Wednesday, July 15, 2015
As a response to IRS and congressional concerns that U.S. taxpayers were not fully disclosing the extent of financial assets held abroad, Congress passed the Foreign Account Tax Compliance Act (FATCA) in 2010. Many U.S taxpayers, particularly those living abroad, have incurred increased compliance burdens and costs as a result of FATCA’s expanded reporting obligations, most of which repeat existing Report of Foreign Bank and Financial Accounts (FBAR) filing requirements.
These hardships include additional tax preparation fees and the unwillingness of some foreign financial institutions to do business with U.S. expatriates. FATCA places substantial day-to-day compliance burdens and costs of implementation on financial institutions. For example, a broad range of U.S.-source payments to a foreign financial institution (FFI) are subject to a 30 percent withholding tax, unless the FFI agrees to provide comprehensive information regarding accounts of U.S. taxpayers.
FATCA further charges withholding agents with the responsibility of determining whether they are obliged to undertake FATCA withholding and implementing it when required.
In turn, FFIs who have reached agreements with the IRS to avoid being subject to systematic withholding must impose withholding on any of their own customers defined as “recalcitrant account holders.” Although FFIs have some latitude in identifying recalcitrant account holders, customers are in jeopardy of facing withholding if they do not provide the FFI with either a Form W-9 to certify they are U.S. persons, or a Form W-8BEN to certify they are foreign persons.
When completing a Form W-9, individuals are generally obligated to provide a Social Security number (SSN). 9 TAS has received reports these SSNs are becoming increasingly difficult to obtain for U.S. persons residing abroad who do not already have them. This difficulty, caused in part by a limited number of locations where required interviews for obtaining an SSN can occur, only enhances the burden of FATCA withholding and increases the challenges to obtaining a credit or refund of the withholding in the future.
As part of the 2013 Annual Report to Congress, the National Taxpayer Advocate expressed concerns over the broad sweep of FATCA and the compliance burdens it imposed on individuals and financial institutions. In identifying this issue as a Most Serious Problem, the National Taxpayer Advocate urged the IRS to:
■ Gather only the information it would actually use;
■ Learn from its experiences with the Offshore Voluntary Disclosure (OVD) programs to more effectively preserve the due process rights of taxpayers; and
■ Burden impacted parties as little as possible, consistent with the congressional mandate of FATCA.
The Consequences of FATCA Continue to Fall Heavily on Honest Taxpayers In her 2013 report, the National Taxpayer Advocate also observed that based on analysis of the data then available “… to this point, the IRS is imposing additional reporting burdens and increased potential penalties primarily on a category of taxpayers that, under principles of quality tax administration, should be encouraged, rather than penalized."
Further review of updated and expanded data from FY 2010 through the present continues to demonstrate the weight of FATCA is being felt not by tax evaders, but by U.S. taxpayers who likely would be compliant regardless. U.S. taxpayers under the FATCA umbrella who must file Form 8938, Statement of Foreign Financial Assets, are generally at least as compliant as the overall U.S. taxpayer population.
This comparison is shown in the following table:
[see table in original report]
Information reporting can be very useful and influence compliant behavior, provided it is narrowly tailored to accomplish a reasonable result. The National Taxpayer Advocate previously has observed that taxpayers’ willingness to meet their reporting and filing obligations is driven more by considerations of personal integrity and perceptions of systemic fairness than by economic deterrence and enforcement measures. To this point, the entire population of FATCA filers have not, to TAS’s knowledge, shown themselves to be a group in need of special enforcement procedures. Nevertheless, FATCA starts with the unsubstantiated assumption most taxpayers are bad actors and implements a draconian enforcement regime applied to everyone, even to the vast majority of taxpayers who have been, and likely will continue to be, fully compliant.
As a recommendation to help minimize the burden of FATCA compliance for both individual U.S. taxpayers and businesses, the National Taxpayer Advocate proposed the IRS and Treasury adopt a “same country exception.” This regulatory change would exclude from FATCA coverage financial accounts held in the country in which a U.S. taxpayer is a bona fide resident. It would mitigate concerns about the collateral consequences of FATCA raised by U.S. non-residents, reduce reporting burdens faced by FFIs, and allow the IRS to focus enforcement efforts on identifying and addressing willful attempts at tax evasion through foreign accounts. Nevertheless, to this point, the IRS has not been willing to pursue these recommendations proposed by the National Taxpayer Advocate and supported by other stakeholders.
The IRS’s Approach to Compliance and Enforcement Is Shifting in Ways That Burden Compliant Non-U.S. Taxpayers The IRS is developing policies and procedures governing the credit or refund to taxpayers of amounts withheld under FATCA on payments to FFIs or similar institutions (Chapter 4 of the Internal Revenue Code (IRC)). These policies and procedures likewise will apply to amounts withheld on payments of U.S.-source income made directly to non-resident U.S. taxpayers (Chapter 3 of the IRC). As proposed, taxpayers would be entitled to a credit or refund only if they can document that the withholding agent actually deposited the amount withheld with the IRS.
Some exceptions to this rule may be available if the amount of the under deposit of tax is de minimis, or if the withholding agent is classified by the IRS as having a demonstrated history of compliance with its deposit requirements. By contrast, the IRS currently accepts creditor-risk in the case of domestic withholding, such as on employment taxes, and taxpayers need only show that the withholding actually occurred to be entitled to a credit or refund from the IRS.
The IRS argues the shift in enforcement burden now proposed in the international context is necessary as a means of preventing fraud. TAS is unaware of any systematic or rigorous analysis documenting this risk. Moreover, withholding agents, even those active in the international context, are primarily domestic and therefore could be compelled by the IRS to remit the withholding payments they have collected, even where non-resident U.S. taxpayers are involved. The IRS has far more effective tools and comprehensive resources at its disposal for this type of enforcement than the individual taxpayers to whom this burden would otherwise be allocated. As a result, the National Taxpayer Advocate believes non-resident U.S. taxpayers must still have the right to demonstrate their eligibility for a credit or refund by establishing, to the satisfaction of the IRS, the withholding actually occurred. In addition, TAS is concerned about the IRS’s position it would only consider a Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, filed by the withholding agent as valid documentation for verifying the tax has been withheld, and that there are very few – if any – circumstances where a taxpayer can provide alternative documentation.
TAS will continue advocating, both systemically and through its casework, for theIRS to consider alternative documentation provided by taxpayers on a case-by-case basis. The IRS should not treat FATCA as the occasion for fundamentally shifting the risk attributable to the improper actions of withholding agents to non-resident U.S. taxpayers, who are least well-positioned to address and remedy such problems. Without persuasive explanation or verifiable justification, the IRS’s revised focus under FATCA has transformed Chapter 3 and Chapter 4 tax administration into a system that assumes non-compliance and is dedicated disproportionately to denying unwarranted benefits to the malfeasant few at the cost of the compliant majority who deserve their credits and refunds. In addition to the regulatory changes being contemplated by the IRS, all U.S. taxpayers who file a Form 1040NR requesting a refund of amounts withheld pursuant to FATCA, even those supported by the requisite Form 1042-S, will have the request frozen for up to 168 days, if not longer, while the IRS attempts to match applicable documentation and satisfy itself fraud has not occurred. Thus, thousands of compliant U.S. taxpayers will be denied access to their own funds while the IRS tries to marshal its internal resources and detect a relatively few bad actors. The IRS has made provisions to inform U.S. taxpayers who are experiencing “economic harm” as a result of the refund freeze that they can contact TAS for assistance. Nevertheless, the IRS has not provided TAS with any specific procedures or protocols that can be followed to assist such U.S. taxpayers and release their funds.