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MSP #16: Foreign Account Tax Compliance (FATCA)

The IRS’s Approach to International Tax Administration Unnecessarily Burdens Impacted Parties, Wastes Resources, and Fails to Protect Taxpayer Rights

TAS Recommendations and IRS Responses

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1.

TAS RECOMMENDATION #16-1

Implement policies and procedures for reviewing and issuing Chapter 3 and Chapter 4 refund claims that mirror those processes currently in place with respect to domestic taxpayers under IRC § 31 and related regulations.

IRS RESPONSE TO RECOMMENDATION:

The IRS is currently evaluating policies and procedures for reviewing and issuing Chapter 3 and FATCA refund claims. We are relying on best practices and models, such as fraud filters used to identify fraudulent refunds within the general Form 1040 population.  Our goal is to appropriately balance the responsibility to promptly process and pay legitimate refund claims with the responsibility to protect the government against fraudulent refund claims. The vast majority of refund claims filed by non-residents are those related to Chapter 3 withholding, not FATCA. While this does not eliminate the challenge, the issue is not primarily a FATCA issue.  Both Chapter 3 and FATCA require significant systemic upgrades to improve the IRS’s ability to compare data and quickly determine whether reporting is consistent with third-party reporting, thereby paving the way for the most proper and well-balanced responses possible.

Update: The IRS has finalized and put in place procedures mentioned in our previous response in the form of Job aids. These procedures are based on best practices and models, such as fraud filters used to identify fraudulent refunds within the general Form 1040 population.  We continue to upgrade/fix the system as best as we can. New requirements for Form 1042-S were put in place for tax year 2017 to request Withholding Agent to provide Unique Identification Number, Amendment Numbers, and Foreign TIN to enhance our ability to verify the credit/refund claim. Our goal is to appropriately balance the responsibility to promptly process and pay legitimate refund claims with the responsibility to protect the government against fraudulent refund claims. Below are the job aids that were developed and put in place.

  • F1042-S Verification Job Aid
  • Interim Procedures for Manual Review F1040NR/NR-EZ  with F1042-S Job Aid
  • Compliance Planning & Analytics  (CP&A) Coordinator Job Aid

CORRECTIVE ACTION: Our goal is to appropriately balance the responsibility to promptly process and pay legitimate refund claims with the responsibility to protect the government against fraudulent refund claims. The vast majority of refund claims filed by non-residents are those related to Chapter 3 withholding, not FATCA. While this does not eliminate the challenge, the issue is not primarily a FATCA issue.  Both Chapter 3 and FATCA require significant systemic upgrades to improve the IRS’s ability to compare data and quickly determine whether reporting is consistent with third-party reporting, thereby paving the way for the most proper and well-balanced responses possible.

TAS RESPONSE: In its response, the IRS states, “We are relying on best practices and models, such as fraud filters used to identify fraudulent refunds within the general Form 1040 population.” These filters and processes are themselves in need of substantial improvement, as noted in Most Serious Problem #16. Nevertheless, an approach in which Form 1040 and Form 1040NR filers received equivalent treatment would be a very positive development. TAS looks forward to working with the IRS to develop these filters and models to operate in ways that preserve taxpayer rights and perpetuate quality tax administration. The negative impact that can result from a disparate approach are illustrated by the IRS’s prior decision to freeze Chapter 3 and Chapter 4 refunds for up to one year or longer, while attempting to match the documentation provided by taxpayers with the documentation provided by withholding agents. After the systemic matching program yielded so many “false positives” that it proved untenable, these frozen refunds were finally released. Accordingly, more commonality should be established in the treatment of Form 1040 and Form 1040NR filers, including allowing Form 1040NR filers to establish their right to a refund by presenting persuasive evidence of actual withholding. The National Taxpayer Advocate agrees with the IRS that, “Both Chapter 3 and FATCA require significant systemic upgrades to improve the IRS’s ability to compare data and quickly determine whether reporting is consistent with third-party reporting, thereby paving the way for the most proper and well-balanced responses possible.” Care must be taken, however, not to inconvenience compliant taxpayers either while these systemic upgrades are being developed, or once they are implemented. Instead, the IRS should focus on and allocate its resources to the identifiable groups of taxpayers who represent real compliance risks. This more targeted approach likely would result in more efficient use of resources and would free already-compliant taxpayers from the burdens to which they were subjected under the systemic matching program discontinued in June 2016.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Partially Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A

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2.

TAS RECOMMENDATION #16-2

Adopt a same country exception that excludes from FATCA coverage financial accounts held in the country in which a U.S. taxpayer is a bona fide resident.

