Under Audit
What’s Your Probability of an IRS Tax Audit? Taboo – to say? . . . . shhhhh . . . . “Covered Expatriates”
Many tax practitioners think they are prohibited from discussing with a taxpayer the probability or likelihood that a tax return, tax position or a form (e.g., IRS Form 8854, Initial and Annual Expatriation Statement) will be audited by the IRS.
Many practitioners think such a statement is somehow taboo – and cannot be answered when a client asks the question: “Will my tax return get audited?”
Someone who has become a “covered expatriate” might want to know – whether the IRS audit of expatriate tax returns is high or low? What if I do not even have a social security number (e.g., as a U.S. citizen born outside the U.S.) from my date of birth, and I have lived outside the U.S. almost all of my life? Will that impact the chances of tax audit? Can answers be provided to these logical questions raised by taxpayers?
First, no one ever knows whether any tax return or position will get audited. The answer necessarily requires the ability to peer into the future.
Mérida – the Place to be in February (19th and 20th)
The implications of the Aroeste v United States – Order (Nov 2023) particularly for millions of taxpayers globally and “U.S.” taxpayers affected by pertinent tax treaty provisions, will be a focal point of discussion at the upcoming international tax conference in February.
The University of San Diego School of Law – Chamberlain International Tax Institute will take place on February 19th and 20th, 2024, at the International Convention Center in Mérida, Yucatán, México. You can register for the conference – HERE –
Among the courses offered, there will be a detailed examination of- Aroeste v. the United States: Limits on Government Authority Re: Tax Treaty Law ++– along with other international tax topics and sessions featuring much Moore:
- United States Supreme Court – Tax Decisions & Moore
- International Tax Reporting: New Reporting of International Partnerships – K-2s & K-3s
- United States-based Cross-Border Real Estate Investments (Advanced)
- U.S. Investor Visa Options and Limitations
- California, Texas & Florida Probate Proceedings of Cross-Border Estates
- Corporate Transparency Act/anti-money-laundering FinCEN Reporting
- Avoiding Estate Taxes on U.S. – “Situs” Assets (risks in the Bolsa and opportunities)
- Latest Developments in International Corporate Reorganizations
- Check the Box Planning Including Pre-Immigration (Asset Planning – + International Companies)
- Pitfalls of International Trusts with U.S. Beneficiaries (in a high-interest rate environment)
- EB-5 Visa Requirements and Tax Implications
- Aroeste v. the United States: Limits on Government Authority Re: Tax Treaty Law ++
- Pillar 2 in Effect: First Qtr 2024 Planning & Compliance + Pillar 1 with Public Comments – December 11th, 2023
- Expiring TCJA International Tax Provisions: 2025 Soon Upon Us
- International Tax Advisors: How to – “Go directly to Jail, Do Not Pass “GO”, Do Not Collect $200!”
- International IRS & SAT Collection Enforcement – (cross-border tax judgments and liens)
- Cross-Border Aircraft Acquisitions, Financing and Leasing; Taxes, Aircraft Registration & Permitting
- Tax Treaty Interpretation – Malta Pension Plans ++
Legal Question of the Day: FBAR Penalties for USCs and LPRs Residing Outside the U.S. Is the IRS Website correct as a matter of law?
The IRS website has a specific statement on their website titled Delinquent FBAR Submission Procedures
Importantly, the website provides the following comforting statement:
The IRS will not impose a penalty for the failure to file the delinquent FBARs if you properly reported on your U.S. tax returns, and paid all tax on, the income from the foreign financial accounts reported on the delinquent FBARs, and you have not previously been contacted regarding an income tax examination or a request for delinquent returns for the years for which the delinquent FBARs are submitted.
The question is the following:
Is the IRS bound by their own statement on their website as a matter of law?
In other words, can they go ahead and assess FBAR penalties notwithstanding the statement set forth above on their website?
USCs are necessarily subject to U.S. taxation on their worldwide income because they are defined as “United States persons” under title 26, Section 7701(a)(30)(A). See, 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?
Lawful permanent residents (“LPRs”) may, but are not necessarily defined as “United States persons” under title 26, Section 7701(a)(30)(A) by application of an applicable tax treaty and the flush language of Section 7701(b)(6). See, Timing Issues for Lawful Permanent Residents (“LPR”) Who Never “Formally Abandoned” Their Green Card and see the IRS practice unit discussion, Determining Tax Residency Status of Lawful Permanent … – IRS.gov
Now, this is all relevant to know and understand, in order to determine who exactly has a filing obligation under Title 31: regarding FBARs. See, 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
Assuming you do have an FBAR filing requirement, e.g., residing in your country of residence with financial accounts in your 
own country or in other financial institutions outside the U.S.; can the IRS assess a penalty against you for a delinquently filed FBAR? What if you have properly reported on your U.S. tax returns, and paid all tax on, the income from the foreign financial accounts reported on the delinquent FBARs?
