Why TIGTA Suggests Audits of Incomplete IRS Expatriation Forms

Why TIGTA Recommends IRS Increase Expatriation Audits

TIGTA Recommends IRS Increase Expatriation Audits

When a U.S. Citizen or Long-Term Lawful Permanent Resident decides to formally terminate their relationship with the United States – they will either relinquish their Green Card (I-407) or renounce their US Citizenship (DS Form 4079-4083). When an expatriate is determined to be a “Covered Expatriate,” then they may also be subject to an Exit Tax (aka expatriation tax) at the time they renounce or relinquish their US status. As was seen recently in the case of Tinkov, Taxpayers will oftentimes go to great lengths to avoid paying the exit tax – which in some cases may result in tens of millions of dollars of taxes on income that has not actually been recognized. Let’s take a look at what the Government says about it:

“Expatriation of Individuals” International Compliance Enforcement Initiative

• • • Practice Area: Withholding & International Individual Compliance

    • Lead Executive: Deborah Palacheck, Director of Withholding & International Individual Compliance

    • Campaign Point of Contact: Ursula Gee

      • U.S. citizens and long-term residents (lawful permanent residents in eight out of the last 15 taxable years) who expatriated on or after June 17, 2008, may not have met their filing requirements or tax obligations. The Internal Revenue Service will address noncompliance through a variety of treatment streams, including outreach, soft letters, and examination.

TIGTA September 28, 2020 Expatriation Report

In their report, TIGTA (Treasury Inspector General For Tax Administration) determined the IRS has not been taking sufficient enforcement actions on matters involving expatriation, exit tax, and filing Form 8854. Here are some of the highlights of the report:

Many Expatriates Are Not Filing Form 8854

• • • With the Philadelphia Campus Pursuant to I.R.C. § 6039G, individuals who expatriate are required to send a statement to the IRS (Form 8854) detailing the individual’s income, assets, and liabilities. Expatriates use Form 8854 to certify compliance with tax obligations in the five years before expatriation. Form 8854 is critical in determining whether the expatriate is a covered expatriate who is required to comply with I.R.C. § 877A.

    • Figure 2 shows that, in a 10-year period, from June 2008 to December 2018, 16,798 (or 41 percent) of those individuals who received the CLNs did not send a copy of Form 8854 to the Philadelphia Campus as required.

    • These 16,798 expatriates failed to file a Form 8854 with the Philadelphia Campus to report their prior income tax liabilities and net worth and certify compliance.

    • We identified these expatriates in the expatriate database via analysis that primarily focused on the data field “8854 REC’D” and then determined these records had data field “DATE CLN REC’D” (which is the date the Form DS-4083 (CLN) was received by the IRS from the State Department). By not filing Form 8854, these taxpayers are considered as not certifying their tax compliance as required and are also a covered expatriate under the law

Some Expatriates With High Net Worth Appear to Not Be Paying Their Exit Tax Filing

• • • Form 8854 only satisfies the expatriate’s information reporting obligations under I.R.C. § 6039G. Expatriates must still compute any tax due (including I.R.C. § 877A exit tax, if applicable) and file applicable Federal income tax returns.

    • Specifically, 24,260 expatriates filed a Form 8854 with the Philadelphia Campus to report their five prior income tax liabilities and net worth from June 18, 2008, through December 31, 2018. For the 24,260 who filed a Form 8854:25 • 712 (3 percent) were covered expatriates based on the tax liability rule, of which 68 expatriated during the period from January 1, 2017, through December 31, 2018, with average income tax liability for the five preceding taxable years ending before expatriation date over $570,000.

    • Of the 68 taxpayers, we selected 26 cases reporting a combined net worth of $925 million, capital gains of over $126.3 million, and over $584,000 in five-year average tax liability. •

      • 2,222 (9 percent) were covered expatriates based on net worth over $2 million, of which 347 expatriated in the period from January 1, 2017, through December 31, 2018.

    •  These populations are not mutually exclusive of each other as it is possible for an individual to be included in each of the two categories. For example, a person can average a taxable net income of $165,000 or more for the five years preceding taxable years before expatriation and have a self-reported net worth of $2,000,000 or greater.

    • More Enforcement and a Centralized Compliance Effort Are Required for Expatriation Provisions total net worth of these expatriates was over $4 billion. Of the 347, we selected 35 cases reporting a combined net worth of $289 million and capital gains of nearly $3.3 million.

