Under Audit
The IRS Can Make an Assessment of Taxes and Penalties and Ask Questions Later
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.
Does the U.S. Government Assume U.S. Citizens Having Assets Outside the U.S. are Hiding Assets from the IRS?
Does the IRS Assume U.S. Citizens Having Assets Outside the U.S. are Tax Cheats?
This rhetorical question is asked for a simple reason. In IRS training materials, which are part of the basic core training provided to IRS agents investigating individuals with assets outside the U.S. and international matters and transactions, the IRS makes the following bold statement:
“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 . . . 
“
A slide from these IRS training materials has this statement along with tax evasion activities that IRS agents are to be on the look out. Certainly, the identification of illegitimate tax evasion activities is appropriate for tax authorities, but such a bold statement ignores the larger reality of the international business world.
Unfortunately, such a bold statement by the IRS does not reflect the reality of millions of U.S. citizens and lawful permanent residents residing outside the U.S.; or indeed maybe millions more who live in the U.S. and have offshore business and investment activities.
For additional background of the estimated millions of USCs residing outside the U.S., see an earlier post: Key Take Aways from Senate Investigations re: Foreign Banks and “Offshore Tax Evasion”: U.S. Citizens Residing Overseas have Become a Focus of the Government.
The world is a very global and international marketplace with international commercial activities undertaken throughout at a scale that rivals the volume of international business just a few years ago. The IRS seems to ignore this important consideration, which is supported by the Department of 
Commerce – Bureau of Economic Analysis, in their reporting of international export transactions in goods and services. According to these statistics, the amount of exported services has more than doubled from the year 2004 ($336 billion in services) to 2013 ($682 billion) and total exports for 2013 exceeded $3 trillion.
According to the federal government itself in reports prepared by the Department of Commerce – Bureau of Economic Analysis, these international transactions continue to grow robustly in the year 2014.
Therefore, a more balanced understanding and view of how, when and where international business is conducted by U.S. citizens around the world should help IRS agents when they conduct tax audits and not assume – erroneously 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 . .”
“Neither Confirm nor Deny the Existence of the TECs data”: IRS Using the TECs Database to Track Taxpayers Movements –
There have been a series of previous posts that discussed the IRS and other government agencies ability to track taxpayers and their assets outside the U.S.
See for instance, the following posts: 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
Interestingly, the release of IRS internal training manuals and materials (which were obtained through a Freedom of Information Act – FOIA – request) and includes the Power Point slide in this post, describes the TECs database and how it can be used by IRS agents regarding foreign assets and individuals as follows:
The Treasury Enforcement Communications System (TECS) is a database maintained by the Department of Homeland Security (DHS), and it is used extensively by the law enforcement community. TECS contains historical travel information such as records of commercial airline flights, border crossings, and specific dates that individuals have traveled to and from the United States.
All this information could provide you with potential leads to pursue.
For example, the discovery of where the taxpayer may hold assets or accounts or where the taxpayer conducts business. It may also assist in determining taxpayer’s residency and the credibility of taxpayer testimony. TECS may have gaps in the information captured, caution is advised. For example, it might contain incomplete information about border crossings, private plane and private boat information. It does not contain enough stand alone data to determine residency. It should be used together with other sources of information.
In addition, the IRS training materials demonstrates the secrecy of the TECs database and what steps the IRS tells their agents to take regarding the TECs database. The following excerpt directly from the IRS “Matrix Application Training International Individual Compliance: Basic Structures Part II: Pre-Audit, Investigative Techniques & Statutes”
• IRM 5.1.18.14.10 – Covers using TECS Historical Travel Information
First and foremost, do not discuss the existence of TECS with the taxpayers. We must neither confirm nor deny the existence of TECS data.
Part I: How the IRS “Non-Filer Program” Affects USCs and LPRs Residing Outside the U.S.
U.S. citizens who have spent most all of their lives outside the U.S. are often times shocked to learn about the scope of the U.S. citizenship based taxation system. In recent years, due to the aggressive pursuit of the IRS and Tax Division of the Department of Justice, there has become a keen focus on assets and accounts located outside the U.S.