The answer may surprise you. It will be addressed in a subsequent post.
Incidentally, to date, there have been more than 200 FBAR civil penalty cases filed in U.S. federal courts. The Federal District Courts have seen approximately 200+ civil penalty cases and the Court of Federal Claims, much less popular venue, has seen 5 cases thus far.
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.
See, “Neither Confirm nor Deny the Existence of the TECs data”: IRS Using the TECs Database to Track Taxpayers Movements –, posted Dec. 13, 2014.
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
The Life Insurance “Gotcha Tax” – IRS Assesses Excise Tax on Normal Life & Other Insurance Policies
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”.
IRS Creates “International Practice Units” for their IRS Revenue Agents in International Tax Matters
The U.S. international tax law has become increasingly complex. I am confident when I say that very few individuals in the world (including IRS revenue agents) understand the complexities of Title 26 and Title 31 as they apply to 
international matters such as gifts of foreign property, gifts involving U.S. intangible property, gifts to or inheritances from foreign estates with U.S citizens (USCs) or Lawful Permanent Residents (LPRs) beneficiaries, foreign partnerships with USCs, transfers of property to foreign trusts by USCs or LPRs residing outside the U.S., transfers of property to foreign corporations, etc.
Most USCs and LPRs who live in the U.S. certainly know and understand the basics of IRS Form 1040.
However, the type and scope of international transactions contemplated by the law can be significant and are rarely understood in any depth, even by many tax professionals. I have seen cases during my career of sophisticated individuals ranging from Nobel prize winners to U.S. Ambassadors, who had not a clue about the application of U.S. federal tax law to their lives. See, the Nov. 2, 2015 post, 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
The lack of knowledge of these complex laws within the IRS, and the LB&I (Large Business and International group) which specializes in international matters has led to IRS “International Practice Units”. These are designed to allow IRS revenue agents who are not necessarily specialists in the international tax area to review transactions and be prepared to assess taxes and penalties against USCs and LPRs in the international context. The preamble says in part ” . . . Practice Units provide IRS staff with explanations of general international tax concepts as well as information about a specific type of transaction. . . ”
There are currently 63 different IRS “International Practice Units” all with dates from the last 12 months. Several of them focus heavily on information return filings which carry stiff penalties, even if no U.S. income taxes are owing. For instance see, Monetary Penalties for Failure to Timely File a Substantially Complete Form 5471 –Category 4 & 5 
Filers.
Another interesting IRS International Practice Unit is titled – Basic Offshore Structures Used to Conceal U.S. Person’s Beneficial Ownership of Foreign Financial Accounts and Other Assets.
These IRS materials give a good perspective from where the IRS views the world; including the introduction to this particular IRS International Practice Unit where it states: “This Practice Unit focuses on a U.S. Person’s proactive steps to “conceal” their ownership of foreign financial accounts, entities and other assets for the purposes of tax avoidance or evasion, even though, there may be some situations where there are legitimate personal or business purposes for establishing such arrangements. This unit falls under the outbound face of the matrix and thus, will focus on U.S Persons living in the United States . . . Most U.S. taxpayers using an offshore entity or structure of entities to hold foreign accounts are simply hiding the accounts from the Internal Revenue Service and other creditors . . .” [emphasis added]
This is a breathtaking statement from the IRS internal training manuals that “Most U.S. taxpayers using an offshore entity or structure of entities to hold foreign accounts are simply hiding the accounts from the Internal Revenue Service and 
other creditors . . .”?
The vast majority of the USCs or LPRs who I see who renounce or abandon their citizenship or LPR status, are living outside the United States and in most cases have spent almost all (if not all) of their lives outside the U.S.
Does the IRS mean that a family living in Switzerland that have dual national family members are “. . . .simply hiding the accounts from the Internal Revenue Service . . . ” if they are using, for instance, a Liechtenstein Stiftung to hold their family assets as part of an estate plan recommended to them by their Swiss legal and tax advisers?
Does the statement that this IRS International Practice Unit focuses on ” . . . U.S Persons living in the United States . . . ” give USCs and LPRs residing outside the U.S. relief from the IRS perspective of USCs simply hiding assets from the Internal Revenue Service? Will IRS revenue agents be sophisticated enough to distinguish between these two different groups; U.S. resident versus non-resident USCs and LPRs? Will the law be applied differently with respect to these resident versus non-resident U.S. taxpayers?
