tax compliance

Why Most U.S. Citizens Residing Overseas Haven’t a Clue about the Labyrinth of U.S. Taxation and Bank and Financial Reporting of Worldwide Income and Assets

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This post is written simply because so many U.S. citizens residing overseas are reasonably confused about the complexity of U.S. tax law.  The mere requirement to file U.S. income tax returns for those overseas often comes as a great surprise.  My non-U.S. born wife is an exception (as she also lives outside the U.S.) simply because I have repeatedly told her for our 20 some years of marriage.  IRS Form W-7 Highlighted

Some in the IRS erroneously think U.S. citizens residing overseas do and should understand U.S. tax law.  I posed one simple scenario to a very sophisticated IRS attorney not very long ago who specializes in the FATCA rules.

Her view is (hopefully was) that U.S. citizens throughout the world know or should know the U.S. tax laws because the instructions to IRS Form 1040 are clear.

This thought knocked me off my figurative chair onto the floor!  Smack. 

My surprise is based upon my own experience working with individuals and families throughout the world, in numerous countries.  I have noticed a number of notions, based upon these andectodal experiences as follows:

  1. A minority of U.S. citizens (unless they lived most of their lives in the U.S. and recently moved overseas as an “expatriate”) have no real basic idea of how the U.S. federal tax laws work; let alone to their assets and income in their country of residence.  See USCs and LPRs Living Outside the U.S. – Key Tax and BSA Forms
  2. There are indeed plenty of immigrant U.S. residents (certainly less than 50% by my own experience – especially when concepts of PFICs and foreign tax credits start being discussed) who even understand the basics of U.S. international tax law.
  3. If they reside in an English speaking country that has relatively strong family or historical ties to the U.S. (e.g., England, Ireland, Scotland, and Canada, etc.) they are likely to have a better idea of the U.S. federal tax laws, but still the majority don’t know key concepts.  See, Nuances of FBAR – Foreign Bank Account Report Filings – for USCs and LPRs living outside the U.S.
  4. Even those in English speaking countries that have less historical or family ties to the U.S. have a lesser understanding (e.g., New Zealand, Australia, Kenya, South Africa, India, etc.).US Passport
  5. Those who do not speak English know even less about U.S. tax laws and how they apply to them.
  6. Many individuals who learn of these requirements overseas are sometimes driven to great despair.  The message they receive is not a correct one under the law in my view: as they read IRS materials (for instance, see FAQs 5, 6 and and former 51.2 from the Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers 2014) and come to the conclusion they will soon be going to jail, criminally prosecuted or otherwise be subject to tens of thousands of dollars worth of penalties for their failure to file a range of tax forms.
  7. Literally, sometimes as a tax lawyer I feel more like a psychologist, when these individuals come to me saying they can’t sleep, they can’t eat, they are seeing a cardiologist for high blood pressure, etc. and even in a most extreme case they thought suicide was a solution.  See, How is the offshore voluntary disclosure program really working? Not well for USCs and LPRs living overseas.
  8. Individuals around the world (even tax professionals) and certainly laypeople, are not commonly reading TaxAnalysts (nor would they subscribe) or other tax professional publications that explain many of the intricacies of U.S. tax laws.
  9. Learning and understanding U.S. tax laws, including just the basics, requires a great deal of time, aptitude for nuances and details, literacy, patience and a level of aptitude for such matters that simply escape many people around the world (most I would say).  see, “PFICs” – What is a PFIC – and their Complications for USCs and LPRs Living Outside the U.S.  I can relate to this personally, as I am an international tax professional (indeed I even studied a post graduate law course outside the U.S. in a non-English language), have spent my entire professional career of more than 25 years in the area, and yet only generally have a very superficial understanding of tax laws throughout the countries where I am dealing with clients.  I don’t try to understand the details of those laws. Chart of Trends - US Citizenship Renunications Qtr 3 - 2015
  10. Many people are angry and frustrated (justifiably so, in my view, in many cases) after learning they are subject to these rules.  See comment above about being a psychologist.  Plus, USCs and LPRs residing outside the U.S. – and IRS Form 8938. In addition, see, Taxpayer Advocate Report on Burdens of Benign Taxpayers who Make Mistakes

Back to the intelligent IRS tax attorney.  My question to her was:  “Why would you, as a U.S. born individual not be reviewing the tax laws, tax forms and tax instructions of the country where your parents were born prior to immigrating to the U.S.?”  I asked:  “Are you not reviewing those laws in the original language of your parents (not English, but the other language of your parent’s country) to understand what tax forms and returns you should be filing?”

The IRS attorney’s response was:  “What:  of course, I am not reviewing such tax forms or filing information or tax laws, as I would have no tax obligations in that foreign country where I have no income, no assets or no bank or financial accounts!”

My follow-up question was a simple one:  “Don’t you realize that U.S. federal tax law (Title 26) and financial bank reporting laws (Title 31) do just that!”

“Hmm she paused: how can that be?”  I don’t recall if she said this out loud, or just said it with her puzzled expression.

The answer of course is that through citizenship (including derivative citizenship through a U.S. parent even though the child never spent a single day of residence in the U.S., let alone received any income or assets); that same individual in the mirror position as that IRS attorney is subject to a host of U.S. federal tax and financial reporting laws.  See,

Here is the big disconnect.    It’s not just among the ill-informed or those lesser educated on the fine points of law.  I had the pleasure this week along with my wife to host two educated, worldly and engaging individuals who have been married some 20 years together.  They are well read and highly educated.  Both are lawyers by training, one practices law that often pushes him fairly deeply into the tax law and his wife is a wonderful and experienced judge in the California state courts.