Most recently in August of this year, the IRS has articulated its position for U.S. citizens and lawful permanent residents residing outside the U.S. in a document titled – “New Filing Compliance Procedures for Non-Resident U.S. Taxpayers”
For a brief chronology of the actions taken by the IRS and DOJ and the U.S. Congress in the offshore world during the last few years see, How Congressional Hearings (Particularly In the Senate) Drive IRS and Justice Department Behavior
See, also IRS Audit Techniques – Expatriation, How the IRS Can file a “Substitute Return” for those USCs and LPRs Residing Overseas
The IRS has had for years a specific program for “non-filers”; i.e., those persons who do not file U.S. income tax returns. See, How the IRS Can file a “Substitute Return” for those USCs and LPRs Residing Overseas
The program is detailed in the Internal Revenue Manual, set out below. A follow-up post will discuss some uniquely complex issues affecting U.S. citizens and lawful permanent residents who reside outside the U.S.
- 4.19.17.1 Non-Filer Program
- 4.19.17.2 Non-Filer Strategy
- 4.19.17.3 Non-Filer Processing
- 4.19.17.4 Non-Filer Penalties
- 4.19.17.5 Undelivered Mail
- 4.19.17.6 Taxpayer Replies
- 4.19.17.7 Closures – Non Examined
NYT – More Federal Agencies Are Using Undercover Operations, Speficially Including the IRS
The Sunday morning front page New York Times article has an interesting summary of IRS agents (presumably special agents from the Criminal Investigation division) activities overseas:
More Federal Agencies Are Using Undercover Operations, by Eric Lichtblau and William Arkinnov (15 Nov. 2014)
. . . At the Internal Revenue Service, dozens of undercover agents chase suspected tax evaders worldwide, by posing as tax preparers, accountants, drug dealers or yacht buyers and more, court records show. . .
It’s possible now that the IRS and Justice Department were dealt big defeats in criminal tax prosecutions of non-resident individuals, it is less likely that the focus of these IRS efforts will be on non-resident U.S. citizens or lawful permanent residents who live throughout the world? See, Part II: U.S. Citizens Residing Outside the U.S. Probably Have Some Solace Re: Acquittals of Foreign Bank Employees
POSTED ON MARCH 2, 2014
No Need to Provide a Negative Definition for Fraud – says Daniel Price, Attorney for IRS: as Reported by TaxAnalysts at USD-PITI
IRS Office of Chief Counsel attorney Daniel Price had some astute observations at the October 30 panel at the University of San Diego School of Law-Procopio International Tax Law Institute annual conference. For specific coverage by tax journalist Amanda Athanasiou of TaxAnalysts, in their Worldwide Tax Daily – IRS Addresses Questions About OVDP and Streamlined Filing
Specifically, Mr. Price said that “Practitioners know what tax fraud is, practitioners know what willful conduct is — the government doesn’t need to provide a negative definition in this context.”
The panelists spent a significant time on the streamlined filing compliance program and how it should be more efficient for taxpayers and the government. As reported in the TaxAnalysts article, Mr. Price “said the Service’s goal is to direct willful individuals with true criminal liability to OVDP and non-willful individuals to the streamlined program.”
See, IRS and Practitioner Comments on the Streamlined NonWillful Certification from the Federal Tax Crimes Blog for further comments and observations.
IRS Releases Clarifying rules for U.S. Citizens Living Outside the U.S. – Re: Streamlined Filing Guidance
In June of this year, the IRS announced a new administrative method by which taxpayers can file late or never filed tax returns and information returns. See, The Risks to USCs and LPRs – Filing Late U.S. Income Tax Returns via the so-called “Streamlined” process
I previously posted a note about the so-called “Streamlined” process the IRS [which are now gone and removed from the IRS website] had announced in June 2012, Why the so-called “Streamlined” Process is “Much Ado About Nothing” – Legally Speaking. I explained that legally speaking, there is no legal protection to the taxpayer provided by this administrative procedure.
The IRS again just announced further clarifications to this program and just released on the IRS website a description of the streamlined filing compliance procedures (“SFCP”) for U.S. taxpayers residing abroad and related “FAQs”. These FAQs can be reviewed here: Specific Instructions for the Streamlined Foreign Offshore Procedures
FAQs are all the rage these days with the IRS, as the government does not take the time or spend the resources to follow the Administrative Procedures Act or similar requirements which are required in order to issue binding rules and regulations. See a previous post regarding these requirements, specifically regarding those who renounce U.S. citizenship or abandon LPR status and have not complied with IRS Notice 2009-85. See,Does IRS Notice 2009-85 regarding expatriation have the “force of law”? Posted on April 14, 2014
Hence, these SFCP are not legally binding on the IRS and they can pick cases as they choose for audit, review and penalty assessment in any manner they think is consistent with the law. Sometimes they do it in a manner that is not consistent with the law.