What role will these IRS “International Practice Units” play in forming perceptions and molding ideas of IRS revenue agents who have had little to no life experience in international affairs, multi-national families, global finance and international business operations?
More observations to come from specific IRS “International Practice Units.
Tax Expatriation: The Numbers Affected Are Far Greater for Lawful Permanent Residents vs. Citizens
The last post discusses a scenario where an individual can be forced into “tax expatriation” by a third-party; i.e., the government, if a criminal tax investigation were to be pursued successfully. See, Unplanned Expatriation: Lawful Permanent Residents’ Deportation Risks for Filing U.S. Federal False Tax Returns
We can call this “forced expatriation”; when the government takes investigative action to deport a lawful permanent resident (“LPR); i.e., cause a forced tax expatriation where an individual files a false return, provides false information or otherwise submits a false document to the government.
Other posts have discussed the role of U.S. income tax treaties in accidental “expatriation” for lawful permanent residents. See, Countries with U.S. Income Tax Treaties & Lawful Permanent Residents (“Oops – Did I Expatriate”?), posted April 29,. 2014 and The dangers of becoming a “covered expatriate” by not complying with Section 877(a)(2)(C), posted March 9, 2014.
We can call this “inadvertent expatriation”; when the individual themselves who is a LPR inadvertently causes a tax expatriation by operation of law.
There are other data points and relevant government operations of importance to LPRs. For instance, see, Does the IRS have access to the USCIS immigration data for former lawful permanent residents (LPRs)?, posted April 11, 2015. See, More Inforation and More Information: USCIS Creates New Form for Abandonment of Lawful Permanent Residency
The point of this post is to highlight a point previously made:
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.
See, earlier post The Number of LPRs “Leaving” the U.S. is 16X Greater than the Number of U.S. Citizens Renouncing Citizenship
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
See, 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, Posted on April 4, 2015
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
Page 1 of 2 of this form is replicated here.
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.
System location:
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.
* * *
- 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;
- Gender;
- Physical characteristics (height, weight, race, eye and hair color, photographs, fingerprints);
- Government-issued identification information (i.e., passport, driver’s license):
More Information and More Information: USCIS Creates New Form for Abandonment of Lawful Permanent Residency, Posted on April 3, 2015
The U.S. Customs and Immigration Service (USCIS) announced on 23 March 2015, that a new Form I-407 is available and is to be used, per the USCIS website announcement,
Is “It’s Almost Impossible for Me to Get a U.S. Taxpayer Identification Number”; a Defense to Not Filing U.S. Tax Returns?
The U.S. federal government has made the basic task of getting taxpayer identification numbers (“TINs”) very difficult for many individuals. Without a TIN, an individual cannot file tax returns or information reporting returns.
- U.S. Citizens and SSNs – No Exceptions
U.S. citizens (USCs) residing overseas without a social security number (“SSN”) must use a SSN for their TIN. I presented a recent report to various government officials, including the international tax counsel at the U.S. Treasury Department and the Joint Committee of Taxation, among other groups. Some key excerpts of that paper titled URGENT NEED FOR U.S. CITIZENS RESIDING OUTSIDE THE U.S. TO BE ABLE TO OBTAIN A TAXPAYER IDENTIFICATION NUMBER (“TIN”) OTHER THAN A SOCIAL SECURITY NUMBER are set out below in this section:
The U.S. tax law imposing taxation on the worldwide income of USCs[1] residing overseas has created a dilemma that prejudices these USCs without a SSN. This strict SSN/TIN regulatory rule undermines the basic tax administration system and discourages tax compliance for those USCs who never obtained a SSN. This dilemma affects numerous USCs throughout the world, which is now compounded by the certification and reporting requirements of USCs and third parties, such as FFIs and NFFEs[2] under the Foreign Account Tax Compliance Act (“FATCA”).
This dilemma is a creature of the Title 26 regulatory law going back to 1974[3] and how the Social Security Administration (“SSA”) imposes strict requirements on the issuance of SSNs to residents overseas.[4] One essential step is that the USC overseas must have an in-person interview, with a designated individual (who are typically U.S. Department of State employees and some designated military personnel). They are located in only a few cities around the world.[5] Some USCs need to travel thousands of miles to merely be able to apply for and obtain a SSN.
[1] See, IRC § 61 and Treas. Reg. §§ 1.1?1(b) and 1.1?1(a)(1).
[2] See, IRC §§ 1471 et. seq. and the regulations thereunder which define “foreign financial institutions” (“FFIs”) and “non-financial foreign entity” (“NFFEs”).
