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Expat Execution – TIGTA Audit Recommends IRS Increase Its Enforcement Efforts



Expat Execution - TIGTA Audit Recommends IRS Increase Its Enforcement Efforts

One might not expect it, but the United States has experienced an increasing trend in number of expatriates in the last decade. Each year, thousands of individual taxpayers relinquished either their U.S. citizenship or permanent resident status, peaking in 2016 with 5,405 total expatriates. Expatriates are required to comply with specific tax provisions. The Treasury Inspector General for Tax Administration (“TIGTA”) ultimately performed an audit to assess the reliability and effectiveness of the Internal Revenue Service’s efforts to ensure taxpayer (or former taxpayer) compliance.

Sections 877 and 877A, Generally

Sections 877 and 877A of the Internal Revenue Code govern the tax provisions related to expatriates. Under these provisions, certain taxpayers who relinquish their U.S. citizenship or long-term residents who terminate their U.S. residency may be subject to certain tax consequences. Specifically, such taxpayers must certify on Form 8854, Initial and Annual Expatriation Statement, their compliance with all U.S. federal tax laws for the five years prior to the date of expatriation and determine whether they are “covered expatriates.”

For purposes of Sections 877 and 877A, a “covered expatriate” is an individual who expatriated on or after June 17, 2008, and meets one of the following requirements:[1]

  • Tax Liability Rule – The average annual income tax of the individual for the five years ending before the date of expatriation or termination of residency is more than a certain amount, which is adjusted for inflation (e.g., for the tax year ending December 31, 2018, $165,000);[2]
  • Net-Worth Rule – The net worth of the individual as of the date of expatriation or termination of residency is $2 million or more;[3] or
  • Certification Rule – The individual fails to certify under penalty of perjury on Form 8854 that he or she met his or her U.S. federal tax filing obligations for the five years preceding the date of expatriation or termination of residency.[4]

If an individual is determined to be a “covered expatriate,” he or she is subject to an “exit” tax. Generally speaking, this means the individual is deemed to have sold all of his or her worldwide property for its fair market value as of the day before expatriation, and the unrealized gain from such deemed sale is subject to federal income tax.[5] However, there are special provisions in determining the individual’s exit tax, such as net gain reductions, deferred compensation items, specified tax-deferred accounts, etc.

TIGTA’s Final Audit Report – September 28, 2020

TIGTA performed an audit of the Internal Revenue Service’s controls related to the enforcement of the relevant tax provisions to expatriates. Since the HEART Act of 2008 was enacted, a rising number of individual taxpayers have relinquished their U.S. citizenship or resident status. As a result, TIGTA set out to determine the effectiveness of the IRS’s efforts to ensure compliance.

Among its findings, TIGTA noted the following:

Expatriates are required to file Form 8854, Initial and Annual Expatriation Statement, to certify that they have been in compliance with all Federal tax laws during the five years preceding the year of expatriation. TIGTA found that the IRS database of expatriates was incomplete for 16,798 expatriates who did not file Form 8854. In addition, 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 $6 million. From a sample of 61 expatriates who filed a Form 8854, 15 had potential unreported income over $17 million. Lastly, TIGTA also found that expatriates with high net worth appear to not be paying their exit tax. Without a centralized compliance effort, Congress’s attempts to create disincentives to expatriate via Section 877A will not be effective.[6]

Moreover, TIGTA developed several recommendations with which the IRS agreed:

[The IRS should] 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 Certificate of Loss of Nationality is received and no Form 8854; . . . 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; . . . 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 tax under Internal Revenue Code Section 877A; and . . . establish a process to compile information on all expatriates whether they filed Form 8854 with their individual tax return Form 1040-NR, U.S. Nonresident Alien Income Tax Return, or filed Form 8854 with the Philadelphia Campus and use this information to identify the highest risk expatriate returns for tax compliance.[7]

For more details related to TIGTA’s audit procedures and findings, see TIGTA’s Final Audit Report.

Conclusion

Based on TIGTA’s final audit report, it is apparent that the Internal Revenue Service intends to implement new processes and procedures to ensure future compliance with expatriate tax provisions—Sections 877 and 877A. Taxpayers who intend to abandon their U.S. citizenship or permanent resident status should be mindful of their reporting requirements and potential tax obligations. In short, an overhaul in the IRS’s compliance efforts may lead to actual, cognizable disincentives for taxpayers seeking expatriation for tax reasons.

