With the impending Common Reporting Standard, new Tax Information Exchange Agreements with the US, and well-publicized investigations and voluntary disclosures, there is clearly no shortage of information about noncompliant US taxpayers flowing to the US Internal Revenue Service (IRS). Unknown to many people before is that the IRS is now working with the Department of Homeland Security to flag, detain and interview Americans at US ports, and the Department of State can revoke existing US passports and deny applications for new ones – serious reasons for concern among Americans overseas
By Laurence Ho and George McCormick
American taxpayers who live overseas have become increasingly aware of the stringent US federal tax and reporting obligations attached to their worldwide income and assets. While it is conceivable that an American may relocate abroad without a complete understanding of tax reporting requirements, a passive attitude towards US tax and reporting compliance is no longer excusable, considering the significant media attention given to bank secrecy issues and Internal Revenue Service’s (IRS) efforts taken to ensure compliance on a global scale.
The Foreign Account Tax Compliance Act (FATCA), enacted in 2010 to increase disclosure of foreign assets owned by US citizens and permanent residents, has already resulted in many Americans getting singled out – and sometimes even being denied banking service – by non-US banks overseas. That’s because foreign banking institutions are required to report information of any US individual as a bank account holder under the law.
Along with the impending Common Reporting Standard, new Tax Information Exchange Agreements with the US, well-publicized investigations and voluntary disclosures as well as other global developments on tackling tax evasion, there is clearly no shortage of information flowing to the IRS. Now, the IRS has turned to other new “tools” for enforcement and collection of outstanding tax debts, and Americans who are noncompliant with US reporting requirements seemingly have few places to hide.
What’s little known among Americans is the ability of the IRS (since 2012) to work with the US Department of Homeland Security (DHS) to flag, detain and interview noncompliant US taxpayers to help enforce a tax debt. Further, under new provisions of the Fixing America’s Surface Transportation (FAST) Act signed into law on 4th December 2015, the Department of State is now authorized to revoke existing US passports and deny applications for new US passports to Americans with serious tax deficiencies.
American expats who believe they are out of reach of the IRS simply for the fact that they do not plan to return and live in the US may be in for an unpleasant surprise. Customs and Border Protection (CBP) agents are now legally able to detain and question an American at US Customs checkpoints while traveling to (or transiting through) the US. More alarmingly is the possibility of revocation or denial of an American’s US passport – a scenario which could disrupt employment and travel plans, particularly for someone who does not hold another passport.
Detention at US Customs
Historically, US immigration authorities did not have access to IRS records, and vice versa, unless tax deficiencies became a criminal matter. However, the IRS is now given access to the database of CBP, including the Treasury Enforcement Communication System (TECS). If a US taxpayer residing outside the US has a deficiency of US$50,000 or more and the IRS has filed a Notice of Federal Tax Lien, an IRS agent may flag the taxpayer in TECS or obtain the taxpayer’s travel information from the TECS database. The taxpayer, therefore, may be detained by a CBP agent for questioning upon entering or leaving the US.
Here is an example of how it works as explained in the IRS’s Internal Revenue Manual: a taxpayer with a balance due and an overseas address on file is contacted by an IRS agent; if the taxpayer refuses to cooperate, he or she is placed in TECS. Upon the taxpayer’s arrival when traveling to the US, the IRS is informed of the taxpayer’s ultimate destination, length of stay in the US and flight itinerary.
At the port of entry, DHS also secures the taxpayer’s residence address and cellular phone number in the US where a domestic agent is to meet with the taxpayer and secure a payment for taxes due.
The IRS can use TECS to secure payment from a taxpayer who refuses payment but travels to the US. The result may be similar under less egregious circumstances where a US taxpayer has submitted US tax filings, moved abroad without notifying the IRS of a change of address, and missed an IRS Notice of Deficiency sent to an outdated address. In such a case, the taxpayer may have no idea about a delinquent tax debt until he is detained by CBP when entering the US.