[3] See, Treas. Reg. § 301.6109-1(a)(1)(ii)(A).
[4] See, 7 FAM 534.3 Applications for a Social Security Number (Form SS-5-FS).
[5] Id, page 7 FAM 534.3 Applications for a Social Security Number (Form SS-5-FS).
Further posts will discuss a number of the adverse consequences imposed on USCs who do not have a SSN and the severe penalty regime that exists under current law for those unwitting individuals.
- Non-U.S. Citizens and ITINs –
Many individuals who are not USCs nevertheless need to file a tax return and must obtain what is called an individual taxpayer identification number (“ITIN”). See IRS report Obtaining an ITIN from Abroad. An ITIN is applied for by filing an IRS Form W-7, and providing various original documents, principally a passport, directly to the IRS. The process is complex and time consuming. Indeed, the Taxpayer Advocate report included a key summary explanation of the problems associated with obtaining ITINs as follows:
- IRS ITIN Policy Changes Make Return Filing Difficult and Frustrating
Recent changes to the IRS’s Individual Taxpayer Identification Number (ITIN) application program are burdening taxpayers and may harm voluntary compliance.
ITINs play an important role in tax administration, as any individual who has a federal tax filing obligation but is not eligible for a Social Security number must apply to the IRS for an ITIN and then use the ITIN on any return, statement, or other document which requires a taxpayer identifying number
Under the new procedures, most applicants must now submit original documentation by mail or travel to Taxpayer Assistance Centers (TACs) to have documents certified, making the application process more difficult
Since December 17, 2003, the IRS has required ITIN applicants with a filing requirement to attach a valid federal tax return with their application (unless they qualify for an exception).
On June 22, 2012, the IRS implemented temporary changes that required all ITIN applicants to submit original documents supporting the information on their applications. Under these procedures, applicants could no longer submit notarized copies and had to send in original documentation, even if a certified acceptance agent (CAA) reviewed and certified the documentation.
On November 29, 2012, the IRS announced revised procedures for the 2013 filing season that require applicants to submit original documentation or copies certified by the issuing agency.
Although the IRS allows CAAs to submit copies of documentation for primary and secondary taxpayers after reviewing original documentation or certified copies, CAAs must still send in original documentation for all dependent applicants.
A limited number of TACs can certify documents for primary, secondary, and dependent taxpayers.
The Revised Procedures Create an Impediment for Taxpayers Required to File Returns.
The recent changes to the ITIN program have made it difficult for taxpayers to file returns.
More on ITINs to follow in later posts.
- Legal Defense?
The complexities of obtaining a U.S. TIN begs the question: “Is it a legal defense for a taxpayer to NOT file U.S. tax returns, international information returns, if it is particularly difficult (or nearly impossible in some cases) for that individual to even obtain a TIN?”
Will such a taxpayer have a “reasonable cause” defense to avoid penalties in the case of an audit? These are questions unanswered by any case law to date.
USCs throughout the world are required by FATCA to provide their U.S. TIN to financial institutions throughout the world (on IRS Form W-9, or its equivalent), which under current law necessarily must be a SSN. Of course, if they have no SSN, they cannot sign IRS Form W-9 which provides in Part II: “Under penalties of perjury, I certify that: 1. The number shown on this form is my correct taxpayer identification number . . . “
As FATCA requires overseas individuals, including USCs to certify under penalty of perjury their U.S. taxpayer identification number (and if they have none), they necessarily will not be able to comply with this basic reporting requirement.
Will these individuals have a defense under the law for not complying under these circumstances?
Will the government provide relief for these individuals?
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.
See, earlier post The Number of LPRs “Leaving” the U.S. is 16X Greater than the Number of U.S. Citizens Renouncing Citizenship
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,
- etc.
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 Problem with PFICs! “Avoid PFICs Like the Plague”
There are typically numerous tax issues that USCs and LPRs need to consider prior to renouncing their citizenship; or abandoning th
eir lawful permanent residency status.
One of the most confusing comes from the complex rules of a so-called “PFIC” – the acronym for a “passive foreign investment company.” A prior post in March 2014 discussed the basics of these U.S. tax creatures – “PFICs” – What is a PFIC – and their Complications for USCs and LPRs Living Outside the U.S.
Most USCs and LPRs with basic mutual fund investments in their country of residence have PFICs and probably don’t even know it.
The IRS and Treasury have recently spent much attention and resources to the regulation of PFICs. In January of 2014, temporary regulations were issued regarding PFICs. See, Regulations §1.1291–0T, et. seq.