IRS RESPONSE TO RECOMMENDATION: The recommendation would require a change in the law, and as such, cannot be adopted.  The IRS recognizes that the issues faced by individual U.S. taxpayers working, living, or doing business abroad may be unique.  The IRS continues to look for opportunities to ease certain reporting burdens for these individuals. With that in mind, the IRS had set the filing requirement thresholds for U.S. individuals living abroad much higher, comparing to the taxpayers who live in the U.S., to alleviate the filing burden for a large number of expats. For example, $200,000 (at year-end) or $300,000 (at any time) for U.S. individuals living abroad filing single status vs. $50,000 (at year-end) or $75,000 (at any time) for U.S. individuals living in the U.S.  All Americans are required to report and pay tax on worldwide income, regardless of where they live, work, or doing business. The risk of U.S. tax avoidance by a U.S. taxpayer holding an account with an FFI exists regardless of whether the U.S. taxpayer holds an account in his or her foreign country of residence or another foreign country.

CORRECTIVE ACTION: N/A

TAS RESPONSE: The larger thresholds for FATCA coverage established regarding expatriates are helpful in reducing compliance burdens. Nevertheless, these thresholds do not directly address the problem of banking lock-out that has been widely reported by expatriates. This unfortunate and unintended consequence of FATCA could largely be remedied by a same country exception if the IRS would implement such an exception, or, if the IRS believes it lacks the authority to do so, would join the National Taxpayer Advocate and several organizations of expatriates in asking Congress to provide the remedy.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A

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3.

TAS RECOMMENDATION #16-3

Protect the rights of taxpayers potentially impacted by the new law regarding revocations and denials of passports by broadly interpreting hardship and other discretionary exclusions; providing an administrative appeal before certifying a “seriously delinquent tax debt” to the Department of State; working with the Department of State to encourage it to adopt expansive definitions of humanitarian and emergency exceptions; and informing taxpayers of the availability of TAS assistance before passport revocation or denial occurs.

IRS RESPONSE TO RECOMMENDATION:

The NTA first suggests that the IRS “broadly interpret hardship and other discretionary exclusions.” Section 7345 affords the IRS discretion to exclude categories of tax debt that would otherwise meet the definition of “seriously delinquent tax debt.” The IRS will specify these categories in sections of the Internal Revenue Manual that deal with section 7345.  The NTA also suggests that the IRS “provid[e] an administrative appeal before [certification].” Section 7345 does not provide administrative appeal rights to individuals who will be or have been certified as having a seriously delinquent tax debt. As such, the IRS decided not to provide administrative appeals of its certification decisions. However, for a taxpayer’s debt to qualify as “seriously delinquent tax debt,” the taxpayer will have had an opportunity to go to Appeals—either in the deficiency or collection due process context—regarding the liabilities that gave rise to their certification. Moreover, upon being notified of certification by the IRS, section 7345 gives taxpayers the immediate right to judicial review in either federal district court or the Tax Court. The NTA’s third suggestion encourages the IRS to work with the Department of State “to adopt expansive definitions of humanitarian and emergency exceptions.” The provision of the FAST Act that grants the State Department the authority to issue a passport to a taxpayer for emergency or humanitarian reasons despite certification was codified at 22 U.S.C. § 2714a. The State Department is responsible for interpreting and implementing this provision. The IRS has no authority to do so. Also, this exception is identical to one already in place for individuals who are denied or lose their passports upon failure to pay child support.  The State Department may choose to exercise its authority to grant emergency and humanitarian exceptions in IRS cases in a manner similar to child support cases.  Regarding the NTA’s suggestion that the IRS inform taxpayers of the availability of TAS assistance before passport revocation or denial occurs: Section 7345(d) requires the IRS to send notice to the taxpayer upon certification. Although the notice, CP508C, is mailed to the taxpayer contemporaneously with certification, as opposed to before certification, it informs the taxpayer of the availability of TAS assistance.

Update: Per the form, specific actions taken were: IRM 5.1.12, Field Collecting Procedures, Cases Requiring Special Handling, and IRM 5.19.1, Liability Collection, Balance Due, were published with an effective date of January 8, 2018. These IRMs contain the following IRS discretionary exclusions:
-Debt that is currently not collectible (CNC) due to hardship (unreversed TC 530 cc 24 – 32)
-Debt that resulted from identity theft (unreversed TC 971 AC 501, 505, 506, 522, 523, and 525),
-Debt of a taxpayer in bankruptcy,
-Debt of a deceased taxpayer,
-Debt that is included in a pending Offer in Compromise
-Debt that is included in a pending installment agreement
-Debt with a pending adjustment that will full pay the tax period
-Taxpayers in a Disaster Zone

CORRECTIVE ACTION: IRM revisions (IRM 5.1.12 and 5.19.1) specifying additional categories of IRS discretionary exclusions will be re-cleared and published prior to Passport legislation implementation. Passport implementation date is unknown at present while IRS works with the Department of State to resolve implementation issues.

