inc. a property tax case; Direct Marketing Association v. Brohl a sales tax case; and, Maryland v. Wynne an income tax case).
None of these cases or any Supreme Court case before them has dealt with the U.S. “exit tax” arising out of IRC Sections 877, 877A, 2801, et. seq. Indeed, to date, there have been few cases heard by other courts regarding these provisions. One of the most important and relevant is the Topsnik v. Comm’r (146 T.C. No. 1) case published this year. The Topsnik case will be discussed in more detail in a later post. The short version is that the taxpayer in Topsnik lost the case and was found to have been a “covered expatriate” with the consequent adverse tax consequences that follow.
Taxpayers have a right of appeal from the U.S. Tax Court. If a case is appealed from the U.S. Tax Court, e.g., Topsnik or another federal court (e.g., from Court of Federal Claims) it will go to one of 13 appellate courts. An appeal from one of these 13 appellate courts will lie with the U.S. Supreme Court.
The U.S. Supreme Court is generally not obliged to review cases (per the Certiori Act of 1925), including tax cases, and will rarely take up a tax case, whether or not it addresses a Constitutional question. Hence, a case like Topsnik will almost certainly never become binding precedent to all the courts in the land, e.g., the Court of Federal Claims.
The Canadian income tax system has a sensible rule that treats immigrants into the country “as if” they had sold their non-Canadian assets just prior to becoming a Canadian income tax resident.
- If you owned certain properties, other than taxable Canadian properties, while you were a non-resident of Canada, we consider you to have sold the properties and to have immediately reacquired them at a cost equal to their fair market value on the date you became a resident of Canada. This is called a deemed acquisition.
- Usually, the fair market value is the highest dollar value you can get for your property in a normal business transaction.
- You should keep a record of the fair market value of your properties on the date you arrived in Canada. The fair market value will be your cost when you calculate your gain or loss from selling the property in the future.
The U.S. does not have such a rule generally for immigrants coming to America. Instead, the non-U.S. citizen will typically have their historic tax basis (by applying U.S. tax principles) in the property they own prior to coming to the U.S. For instance, an immigrant from the South American continent who owns real estate in their country of citizenship, may have a large “unrealized gain” in that property for U.S. federal income tax purposes.
This means that if the South American sells the real estate, while being a U.S. income tax resident (after immigrating to the U.S.), the gain in the South American real estate will be subject to taxation in the U.S. This is very different from the sensible Canadian rule, which exempts the appreciation in the property of the immigrant while living outside of the North American continent.
This can be a very bad result for the uninformed immigrant, since the example above can get worse, when the immigrant to the U.S. has received properties in the form of gifts (e.g., from their family members) which could have very low tax bases per U.S. tax law. Assume a gift of South American real estate received by the immigrant prior to moving to the U.S. with a low historic basis of US$500K. Assume further it is sold for US$3.3M while the immigrant is residing in the U.S. If the property was worth US$3.2M when she immigrated to the U.S., only US$100K of appreciation occurred while residing in the U.S. Nevertheless, under U.S. law, the entire US$2.8M gain (US$2.7M of which occurred while living outside the U.S.) will generally be subject to U.S. federal income tax.
This comes as quite a surprise to many.
An immigrant to Canada in the same case, would only have US$100K of taxable gain, with the US$2.7M gain being free from taxation under Canada’s “deemed acquisition” rules.
There is one exception in the U.S. tax law. Unfortunately, it applies to “covered expatriates” who readers of this site understand, that the U.S. tax regimes are typically quite undesirable. They are as follows:
- The “Mark to Market” taxation on unrealized gains of worldwide assets, arising from the renunciation of U.S. citizenship or termination of “long-term residency” status (i.e., the so-called “exit tax”); See, Inflation Adjusted Exclusion Amounts Since Inception of 2008 “Mark to Market” Expatriation Tax Law: Example and
- The tax payable by U.S. beneficiaries whenever they receive so-called “covered gifts” and/or “covered bequests.” See, The “Hidden Tax” of Expatriation – Section 2801 and its “Forever Taint.” (April 2014) and a post from September 2015, Finally – Proposed Regulations for “Covered Gifts” and “Covered Bequests” Issued by Treasury Last Week (Be Careful What You Ask For!).