Have a question? Contact Zachary Montgomery, Freeman Law, Frisco, Texas.er

[1] See I.R.C. § 877A(g)(1).

[2] See I.R.C. § 877(a)(2)(A).

[3] See I.R.C. § 877(a)(2)(B).

[4] See I.R.C. § 877(a)(2)(C).

[5] See I.R.C. § 877A.

[6] TIGTA, More Enforcement and a Centralized Compliance Effort Are Required for Expatriation Provisions (Sept. 28, 2020).

[7] Id.

Zachary Montgomery

Zachary Montgomery is a dual-credentialed attorney and CPA. He practices in the area of federal and state tax litigation, white-collar defense, business and tax planning, and litigation. Montgomery has experience representing both businesses and individuals in federal tax controversies, including appeals, examinations, penalty abatement and collection matters. He has also represented taxpayers—from small organizations to Fortune 500 companies—with Texas franchise tax refund claims, audits, penalty abatement, and corporate structuring.

Montgomery is a graduate of the University of Virginia School of Law where he focused his studies on corporate and tax law and served on the editorial board of the Virginia Tax Review. Prior to joining the firm, he gained experience with PricewaterhouseCoopers, LLP, and a regional firm, focusing on federal and state tax controversies. His previous experience also includes Deloitte & Touche and a judicial student clerkship with the First Court of Appeals of Texas.

Montgomery is a graduate of Texas A&M University, where he graduated Summa Cum Laude and received his B.B.A. with a double major in Accounting and Business Honors and his M.S. in Management Information Systems. While attending Texas A&M, he developed his business acumen, working as an enterprise risk consultant and financial analyst.

Montgomery is a member of the Dallas Bar Association, Association of Certified Fraud Examiners (ACFE), and Texas Society of CPAs (TSCPA), and serves on the TSCPA Relations with IRS Committee.

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3 thoughts on “Expat Execution – TIGTA Audit Recommends IRS Increase Its Enforcement Efforts

  1. Avatar David Johnstone says:

    Zachary,

    Thank you for putting out this good article.

    I would like to point out two additional points that I have not seen in your article. I believe that these two points are relevant to your conclusion that “an overhaul in the IRS’s compliance efforts may lead to actual, cognizable disincentives for taxpayers seeking expatriation for tax reasons.”

    In summary, those two points are 1) that the report’s data and the IRS management response indicate that the IRS doubts that additional compliance or enforcement efforts will lead to any additional revenue, and 2) that the proposed intergovernmental request to the State Department for the addition of a Social Security Number (SSN) field on the renunciation form could lead to the effective revocation of the right of some citizens to expatriate (e.g., individuals without an SSN), which would not only contravene the long-standing position and law of the United States that renunciation of citizenship is a fundamental right, but also contradict the relief procedures that were enacted by the IRS in September 2019 for certain former citizens. In the worst case, a mandatory requirement for a SSN on the renunciation form could constitute a human rights violation.

    In more detail, these points can be stated as follows:

    1. The underlying data analyzed in TIGTA’s report and the IRS management’s own assessment show that it is doubtful that the suggested additional enforcement actions will lead to any additional revenues for the IRS.

    The report’s own data show that, of the 41% minority of renunciants (16,798 individuals) who did not send a copy of form 8854 to the IRS’s Philadelphia campus, TIGTA could only identify 55 individuals who may have owed tax under section 877A, under the tax liability test. 55 out of 16,798 cases in which the Philadelphia campus did not have a form 8854 on file works out only to 0.3% of non-filers!

    The 26-person sample you mention was selected from this group of 55 individuals. Thus, when TIGTA writes that it found that 5 people out of the 26-person sample appeared to owe some tax under section 877A, what this really means is that the tax evasion rate appears to be only 0.06%!

