Expatriation – IRS Told to Get Tough and Enforce the Law

The Treasury Inspector General for Tax Administration (TIGTA) recently issued its report “More Enforcement and a Centralized Compliance Efforts Are Required for Expatriation Provisions”, (Reference Number: 2020-30-071, September 28,2020) telling the Internal Revenue Service (IRS) that it needs to do more to make sure that the rising number of US citizens and long term residents abandoning their US status are paying up. TIGTA found massive noncompliance with the tax provisions applicable to so-called “expatriates”.  My blog post here details these tax rules, including the so-called “exit tax” and the special “transfer tax” that can apply to certain expatriates (and their loved ones, if they are US persons).

Even if a taxpayer has not fully complied with all of the tax rules and has expatriated, the IRS has implemented a special program to fix mistakes and file missing forms. I have written about that program hereI suspect these “fix-it” procedures will become more popular as the IRS has been cracking down on expatriates through its special “campaign” which was instituted last summerNow with the issuance of TIGTA’s report, the IRS will be working full steam ahead to enforce the expatriation rules more closely. If a taxpayer needs to correct any expatriation-related tax issues, this should be done before the IRS makes any contact since this could preclude favorable treatment.

TIGTA’s Findings

TIGTA examined taxpayer data from 2008-2018.  Below are some of its more interesting findings.

TIGTA found that the IRS did not have a centralized compliance effort aimed at enforcing the expatriation rules. Even though the IRS is equipped with an “expatriate database”, it was not used to identify and/or address expatriates who have not complied with their so-called “exit tax” or other tax obligations. Instead, TIGTA found that the IRS is primarily focused on collecting and publishing data on expatriates in the Federal Register (the so-called “Name and Shame” list, which, it should be noted, is not necessarily complete or accurate).  The numbers published on that list jumped dramatically after the latest major change to the expatriation rules was wrought by the “Heroes Earnings Assistance and Relief Tax Act of 2008” (the “HEART Act”).  Since enactment of the HEART Act, the number of names of expatriates published in the Federal Register increased from 312 in calendar year (CY) 2008 to a peak of 5,405 in CY 2016. The numbers continue to skyrocket.  Misconceptions about the HEART Act changes still linger and I find that many people (including tax professionals), are mistaken about the current rules. For example, it is not true that failing to file Form 8854 means that the individual is still treated as subject to US tax on his worldwide income!

TIGTA examined the IRS database of expatriated individuals in the time frame from June 18, 2008 through December 31, 2018. It contained 41,058 expatriates.  Of these individuals, 16,798 did not file Form 8854.

TIGTA found instances of potential non-filing, underreporting of income, and/or payment compliance issues by expatriates. From a sample of 26 expatriates who did not file a Form 8854, five had potential unreported income over US$6 million. From a sample of 61 expatriates who filed a Form 8854, 15 had potential unreported income over US$17 million. TIGTA also found that expatriates with a high net worth appear to not be paying the exit tax.

TIGTA found that the expatriate database maintained by the IRS is not sufficient to enforce the exit tax and that the examination rate of expatriate last tax returns is “low”.  While some individuals may take this as great news, I remind taxpayers that the statute of limitations may still be open with respect to a tax year if there is unreported income or a failure to file any of the numerous tax information forms required with respect to foreign assets (e.g., Form 8938 is one such form, Form 926 is another).  My blog post here discusses these thorny statute of limitations issues.  Expatriation does not take away the tax problems!

Why It’s a Mess

Some information contained in the TIGTA report helps to explain why enforcement of the expatriation tax rules is not working as it should. When a taxpayer expatriates, a Certificate of Loss of Nationality of the United States (CLN), is completed by the State Department. The State Department transmits the CLN forms to the IRS. The IRS’ Small Business/Self-Employed (SB/SE) Division’s Examination function assigned the responsibility for compiling information related to expatriates to unit tax examiners at the IRS Low-Income Housing Credit (LIHC) “Philadelphia Campus”.  These examiners enter the taxpayer name, the date the CLN was received, the expatriate’s address, and expatriation date into the “expatriate database”. Nothing else is apparently input into the database. At one point, the SB/SE Division had the “expectation” that the LIHC unit would take tax compliance actions as well; however, the LIHC unit at the Philadelphia Campus does not take compliance actions!  So, it sounds as if the right hand did not know what the left hand was doing and compliance actions were essentially left in limbo.

For tax purposes, the usefulness of the CLN is limited because it does not contain the Taxpayer Identification Number, i.e., Social Security Number (SSN). This number is essential for the IRS to verify a taxpayer’s filing and payment compliance. This is a very big reason that tax compliance actions for expatriates has sat in an apparent limbo.

All of these problems were worsened because there was no coordination within the agency.  The IRS has not developed any Internal Revenue Manual procedures related to expatriates.

Given all of these factors, small wonder it’s a mess.

TIGTA Recommendations – IRS Agrees to Implement

Before detailing the TIGTA recommendations, I will point out that the IRS agreed with the TIGTA recommendations. This means that we will likely see the IRS implementing these changes and that enforcement of the expatriation tax rules will become far more robust.  Even if a taxpayer expatriated years ago, if the statute of limitations remains open, the IRS can come calling despite the passage of time.

TIGTA recommended that the IRS and Department of State coordinate with information exchange on those expatriating. Specifically, TIGTA recommended that the IRS contact the Department of State, via the Federal Intergovernmental Program, for an SSN data field to be added to the CLN and to explore the feasibility of obtaining the CLN electronically.   Thus, we may soon see that the CLN will contain the taxpayer’s SSN!  If the CLN is linked with the expatriate’s SSN, it is obvious that tax return compliance can be very easily checked.

TIGTA recommended that the IRS update the Letter 2399C “Failure to File – Initial Form 8854”, and Letter 4135C, “Failure to Respond to Initial Form 8854 Request”, for compliance under the HEART Act, and develop Internal Revenue Manual procedures to use these letters to obtain Form 8854 when a CLN is received from the State Department but no Form 8854 is received from the taxpayer.

TIGTA advised that IRS should evaluate the information reported on Form 8854 and determine what data fields should be added to the expatriate database to ensure tax compliance of taxpayers who expatriate, e.g., Form 8854, Part IV, Section B, Property Owned on Date of Expatriation.  In addition it should develop Internal Revenue Manual procedures for transcribing Form 8854 data, correcting Form 8854 data when information as filed by expatriates is missing or incomplete, and preparing analysis, as needed, to determine if the expatriate is a “covered expatriate” and subject to the exit tax and other consequences of such status.

TIGTA also advised that the IRS should establish a process to compile information on all expatriates whether they filed Form 8854 with the Philadelphia Campus and use this information to identify the highest risk expatriate returns for tax compliance.

Take Action Now

I am happy to assist in rectifying tax problems that may be lurking in the background of prior years’ returns or to advise on expatriation matters going forward.  Relief from “covered expatriate” status is well worth the effort.  This is especially true if a taxpayer has US family members who may receive gifts or bequests from the expatriate in the future.  No taxpayer should let “covered expatriate” status shrink the future gifts or inheritance provided to loved ones by the whopping 40% transfer tax.

Posted October 8, 2020

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