The statutory provision under IRC Section 877A(h)(2) provides relief from the first tax; for purposes of calculating the “mark to market” tax. It provides in relevant part that the “covered expatriate” –
- . . . shall be treated as having a basis on such date [the date of immigration to the U.S. in the first place] of not less than the fair market value of such property on such date . . .”
Accordingly, the appreciation of the property owned by the immigrant (see, US$2.7M example above – who is in the process of emigrating out of the U.S. -by way of “covered expatriate” status) will generally escape income taxation under IRC Section 877A(h)(2) on the unrealized gain in the property that arises prior to moving to the U.S. in the first place. This limited rule is similar to the sensible Canadian “deemed acquisition” rules.
Unfortunately, there is no such rule as this “deemed acquisition” concept that could reduce the future tax payable by U.S. beneficiaries of “covered gifts” and “covered bequests.”
Part II: “Neither Confirm nor Deny the Existence of the TECs Database”: IRS Using the TECs Database to Track Taxpayers Movements – and Assets
Part II: This is a follow-up to the federal government’s database known as “TECS” (Treasury Enforcement Communication System)that is now operated by the Department of Homeland Security (“DHS”). The IRS uses it to track travel, trips, movement and even asset movements (e.g., wire transfers) by U.S. citizen taxpayers; including those residing outside the U.S.
This previous post described how the U.S. federal government uses the TECS to locate assets and travel patterns of U.S. citizens; specifically outside the U.S. The IRS trains their employees to (1) Not discuss TECS with taxpayers; (2) Neither confirm nor deny existence of TECS; (3) Keep in separate “Confidential” envelope; and (4) Stamp documents as “OFFICIAL USE ONLY”
The image in this post reflects a page from IRS training materials for their employees; e.g., revenue agents (those individuals who audit taxpayers and determine tax deficiencies and the like), revenue officers (those individuals who work on collecting taxes owed or alleged to be owed) and chief counsel attorneys (those individuals who litigate tax cases against taxpayers); among other IRS employees.
Frankly, there is not a lot of detailed law about how and when the IRS can use TECS or other tracking techniques of individuals and their assets. There are no tax cases (at least none that I am aware of) where the Courts have tried to impose limits on the use and methods of the federal government in collecting this type of TECS information. Indeed, there are specific provisions granting broad use of taxpayer information when the government alleges there is a “terrorist incident, threat, or activity” as that term is defined in IRC Section § 6103.
On the other hand, there are important laws about how the IRS cannot generally disclose taxpayer information. For instance, see the same code section IRC Section § 6103 for wrongful disclosures of taxpayers’ information. That statute makes it a violation (even a criminal violation in certain willful circumstances) to disclose taxpayer information in “most” (or at least many) circumstances. The statute is comprehensive and there is a lot of case law interpreting various provisions. A good overview of the statute can be found in the Criminal Tax Manual for the Department of Justice, Tax Division – Chapter 42.00
A recent case (United States v. Garrity, 2016 U.S. Dist. LEXIS 66372 (D. Conn. 2016), discussed in Jack Townsend’s blog, was one where the IRS had disclosed the name of a deceased taxpayer Paul G. Garrity, Sr. regarding his foreign (non-U.S.) accounts. The disclosure included IRS investigation techniques that were disclosed as part of a FOIA request, which ultimately made it to the public. This was found to be disclosure of return information as defined by IRC Section § 6103. However, the Court there found that there was no violation of the statute by the IRS, as the taxpayer was deceased by the time the claim was brought by the estate. The government made a Title 31 FBAR penalty assessment of over US$1M including interest and penalties that is still pending.
It seems to me that the use of the TECS database by the IRS and Section 6103 are a bit like two heads of a coin. It all deals with taxpayer information and what rights, if any do taxpayers have to protect their personal and financial information – especially where it can (purposefully or inadvertently – e.g., through a data breach/hacking) be released to the public.
There are many unanswered questions as there has been little to no litigation regarding how and when the TECS database can and should be used.
Does the government have any limits on its use?
This ultimately becomes more of a policy discussion about how and to what extent can/should the federal government have and use and collect personal financial and travel information of individuals (particularly for tax purposes)?