Of course, most practitioners do not think the IRS will “willy-nilly” ignore their own FAQs procedures for taxpayers who file under the SFCP (at least not across the board); lest taxpayers lose confidence in the IRS.
At the end of the day, any particular U.S. taxpayer residing overseas, should understand carefully these legal implications of the SFCP before “jumping in the pan”; which is hopefully not a “frying pan”.
The Risks to USCs and LPRs – Filing Late U.S. Income Tax Returns via the so-called “Streamlined” process
I previously posted a note about the so-called “Streamlined” process the IRS [which are now gone and removed from the IRS website] had announced in June 2012, Why the so-called “Streamlined” Process is “Much Ado About Nothing” – Legally Speaking. I explained that legally speaking, there is no legal protection to the taxpayer provided by this administrative procedure.
The new “streamlined” procedure from June 2014 does not provide any additional legal protection or finality. To be blunt, the government has used the FBAR as a “trap” for the taxpayer. See, Why the Zwerner FBAR Case is Probably a Pyrrhic Victory for the Government – for USCs and LPRs Living Outside the U.S. (Part II).
If the individual did not check the right box on Schedule B, Part III, therefore the government may well argue they were “willfully blind” of the requirements of filing FBARs, even if they did not know of the filing requirements. The FBAR regulations are extremely complex and I am confident few tax experts anywhere in the world could take a basic exam of what is a “financial interest in” and “signature authority over” such accounts according to these regulations and get more than about 75% (a “C” or maybe “D” grade) of these questions rights. See, Take Caution when Completing a “Tax Organizer” Provided by Your Tax Return Preparer.
The problem with this streamlined process is there is no protection from penalties for failure to file tax returns, failure to file information returns, failure to file FBAR forms; nor from IRS audits of prior years (when the statute of limitations is still open), etc. In short, the IRS (or the Justice Department) can always fully pursue a USC or LPR who has not properly filed U.S. income tax returns, information returns on foreign assets or FBARs for prior years, as provided under the law.
In the meantime, the government will never be required to refund the so-called “5% miscellaneous offshore penalty” (which of course is not a penalty under the law in the first place), pursuant to the very terms of the Certification. The taxpayer waives ” . . . all defenses against and restrictions on the assessment and collection of the [5%] miscellaneous offshore penalty.” It is a one way street.
In addition, the individual is now subjecting themselves to potential greater liability in the event the government ever wants to challenge the certification made under penalties of perjury. Indeed, the certification is not drafted in the words of the taxpayer, but rather the U.S. federal government. Many practitioners have been analyzing and parsing the meaning of “negligence” and “inadvertence” and “mistake” that is a “good faith misunderstanding” of the requirements of the law. It’s entirely unclear how these terms will be interpreted by the government in any particular case. Certainly the vast majority of these cases that are entered into this system will not be challenged; if for no other reason the limited resources of the IRS.
However, there are so many ways they can be challenged against any particular taxpayer. What if a taxpayer threw away the monthly bank statements for the year 2012 regarding a foreign account? Will that be a breach of the Certification? Will all bets be off against the taxpayer? The terms of the certification seem to provide such a result.
I suspect we will see cases where the government will go after (selectively) some taxpayers who enter into the streamlined process. They cases they will select are the ones they think the taxpayer should have gone in under the OVDP. That will be the determination of the government, not the individual taxpayer; and hence can put the taxpayer in further jeopardy.
Finally, the most troubling issue of this program for U.S. residents, is they are agreeing to pay something that does not exist under the law and may have no correlation with any income taxes owing; i.e., the so-called “5% miscellaneous offshore penalty.” Why should a “good faith” taxpayer be paying any portion of their principal to the government, if they made an inadvertent mistake of what are typically very complex provisions in the tax law?