TAS RESPONSE: The National Taxpayer Advocate reiterates her recommendation that the IRS broadly interpret hardship and other discretionary exclusions. TAS looks forward to the specification of these categories in the forthcoming Internal Revenue Manual (IRM) guidance. The National Taxpayer Advocate likewise urges the IRS to exclude already-open TAS cases from certification. Failure to do so exacerbates problems faced by taxpayers and impinges on the National Taxpayer Advocate’s ability to fulfill her congressionally assigned role of advocating on behalf of taxpayers.Despite the circumstance that taxpayers will have had access to an appeal in the context of the underlying proceeding giving rise to the tax debt itself, and will be able to seek judicial review of the determination that the tax debt is “seriously delinquent,” such an important determination with so many far-reaching ramifications should not be made in the absence of administrative appeal rights. Taxpayers should not be forced to seek such review in court, but instead should be allowed to make a case to Appeals as to why the IRS’s determination is incorrect. The ability to do so may well reduce substantial stress and expense on the part of taxpayers, and save significant resources for the IRS and the courts.The National Taxpayer Advocate is aware that the FAST Act places the State Department in the position of granting humanitarian and other emergency exceptions. Nevertheless, from a practical perspective, the IRS will be working closely with the DOS regarding the passport revocation program and she urges the IRS to expeditiously refer such cases to the correct office within the DOS, and, insofar as feasible and permissible, to encourage the DOS to apply the humanitarian and emergency exceptions broadly.Further, taxpayers should receive notice informing them that the IRS has initiated proceedings to certify their tax debt as “seriously delinquent.” As part of this communication, which would protect taxpayers’ due process rights, they should also be informed that TAS is available to assist.Notifying taxpayers of the possibility of TAS assistance only after the tax debt has already been certified as “seriously delinquent” is often a case of too little, too late. Of course, TAS will do its best to help taxpayers post-certification, but taxpayers would benefit from assistance and advocacy during the process leading to the certification determination. The IRS should make taxpayers aware that the process has been initiated, and that TAS can assist on an ongoing basis.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A

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4.

TAS RECOMMENDATION #16-4

Reduce burdens on FFIs by adopting a collaborative model of tax administration that encourages foreign financial institutions (FFIs) to correct erroneous reporting and focuses on providing the clarity and consistent guidance needed for reasonable, cost-effective compliance with FATCA.

IRS RESPONSE TO RECOMMENDATION: A large majority of FFIs are operating under the laws of foreign countries, not the United States. It should also be noted that the applicable intergovernmental agreements establish a legal framework that is a fully collaborative model that requires communication and collaboration between the two jurisdictions’ competent authorities. Having noted that, the IRS recognizes the issues and challenges FFIs face with FATCA reporting. In addition to providing a two-year (2014 & 2015) transition period to allow sufficient time for the FFIs to put in place their FATCA reporting infrastructures, we continue to look for ways to ease the FFIs’ reporting burdens and have implemented various procedures to ensure that FFIs continuously receive the guidance and support they need to comply with FATCA reporting. To encourage correction of reporting errors, FFIs receive electronic notifications of the errors so that corrections can be made timely. Upon submitting a FATCA Report, the filer is automatically notified of any validation errors in the FATCA XML Schema. This prompts the filer to correct the error without any lag in time or requiring the FFI to expend additional resources to identify the error. Additionally, no penalty is applied in this instance.   The IRS also continuously provides clear guidance to help FFIs comply with FATCA reporting in a cost-effective manner.  Resources are available at no cost to every FFI on our IRS.gov FATCA website. The IRS regularly updates webpages with the most recent guidance and FAQs as they become available. For example, if IRS identifies an issue that is prevalent in the industry or affecting multiple FFIs, a FAQ is published on the FATCA FAQ website. The publication of the question and response provides guidance for other FFIs that may encounter the same issue in the future without the FFIs needing to expend time and resources to research the issue. In addition to the FAQs, other assistance is available to FFIs and Foreign Competent Authorities through the Information Reporting Program Advisory Committee (IRPAC), IDES Help Desk (via email or toll free phone), Global IT Forum, FATCA XML Schema User Guides and FATCA Newsletters.

CORRECTIVE ACTION: N/A

TAS RESPONSE: The National Taxpayer Advocate applauds the IRS’s efforts at improving its FATCA-related technology and communications where FFIs are concerned. The IRS can reduce compliance burdens on FFIs and ultimately achieve more effective results if it continues moving toward a collaborative model of tax administration with respect to FFIs. For example, a significant step in this regard would be to simplify and clarify the definition of “good faith efforts” under IRS published guidance. As things stand now, “…over-reporting, over-withholding, and misinformation could make it difficult for the IRS to use the information it is receiving as intended, and may lead to false-positives.” As pointed out by industry and echoed by the National Taxpayer Advocate, the IRS should “distinguish between FFIs that are colluding with their local authorities to avoid FATCA and FFIs that are making genuine, ‘good faith’ efforts to comply, but are unable to because of the complexity of the law.” The IRS appears to be making some strides in this regard, and is working cooperatively with FFIs to maintain and improve reporting rather than simply penalizing them for noncompliance. For example, the practice of informing FFIs regarding reporting errors and giving them the opportunity to remedy those errors is a positive step and is in accordance with the recommendations of the National Taxpayer Advocate. Continued cooperative progress regarding the various aspects of FATCA reporting will be most beneficial for all concerned.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Partially Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A

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