In recent years, there have been numerous reports of delinquent taxpayers being detained and questioned by CBP and then contacted by IRS agents while traveling to the US. This can be avoided by staying in compliance with your US tax filings. A US taxpayer who has fallen behind in filings, with proper advice, can take steps to avoid inclusion in the TECS database, which may involve entering into an installment agreement or offer in compromise with the IRS.
The concept of revoking or denying passports for Americans with outstanding tax deficiencies has previously been considered. The General Accountability Office (GAO) issued a report in 2011 on the subject and highlighted the fact that US passports continued to be issued to individuals who, at one point in 2008, collectively owed US$5.8 billion in unpaid federal taxes. It reasoned that the possible denial of US passport issuance could increase US tax compliance among Americans, particularly those residing abroad.
However, in the absence of new legislation, agencies of the executive branch were restrained from acting on the report’s findings because, in part, the IRS was not permitted to share taxpayer information. The FAST Act changed all that: the IRS is now authorized to inform the Department of State about US taxpayers with tax due, and the Department of State can revoke a US individual’s passport or deny an application for a new passport – a reason for taxpayers living abroad to address their tax debt.
Now, under the FAST Act, the IRS has the authority to disclose information to the Department of State on the ground of individual tax debt. Once informed by the IRS, the Department of State will not issue a passport and may revoke a previously issued passport to any individual who has a “seriously delinquent tax debt.” It could result in a taxpayer being denied entry to a foreign country and immediately returned to the US. For an expat residing abroad on a work permit who depends on the validity of a passport, this is a serious cause for concern.
The law defines “seriously delinquent tax debt” as an unpaid, legally enforceable federal tax liability of greater than US$50,000 and either (i) a Notice of Federal Tax Lien has been filed and the IRS appeals process has been exhausted, or (ii) a levy was made due to neglect or refusal to pay a notice and demand for payment. This is a low threshold considering the tax debt includes interest and penalties assessed against a taxpayer, which can quickly accrue on modest tax deficiencies.
It is important to note that the potential revocation or denial of a US passport under the terms of the FAST Act does not affect the underlying status of American citizenship. The new enforcement mechanism, instead, is intended to deny the benefits of travelling on a US passport while encouraging US tax compliance.
Given all of these circumstances, it is not surprising that the number of individuals considering renouncing US citizenship has grown, but that assumes the individual has a second passport. Moreover, the renunciation process itself should not be undertaken lightly as it requires careful consideration, clear intent and a formal interview with the nearest US Embassy or Consulate. Importantly, the expatriating individual must certify his US tax compliance under penalties of perjury.
The global trend towards transparency means that information regarding noncompliant US taxpayers will flow to the IRS, and the IRS is arming itself with new enforcement and collection tools. Americans with tax issues have a limited window of opportunity to come into compliance under various voluntary disclosure programs before the IRS finds them. There is no better time to take a proactive and diligent approach to US tax affairs. Otherwise, they may be given a rude awakening the next time they step off their long transpacific flight.
Laurence Ho is a partner in the US Wealth Planning department of Withers and focuses on international tax, trust and estate planning for families with US connections or investing into the US. More specifically, he advises individuals on international estate and probate planning, foreign trust and holding company structures, and tax planning related to expatriation from and immigration to the US. He also counsels individuals in connection with their IRS tax audits/examinations, voluntary disclosures and foreign bank account reporting issues. He holds a BBA from the University of Michigan and a JD from Boston College Law School, as well as an LLM from New York University’s School of Law.
George McCormick is a Hong Kong-based registered foreign lawyer with Withers and provides tax, trust and estate planning advice for individuals and families from a US and international perspective. He also advises on tax compliance, expatriation and pre-immigration to the US. McCormick holds a BA in Economics from the University of Florida, a JD from Washington and Lee University’s School of Law, and an LLM in Taxation from New York University’s School of Law. He is co-author of an article titled Bank Leumi account holders under IRS Scrutiny, published in Jewish Times Asia, April 2015.