One of the many new requirements of these regulations are annual information filing requirements. This means that a U.S. taxpayer (e.g., U.S. citizen or LPR) residing outside the U.S., must file an annual report on IRS Form 8621.
- When Might You have a PFIC?
Taxpayers who have simple passive investments in mutual funds based outside the U.S.. e.g., in their country of residence, almost always have PFICs. There is no percentage ownership threshold in the foreign entity that triggers PFIC tax consequences. An ownership interest of 0.000001% triggers the consequences if either the “income test” or “asset test” are satisfied. Other type of investment funds in the form of a legal entity also typically qualify as a PFIC.
Specifically, a PFIC is a foreign corporation in which a U.S. person has some ownership in (without any percentage threshold requirement) if (i) at least 75% of its gross income is passive income (the “income test”), or (ii) at least 50% of its assets produce passive income (the “asset test”). See IRC § 1297(a).
Also, many retirement funds in various countries (including both private and many government run retirement plans) typically fall into the category of a PFIC. For instance, the Singapore retirement fund system, Central Provident Fund (“CPF”), is actually created by the government, but Singapore taxpayers who are obligated to contribute to the retirement fund will select various mutual funds to invest in through the CPF. Hence, these mutual fund investments are PFICs. See also the technical paper regarding Mexican retirement funds that argues, WHY MEXICAN RETIREMENT FUNDS SHOULD NOT BE SUBJECT TO THE NEW REPORTING REQUIREMENTS UNDER IRC SECTION 1298(f).
- Ugly Tax Consequences of a PFIC
PFICs are taxed to the U.S. taxpayer in a very complicated manner compared to taxation of U.S. based mutual funds or other U.S. based investments. In short, the income earned from PFICs, under the default regime, are taxed at the ordinary income rates, and for past years are typically taxed at the highest marginal ordinary income tax rate is 39.6% (even if the income would otherwise qualify for qualified dividend or long-term capital gains rates – which are taxed at no more than 20%).
There are three alternative regimes for how a U.S. investor is taxed in a PFIC: (i) the “excess distribution” regime (which is the default regime); (ii) the qualified electing fund (“QEF”) regime and (iii) the market-to-market (“MTM”) regime. Each of these regimes will be discussed in later posts.
One key point to know is that most foreign investment funds do not keep records and account for income and expenses in a manner that even allows a U.S. taxpayer to report accurately under the QEF or MTM regime, even if such treatment provides a lower overall U.S. tax.
More on how PFICs are taxed in a later post.
- Even Uglier Tax Reporting – Compliance Consequences of PFICs Driven by FATCA
Finally, the 2010 FATCA legislation has led to the new regulations that now require annual reporting of PFICs. This is done on IRS Form 8621. It is a laborious form and requires extensive and detailed information.
The consequences of not reporting can lead to disastrous tax results. See a prior post from March 2014, 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.
- Why You Don’t Want to Die with a PFIC or Gift a PFIC Away (even to Your Favorite Charity or Spouse).
Lastly, a later post will explain in more detail why a USC or LPR generally wants to avoid PFICs if at all possible. Many countries require their residents to contribute on a mandatory basis to retirement funds that invest in mutual funds, which may not allow a USC to avoid PFICs. One of the principle reasons to avoid PFICs is the income tax that arises and is owed by the U.S. person, even if he or she tries to give the PFIC away. A gift of a PFIC will typically cause an income tax to the donor in addition to the estate/gift tax rules. This is true for gifts to charity and even to your own spouse.
- Why You Should Avoid PFICs Like the Plague
At the end of the day, the above complications, mean that most USCs and LPRs residing overseas should “avoid PFICs like the plague”.
In the context of USCs who wish to renounce their U.S. citizenship, they will not be able to avoid “covered expatriate” status if they have not complied with these PFIC rules, as they will not be able to “certify under penalty of perjury that he has met the requirements of this title for the 5 preceding taxable years or fails to submit such evidence of such compliance as the Secretary may require.”
The ugly consequences of PFICs can be summarized as follows:
- Higher income tax rate than U.S. based investments on the earnings of the investment, at least under the default method;
- Practically impossible to report the earnings on a more favorable MTM or QEF method;
- Extensive information reporting requirements annually;
- Open ended statute of limitations in favor of the IRS to audit all items on the tax return, for failure to properly file IRS Form 8621;
- Paying a U.S. income tax, even if you gift away the PFIC to charity or to your spouse;
- Trying to even explain effectively the consequences of a PFIC to your tax return preparer; and
- Being subject to the “forever taint” of being a “covered expatriate” for failure to comply with the PFIC rules. See, The “Hidden Tax” of Expatriation – Section 2801 and its “Forever Taint.”