    Based on this outcome alone, it would appear to be difficult to justify committing significant resources to this apparently marginal issue. Indeed, the IRS management response appears to admit as much: “while the forms you reviewed included some reporting discrepancies, it does not necessarily follow that an examination of the relevant taxpayers will result in an increase of revenue”. (cf. Appendix IX: Management’s Response to the Draft Report)

    Furthermore, nowhere in the report are the results compared to the tax collected under section 877A. Perhaps TIGTA will make this comparison part of a follow-up analysis. In any event, even if the tax evasion rate is higher than the percentages calculated above, and even if that evasion rate is higher than the domestic rate, one can only presume that the IRS management knew the total tax collected under section 877A, and that such information influenced its response expressing doubt in the potential for additional revenue.

    Finally, due to the likely demographic of many, if not most, form 8854 non-filers, it seems equally likely that if the IRS introduces new or more onerous requirements or penalties, for example, they it could create more disincentives for many renunciants to file anything at all with the IRS or to file truthfully. For instance, there is a significant percentage of renunciants who are either poor (e.g., low income or having assets under the section 877A deduction threshold) or whose connection with the US is so tenuous that it does not matter to them if they become covered expatriates upon renunciation (e.g., no US-source income, no US-situated assets, and no US heirs). Surely such individuals are over-represented among the pool of form 8854 non-filers. Indeed, the IRS appears to recognize the existence of this set of renunciants since it provided relief procedures to some of them in September 2019 (https://www.irs.gov/individuals/international-taxpayers/relief-procedures-for-certain-former-citizens) which explicitly provide for certain persons to make a retroactive filing without a SSN! This group of renunciants, which would undoubtedly include all so-called Accidental Americans has nothing to lose by not filing form 8854, so presumably, many if not most of the people likely to omit to file form 8854 will continue to omit to file this form no matter what the IRS says or does. If one either cannot afford to file form 8854 (maybe one is receiving welfare benefits where one lives, and one’s biggest financial priority is being able to keep one’s bank account open) or there is no downside for not filing it because one has no connection with the US, then why would one file form 8854 at all? Especially if doing so means potentially paying thousands of dollars on top of the highest-in-the-world renunciation fee to prepare a form that shows no tax liability?

    2. The proposed intergovernmental request to the State Department for the addition of a Social Security Number (SSN) field on the renunciation form could lead to the effective revocation of the right of some citizens to expatriate (e.g., individuals without an SSN), which would not only contravene the long-standing position and law of the United States that renunciation of citizenship is a fundamental right, but also contradict the relief procedures that were enacted by the IRS in September 2019 for certain former citizens.

    Since at least the 19th century, the United States has held that the right to expatriate is a fundamental right that should be available to all individuals. The United States insisted on this so that new immigrants could become United States citizens and abandon the citizenship of their countries of origin. More recently, in 1974, the United States enacted the still-in-force and still-enforced Jackson-Vanik Act designed to punish foreign nations that restricted the right of their citizens to emigrate. Two of the provisions target the imposition of more-than-nominal charges, taxes, or other fees on individuals desiring to emigrate.

    At present, the fee to relinquish or renounce one’s US citizenship (i.e., the fee imposed on US citizens wishing to emigrate) is $2,350. This compares to a $0 fee before 2008, and a $450 fee until 2014. In addition to this fee, there is an exit tax imposed under section 877A, which, in addition to the 2008 HEART ACT that amended this section, is the underlying text relevant to TIGTA’s recent report.

    While it is arguable that these provisions would violate the Jackson-Vanik Act if they were enforced by any country besides the United States, the relevant point in TIGTA’s September 2020 report is what effect the inclusion by the State Department of a SSN field on the renunciation form will have on the right of US citizens to expatriate.

    If the SSN field on the renunciation form is made mandatory, then this will clearly prevent some individuals without a SSN from renouncing at all. Such a requirement would not only contradict long-standing US law and international human rights laws, but it would contradict the relief measures granted by the IRS to certain former citizens just last year that explicitly allow individuals to file certain forms with the IRS, including previous year 1040s, without a SSN!

    Furthermore, if one must now obtain a SSN for the sole purpose of renunciation, then due to the difficulty of getting an SSN for individuals living abroad who don’t have one, typically people who left the US or were born abroad to US parents pre-1986, as well as the attending intrusive requirements to prove that such individuals have not lived in the US, then it may increase the waiting time to renounce by one year or more. In addition, it may considerably increase the total cost of renunciation due to the SSN process, and it may even have the effect of prohibiting those who do not have school and tax records for every month and year since they were babies, or the means to pay for the translation of such a large number of documents, from expatriating.