A basic example can demonstrate the injustice of this approach. Taxpayer Pierre, moves from France to the U.S. some 10 years ago. He was an accounting major in France and practiced as an accountant before becoming a business and property manager. His English is horrible and he relies upon a tax return preparer at “J&Q Blockhead Return Preparers” who only speaks English. His return preparer has never asked good questions, about if he has any non-U.S. assets, as he meets with him for 60 minutes each year after taking his W-2 and 1099 forms to the office as requested.
Pierre inherited from his non-U.S. citizen parents accounts in Switzerland and France with a value of US$3M and some real estate outside Paris worth approximately US$2.5M that generates rents monthly. His return preparer always sent his returns with the “No” boxes checked on Schedule B, Part III and never filed FBARs or IRS Form 8938. See, USCs and LPRs residing outside the U.S. – and IRS Form 8938. Pierre was told by his French tax advisers, who are very sophisticated, that the U.S. should not levy tax on his European assets; but rather he should only pay tax in France and Switzerland on these assets. Assume the taxes withheld at source in Europe are greater than the U.S. income tax that would be generated on this income; hence he can fully credit (with the U.S. foreign tax credit) the U.S. federal income tax, except about $700.
Pierre reads the news release on a French news website of the new “streamlined” program announced by the IRS in June 2014. He asks his return preparer about it – who has no idea what he is talking about.
What is Pierre to do? Why should Pierre pay approximately US$325,000 (5% of US$6.5M) to participate in this program when he owes less than US$1,000 of federal income tax?
When Pierre discusses this press release with the manager at “J&Q Blockhead Return Preparers”; the manager says all customers are given a (1) a package of documents and a pamphlet that says “Do you have any foreign assets?” on page 37, paragraph 3; and (2) a free coffee mug with “J&Q Blockhead Return Preparers” prominently displayed. The manager at “J&Q Blockhead Return Preparers” tells Pierre – “you are not going to pin this one on me!”
How is the payment of US$325,000 that is not contemplated under Title 26, a correct result under the law?
If Pierre does not go into the streamlined program and files amended tax returns, will the IRS and Justice Department try to “Zwerner” him (assess multiple year 50% willfulness penalties – arguing he was “willfully blind”)? What if they start an audit and investigation and ask the return preparers at “J&Q Blockhead Return Preparers” about the case with the response being “We tell all our customers they have to report their foreign assets and have it in writing. See our pamphlets and website.”
That is the risk Pierre will have to take; (1) comply with the law under Title 26 as amended returns are contemplated and risk the government will pursue him for 50% willfulness penalties (as the failure to file IRS Form 8938 – should be only for 3 years at $10,000 per year) or (2) be forced into a “streamlined” procedure that will make him pay a large portion of his family inheritance from Europe to the U.S. since he did not file IRS Form 8938 or FBARs.
Does the IRS investigate United States Citizens (USCs) and Lawful Permanent Residents (LPRs) residing overseas?
One issue on the minds of many United States Citizens (USCs) and Lawful Permanent Residents (LPRs) living overseas (overseas from a U.S. perspective – i.e., offshore from a U.S. perspective) is whether the IRS investigates these individuals.
The short answer is yes, with varying degrees of investigation; reviews or audits. Of course, not all individuals are audited or investigated. However, the new data that will be collected under FATCA will be an increasingly valuable source of information for the IRS. In practice, I am increasingly seeing the IRS automatically generate “substitute for returns” for individuals living overseas where no U.S. federal income tax return has been filed. In these cases, the IRS is receiving some type of income information (e.g., from a bank or company) and then issuing the substitute for return. See, IRM regarding “Substitute for return (SFR) and delinquent return procedures were developed to deal with taxpayers who do not file required tax returns.”
There are a host of techniques used by the IRS. A series of posts will discuss some of these techniques. There are also legal limitations imposed on the IRS and Justice Department when assets are located overseas. See, U.S. Enforcement/Collection of Taxes Overseas against USCs and LPRs – Legal Limitations
First, there has been a much greater focus during the last 6 years on foreign, international tax matters. That focus continues under the current Commissioner.
Second, the IRS has been opening offices internationally in different countries. Most recently, an office in Beijing, China.
To learn more about the functions of the Tax Attachés (TA) and Deputy Tax Attachés (DTA) and how they serve in the IRS overseas Posts, see the IRM, 4.30.3 Overseas Posts
Third, with additional information that will be collected under FATCA (starting in 2015 for information for the calendar year 2014), the IRS will have additional information to sort, examine, audit, etc. This will undoubtedly cause more substitute for returns to be automatically generated by the IRS for those individuals who have not been filing U.S. income tax returns.