    • We reviewed these 61 cases for compliance with I.R.C. § 887A deemed sale of worldwide assets and potential tax noncompliance issues, such as nonfiling, underreporting, and/or payment issues. As we previously stated, Form 8854, Part IV, Section B, Line 8, includes the expatriate’s calculation of the gain or loss on the deemed sale. Further, the information on Form 8854, Part IV, is not transcribed on the expatriate database.

    • We used information return documents for actual sales and compared to the expatriate’s Form 1040 or Form 1040-NR last tax return. These taxpayers reported a combined net worth of $1.2 billion on Form 8854 and capital gains of $129.6 million, which were identified from either Form 1040 or Form 1040-NR as follows:

      • Capital Gain or Loss – Line 14.

      • Other Gains or Losses – Line 15.

    • Without an examination of the expatriates’ last tax return or their calculation of the gain or loss on the deemed sale from the Form 8854, we cannot determine with certainty whether the taxpayers who reported capital gains or losses on Form 1040 or Form 1040-NR are in compliance under I.R.C. § 877A. For the 61 cases, we determined that 39 cases reported gains or losses and 22 cases did not report any gain or loss. Specifically, for the 26 tax liability cases:

      • • In 12 cases, the expatriates reported combined net worth of nearly $852 million and capital gains of $126 million, or 15 percent in capital gains compared to net worth.

        • In 14 cases, the expatriates either did not report any gain on Form 1040 or Form 1040-NR yet reported a combined net worth over $73 million (an average of over $5 million) on their respective Form 8854 or did not file a tax return. For the 35 net worth cases:

        • In 29 cases, the expatriates reported combined net worth of nearly $224 million and capital gains of nearly $3.3 million, or nearly 1 percent in capital gains compared to net worth.

        • In six cases, the expatriates did not report any gain on Form 1040 or Form 1040-NR yet reported a combined net worth over $65 million (an average of nearly $10 million) on their respective Form 8854. However, the capital gains reported were based on actual sales of assets and not from the deemed sale provisions of I.R.C. § 877A. Given the high net worth of these 61 covered expatriates with combined net worth of $1.2 billion, it appears that these taxpayers failed to pay the required exit tax.

      • The expatriate is also allowed to reduce net gain by a specified amount ($711,000 for TY 2018) that is adjusted for inflation but not below zero. At a minimum, the 20 of 61 taxpayers who failed to report any gains or losses (14 tax liability and six net worth cases) are not in compliance with I.R.C. § 877A and may have owed exit tax. It is critical that the IRS establish an effective strategy to strengthen enforcement efforts pertaining to the exit tax by actively identifying individuals who relinquish citizenship or terminate residency.

      • Similar to prior CLN sample results, we also found instances of potential nonfiling and underreporting when a Form 8854 was received by the Philadelphia Campus. Specifically, we found that, in 19 cases of the 61 cases, the expatriate did not report taxable income and/or did not file a subsequent year tax return.

      • The potential unreported income is based on information return documents, e.g., interest, dividends, capital gains, filed with the IRS. 

      • More Enforcement and a Centralized Compliance Effort Are Required for Expatriation Provisions these cases with IRS executives, they had concerns with four cases that included real estate sale transactions.

      • Specifically, that real estate sale transaction information returns do not include the cost basis and that taxpayers who used the property as a personal residence may qualify to exclude up to $250,000 or $500,000 for married filing jointly.

      • After using an aggregate threshold of $25,000 for the information return documents, and excluding cases with real estate sales transactions of nearly $5 million, we determined that 15 of 61 cases had potential unreported income over $17 million of which seven had an unfiled return in the subsequent tax year. These cases were not identified because the expatriate database information is not used to identify potential unreported inco

TIGTA Compliance Recommendations Explained

TIGTA recommended that the IRS:

• • • 1) contact the Department of State, via the Federal Intergovernmental Program, for the Social Security Number data field to be added to the Form DS-4083, Certificate of Loss of Nationality of the United States, and explore the feasibility of obtaining the Certificate of Loss of Nationality electronically;

    • 2) 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;

    • 3) 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;

    • 4) 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

    • 5) 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.

  • The IRS agreed with TIGTA’s recommendations.

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