As FATCA data collection has now allowed exchanges of millions of records, these questions in my view take on even greater importance. See 21 Dec 2015 post, Foreign Government Receives a “FATCA Christmas Gift” from IRS: 1 Gigabyte of U.S. Financial Information.
See a prior related post, 19 Jan 2014 – 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
Graphs and charts are a nice way to show key pieces of information quickly. The charts I create showing the numbers of U.S. citizens (“USCs”) who have renounced their citizenship help me better understand and track the detailed data behind the graphs.
In this vein, I have added trend-lines to two of the graphs that reflect the total annual and quarterly numbers of individuals who have renounced over the last few years.
The trend-lines are the blue dotted lines in each chart. The first chart reflects annual renunciations over a longer period of time, which is compressed much more along the “x axis” – i.e., the horizontal axis. The trend of USCs who are renouncing looks quite dramatic in this chart; a giant ski slope heading upwards fast.
The next chart includes many more data points along the “x axis” spread out over a shorter period of time, which is also reflected by the dotted blue trend-line. Accordingly, the trend-line appears to be a more gradual increase of USC renunciations.
Nevertheless, both show the trend over time as increasing substantially over time.
As has been explained in prior posts, those U.S. citizens who are considering renouncing U.S. citizenship should not take the decision lightly unless they want to be a “covered expatriate” with various adverse U.S. tax and legal consequences.
See, for instance the following prior blogs, Revisiting the consequences of becoming a “covered expatriate” for failing to comply with Section 877(a)(2)(C).
The number of U.S. citizens who are reported to have renounced U.S. citizenship was 1,158 for the 1st quarter of 2016. I keep and track all names of USCs who are reported by the U.S. Treasury in the Federal Register. The data tracking reflects a significant increase in quarterly renunciations since 2008. That is the general trend. There is no direct quarter to quarter trend, as my graph above reflects (where 1,158 is the latest number of USC renunciations).
For some historical references, see, New Record of U.S. Citizens Renouncing – The New Normal, 11 Feb, 2015.
There are several strategic decisions that most all U.S. citizens need to consider prior to renouncing citizenship. See, for instance – Part II: C’est la vie Ms. Lucienne D’Hotelle! Tax Timing Problems for Former U.S. Citizens is Nothing New – the IRS and the Courts Have Decided Similar Issues in the Past (Pre IRC Section 877A(g)(4)) Part II: C’est la vie Ms. Lucienne D’Hotelle! Tax Timing Problems for Former U.S. Citizens is Nothing New – the IRS and the Courts Have Decided Similar Issues in the Past (Pre IRC Section 877A(g)(4))
The world is starting to wake up to better understand how the U.S. Treasury negotiated so-called “bilateral” FATCA Intergovernmental Agreements (“IGAs”) with some 113 countries around the world. The list of all countries can be found here at the Treasury website – Foreign Account Tax Compliance Act (FATCA)
Not all of these countries have actually signed the IGAs. Many of them have what the U.S. Treasury calls an “agreement in substance.”
How does this impact USCs and LPRs residing outside the U.S.? Many ways.
First, extensive information is being collected by foreign financial institutions (FFIs – non-U.S. financial institutions) throughout the world to identify “U.S. Persons” and “Substantial U.S. Owners.” The IGAs use the term “Specified U.S. Person” with respect to what are defined as “U.S. Reportable Accounts.” See as an example, the Treasury FATCA IGA with Colombia, which is largely identical in form to almost all other IGAs.
Second, many FFIs have adopted a policy to no longer accept or retain U.S. accounts, due to the cost of compliance associated with U.S. citizens and lawful permanent residents. Also, many FFIs simply want to avoid the risk of being penalized heavily by the U.S. federal government for having U.S. taxpayers and being charged with some type of wrongdoing; namely aiding and abetting U.S. taxpayers to evade U.S. tax obligations. See, Jack Townsend’s thoughtful website Federal Tax Crimes that reviews in detail the various cases with foreign banks, with a particular focus on Swiss banks, U.S. DOJ Program for Swiss Banks .