Fourth, the offshore voluntary disclosure program has been a treasure trove of information for the government regarding non-U.S. banks and non-U.S. advisers (bankers, accountants and attorneys).
Fifth, the deferred prosecution agreements entered into with various Swiss financial institutions will be an additional source of information regarding USCs and LPRs and their accounts and assets.
Sixth, the IRS has developed a number of methods of collecting, sorting and identifying information (including the information that will be collected above). For instance, in the Internal Revenue Manual provides the following, regarding USCs and LPRs, including those living overseas –
Section 18. Locating Taxpayers and their Assets (Cont. 1)
* * *
5.1.18.13.3 (05-20-2008)
Using Passport Information
- Use any new address or new asset information received from the passport office as discussed above.
- See IRM 5.1.12.25, Outgoing Mutual Collection Assistance Requests, if you determine that the taxpayer:
- resides in a treaty country, or
- has assets in a treaty country.
- The Treasury Enforcement Communications System (TECS) is a database maintained by the Department of Homeland Security (DHS), and it is used extensively by the law enforcement community. It contains information about individuals and businesses suspected of, or involved in, violations of federal law.
- For IRS field Collection,TECS provides two sources to help make contact with taxpayers or locate assets :
- Revenue officers can request that delinquent balance due taxpayers be entered into TECS, and the Department of Homeland Security (DHS) will then advise IRS when those taxpayers travel into the United States for business, employment, or personal reasons. The taxpayers entered into TECS for this purpose are on a DHS lookout indicators list. IRS employees must help maintain the TECS database by requesting that appropriate taxpayers be entered into TECS or be deleted from TECS. (See IRM 5.1.18.14.6.1 for criteria for including taxpayers in TECS data base.)
- Revenue officers can also request information housed in TECS on past travel that a taxpayer has made to and from the United States.
- Many of the taxpayers entered into TECS for a DHS lookout indicator are International ones because the cases usually concern persons who reside abroad. However, domestic taxpayers may also be entered into TECS if we have been unable to locate them and if they are believed to travel outside the US . Taxpayers placed on TECS are often not subject to ordinary administrative and judicial collection procedures because they frequently reside outside the jurisdiction of the US Courts. Information derived from placing a taxpayer on TECS can facilitate contact with these taxpayers or provide asset information which, in turn, may facilitate collection of their delinquent liabilities.
Note:
IRM 9.4.2.4.2.5.3, Other IRS Functions, also discusses TECS and prescribes the use of Form 5523, TECS Query Request, to request information from TECS. However, SB/SE Collection Field (FC) employees should not use Form 5523.
- Consider the following example as an illustration of how using TECS to place a taxpayer on the DHS lookout indicator list could help in your casework.
Example: A FC RO has a balance due taxpayer in his/her inventory and he determines the taxpayer resides in Norway. The RO transfers the case to International. The International RO determines the taxpayer is “Unable to Contact” and closes the case from open inventory. The RO requests that the taxpayer be placed on TECS. One year later, the taxpayer travels to the US and initially arrives at an airport in New York. Upon the taxpayer’s arrival, Customs and Border Protection (CBP) informs the TECS Coordinator where the taxpayer is ultimately traveling to, how long the taxpayer plans to stay, and on which flight(s) the taxpayer will be departing. The taxpayer will be staying in Denver for one week. The ROs who had previously worked the case had not been aware of any connection the taxpayer had to Denver. The TECS Coordinator notifies the group manager (GM) in International who is responsible for cases in Norway (the country in which the taxpayer resides). The International GM issues an OI to the Collection group working the location in Denver where the taxpayer is staying. The GM in Denver assigns the case to an RO, and the RO meets with the taxpayer and secures a financial statement. When this happens, the IRS learns about the taxpayer’s assets for the first time as other research methods and attempted contacts were unsuccessful. The RO provides the information to International and closes the OI. After the OI is closed, the International RO does further research once he/she is aware of the Denver nexus. He/she discovers the taxpayer has real property held in the name of a trust and files a nominee lien.
* * *
More posts to follow on specific steps taken regarding investigations by IRS of USCs and LPRs living outside the U.S.
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