    Finally, this risk is not just a theoretical possibility. US consulates around the world continue to operate under reduced capacity due to the ongoing pandemic. This means that individuals who would be requesting a SSN in order to expatriate are having to wait longer to obtain the documents they need in their local countries, if they are even available, to submit their applications and that the Social Security Administration is taking longer to process the resulting applications. In addition, many if not most consulates are still closed for renunciation appointments, given that State Department officials openly acknowledge that they allocate the lowest priority to that service. Thus, many persons, especially Accidental Americans, who want to renounce their US citizenship will find themselves unable to do so before the expiration of the 18-month grace period (from January 1, 2020) for foreign financial institutions to obtain SSNs from all US Person account holders under FATCA and corresponding IGAs, at the end of which, the US will be able to impose 30% penalties on “non-compliant” institutions. Hence, many individuals without a SSN for legitimate reasons will find that they could legally have their local bank accounts closed as early as July 1, 2021, without any possibility of renouncing their US citizenship in time to keep their accounts open. Indeed, since Treasury refuses to confirm in a legally binding way that it will honor the forementioned grace period, many individuals, particularly in the Netherlands, are already receiving letters from their banks informing them of impending account closure. In the worst case, there could be individuals who lack the proof of non-residence in the US to even obtain a SSN, since the SSA requires proof of residence for every year, and in some instances, for every month or day, that an individual has not lived in the US (school records, tax records, pay slips, bills, etc.).

    For the above reasons, one would hope that the proposed intergovernmental request to the State Department to include a SSN field on the renunciation form will specify that this field will be optional.

    To conclude, most of TIGTA’s proposals would appear to be common-sensical from the point of view of Treasury and the IRS. However, the devil is in the details with respect to the two points I discussed above. It does not appear to be obvious that additional enforcement or examinations will lead to additional revenue, and it does not appear that the inclusion of a SSN field on the renunciation form will protect the right of US citizens to expatriate. Thus, one doubts whether these proposals are either cost-effective or proportional to their objectives.

    Looking at these points from a policy maker’s perspective, if I were at the State Department, I would push back very hard on any request for the mandatory inclusion of a SSN on the renunciation form, and I would evaluate the legality and proportionality of the optional inclusion of this field. If I were at the Treasury or the IRS, I would want to ensure that any changes made to current practice do not provide disincentives from filing or produce the unintended effect of lowered revenues. I would also ensure that any changes do not add unreasonable hurdles to expatriating or preclude the possibility for individuals to expatriate at all, which would lead to a clear human rights violation.

  2. Avatar Karen says:

    Thank you, Zachary, for an informative article. And thanks to David for such a comprehensive response.

    David makes an excellent point that the right to change one’s citizenship is one of the basic human rights enshrined in several international human rights agreements, including some that the US has signed on to. The TIGTA report at one point states that 877A is meant to discourage expatriation (not just tax-motivated expatriation) – this is quite concerning. In that light, I fail to see how the State Department could insist on a Social Security Number before processing a renunciation request.

    Furthermore, TIGTA (and Congress and the IRS) fail to understand the most insidious aspect of the 877A exit tax – it targets assets acquired overseas and, for many long-term nonresident citizens, assets acquired AFTER emigrating from the US, which should never have been subject to the US tax system in the first place. For many emigrants it will take years to acquire the second citizenship needed to renounce US citizenship without being left stateless. Many of the 9,643 former citizens for whom the IRS was unable to identify an SSN probably didn’t have one – or they left the US decades ago so that their name and data are no longer accessible in the IRS system. Extrapolating the noncompliance rate from those where SSNs were identified to the rest of the sample is not justified.

  3. Avatar Frank Smith says:

    The recommedation that the State Department require an SSN as a condition of renunciation suggest one thing: that the inspector general had no idea that a significant percentage of those renouncing have no connection to the US – no assets or income sources in the US. These individuals have no good reason to enter into US tax compliance in order to give up US citizenship.

    My take on this is that the IRS will say “thank you very much” and completely ignore the recommendations. They know full well that there is absolutely no ROI in going after foreign residents when there is no effective means to either determine what if anything might be owed, and to then collect it.

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