Now to the “dirty little secret” of FATCA IGAs. They are not bilateral in the sense that U.S. banks do not need to provide the same detailed information on their non-U.S. clients (e.g., UK, French, Canadian, Mexican, Chinese, Dutch, Spanish, Colombian, Brazilian, residents, etc.) as do FFIs regarding “U.S. accounts.” This is no real secret, since a simple reading of the FATCA IGAs will get you to this conclusion by simply understanding the difference between what is defined as a “U.S. Reportable Account” (which is extraordinarily broad) compared to “Country X Reportable Account.” The latter definition, e.g., a Colombian Reportable Account, only obligates U.S. banks to send information of individual residents on U.S. source income under chapter 3 and certain accounts of Colombian entities.
Hence, all non-U.S. source income to a Colombia resident individual is not subject to reporting by the U.S. financial institution. She could have a portfolio of US$150M in non-U.S. mutual funds, ADRs traded on the NYSE and have no reporting of all of her income going back to the Colombian government. Also, stock sales of U.S. corporations (e.g., Apple, Ford or Microsoft) is not treated as “U.S. source income” defined under chapter 3. Plus, a Colombian resident who has an offshore corporation (e.g., a BVI company) that owns the investments, NO reporting is required of the U.S. financial institution; even if the entire US$150M portfolio were invested in U.S. stocks, U.S. treasuries, and other American made financial investments.
Contrast that with what is defined as a “U.S. Reportable Account” that would include a U.S. Person that is a “Controlling Person” of a “Non-U.S. Entity.” Take the same example in reverse; a Colombian bank must identify all of its clients with Non-U.S. Entities (undertake an expensive due diligence process) to then identify whether such entities (e.g., a BVI company) has a “Specified U.S. Person”. Plus, it does not matter if the income is from Colombian sources or non-Colombian sources. Income is income and must be reported by the FFI.
Accordingly, Banks around the world in at least 113 countries (e.g., UK, French, Mexican, Chinese, Dutch, Spanish, Colombian, Brazilian, Cayman, Singapore, Guatemala, Hong Kong, etc.) are required to drill down and collect detailed information on beneficial owners of basically all companies, trusts and other legal entities. This work is required, so as to identify who are “U.S. persons” to identify “substantial U.S. owners” as that term is defined in the FATCA regulations. The IGAs call these essentially “U.S. Reportable Accounts.” In the case of FFIs, U.S. taxpayers cannot hide behind offshore opaque legal entities (e.g., which would generally be illegal for USCs to form and hold assets in a foreign corporation and not report the assets, activities and earnings of the foreign corporation, which would generally be a CFC or possibly a PFIC). See prior post: March 30, 2015, The Problem with PFICs! “Avoid PFICs Like the Plague”
The FATCA IGAs, require these FFIs to provide extensive information on all income on these “U.S. Reportable Account” to the IRS, either directly or indirectly through their own governments.
In contrast, individuals resident in any foreign country (e.g., UK, French, Mexican, Chinese, Dutch, Spanish, Colombian, Brazilian, Belgium, Guatemala, Luxembourg, etc.) can generally hold their ownership interests of U.S. investment assets in U.S. banks and financial institutions through opaque legal structures and hide behind the entity without worrying that a U.S. financial institution has any duty to identify and disclose who are the beneficial owners to the tax authorities of those residents. See Colombian individual scenario above with a BVI company.
- Why did the Treasury purposefully create this limited reporting obligations for U.S. financial institutions while creating extensive and detailed reporting obligations for FFIs?
- Why are U.S. financial institutions not required under FATCA IGAs to identify the beneficial owners of opaque legal structures to report the income and gains to foreign tax authorities?
- Why are U.S. financial institutions not required under FATCA IGAs to identify the and report non-U.S. source income in their U.S. accounts?
- Why has the U.S. refused to participate in the OECD common reporting standards?
- Why did the U.S. federal government wait until just this month of May 2016, to say it will start increasing the ” . . . transparency [of] the “beneficial ownership” of companies formed in the United States by requiring that companies know and report their true owners . . . “?
- Why is the White House just now saying it is going to be “Closing a Loophole that Enables Foreigners to Hide Behind Anonymous Entities Formed in the United States” when from inception, starting in 2012 all of the FATCA IGAs (which were drafted and negotiated exclusively by the U.S. Treasury) have always allowed foreigners with accounts and investments in the U.S. to hide behind anonymous entities?