I asked them (as I like to ask people around the world) if they had ever heard or understood that the U.S. federal tax law imposes taxation and very detailed reporting on the worldwide income and assets of U.S. citizens who reside outside the U.S.  I discussed Civil War ImageCook v. Tait and the U.S. Civil War a bit.  See both Supreme Court’s Decision in Cook vs. Tait and Notification Requirement of Section 7701(a)(50) and The U.S. Civil War is the Origin of U.S. Citizenship Based Taxation on Worldwide Income for Persons Living Outside the U.S. ***Does it still make sense?

All of it was a great surprise to them! They were in utter shock and both are residents in the U.S., highly educated in the law and are like the vast majority of the world, including U.S. citizens who reside outside the U.S.

This is the common response for many U.S. citizens residing overseas.

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The Intersection of U.S. Federal Tax Law with Collection of International Information – Including other Federal Agencies

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For decades, the IRS largely worked in a vacuum, relative to other government agencies.

Changes started in earnest in 2003 after September 11, 2001, when Congress past various anti-terrorism laws.  For details of the history and how and when the IRS became responsible for these functions, the IRS Internal Passport Inside Back Page - USC Taxation ReferenceRevenue Manual has a detailed explanation – Part 4, Chapter 26, Section 5. Bank Secrecy Act History and Law

In April 2003, the IRS became in charge of civil enforcement of foreign account information under Title 31.  See IRM, Part 4, Chapter 26, Section 16. Report of Foreign Bank and Financial Accounts (FBAR).

The world has changed dramatically in these past few years and the IRS no longer works in such  a vacuum.  For a history of foreign bank and Congressional influences, see, How Congressional Hearings (Particularly In the Senate) Drive IRS and Justice Department Behavior

Today there are a host of governmental inter-agency activities along with foreign government exchanges of information;  e.g., DHS, Department of State, ICE, USCIS, foreign government exchanges of information under FATCA IGAs, a plethora of federal “intelligence agencies” for “terrorism related requests” as identified in IRM pursuant to IRC Section 6103(i), foreign governments under tax treaty exchanges, among many others.

The law is not even clear as to which agencies qualify as “intelligence agencies” as they are not identified in the statute and many are presumably classified organizations.

  • Who is an “intelligence agency” for purposes of the statute?

The following is a list of some of the intelligence agencies that are presumably included in the federal tax statute Section 6103(i)(7):

National

United States Intelligence Community
Director of National Intelligence
National Intelligence Council [NIC]
National Counterterrorism Center (NCTC)
National Counterintelligence Executive [NCIX]
Official
Official
Official
Official
Official
Central Intelligence Agency Official
National Security Agency Official
National Reconnaissance Office Official
National Geospatial-Intelligence Agency Official
Defense Intelligence Agency Official
Federal Bureau of Investigation Official
Department of Homeland Security Office of Intelligence and Analysis Official

Other Defense Department

Assistant to the Secretary for Intelligence Oversight Official
Under Secretary of Defense for Intelligence
Under Secretary of Defense for Policy
Official
Official
Assistant Secretary of Defense for Networks and Information Integration Official
Defense Information Systems Agency Official
Defense Advanced Research Projects Agency Official
Defense Protective Service Official
Defense Security Service Official
US Special Operations Command Official
Army
Army Deputy Chief of Staff for Intelligence
Intelligence and Security Command
Official
Official
Official
Navy
Office of Naval Intelligence
Naval Security Group Command
Naval Criminal Investigative Service
Official
Official
Official
Official
Marine Corps Official
Air Force
Air Force Technical Applications Center
Air Intelligence Agency
Official
Official
Official

Other Federal Agencies

National Security Council
President’s Foreign Intelligence Advisory Board
Office of National Drug Control Policy
Official
Official
Official
Energy Department
Office of Intelligence
Official
Official
Justice Department
Justice Intelligence Coordinating Council
OIG – Office of the Inspector General
DEA – Drug Enforcement Administration
NDIC – National Drug Intelligence Center
USNCB – U.S. National Central Bureau
Official
Official
Official
Official
Official
Official
Official
State Department
INR – Bureau of Intelligence & Research
INL – Bureau for International Narcotics and Law Enforcement Affairs
CT – Counterterrorism Office
DS – Bureau of Diplomatic Security
Official
Official
Official
Official
Official
Treasury Department
Office of Intelligence Support
Office of the Under Secretary (Enforcement)
FINCEN – Financial Crimes Enforcement
FLETC – Federal Law Enforcement Training Center
Official
Official
Official
Official
Official
National Archives and Records Administration
Information Security Oversight Office
Official
Official

A less secret organization is the Social Security Administration which now increasingly intersect with the work of

Passport Inside Back Page - USC Taxation Referencethe IRS.  Also, the Department of State now provides warnings on its Passport applications about tax consequences and requirements of social security numbers (“SSN”s).

See also how in an Application for a U.S. Passport there are now specifically references IRC Section 6039E.

Finally, see also how on the last page (page 28) of currently issued U.S. Passport (“Book“) and paragraph D that explains generally the taxation obligations of citizenship.