A friend
contacted me recently. He was calling to discuss the tax issues of
expatriating. As background, there are two types of expatriation. The first is
renouncing citizenship, which he is not considering. The second is simply
living outside the United States. One remains an American, but one lives
elsewhere.
It is not as
easy as it used to be.
I have, for
example, been quite critical of Treasury and IRS behavior when it comes to
Americans with foreign bank accounts. If you or I moved overseas, one of the
first things we would do is open a bank account. As soon as we did, we would immediately
be subject to the same regime as the U.S. government applies to the
uber-wealthy suspected of stashing money overseas.
Some aspects
of the regime include:
(1) Having to answer questions on your
tax return about the existence of foreign accounts. By the way, lying is a
criminal offense, although filing taxes is generally a civic matter.
(2) Having to complete a schedule to your
tax return listing your foreign financial and other assets. Move here from a
society that has communal family ownership of assets and you have a nightmare
on your hands. What constitutes wealthy for purposes of this schedule? Let’s
start at $50,000, the price of a (very) nice pickup truck.
(3) Having to file a separate report with
the Department of Treasury should you have a foreign bank account with funds in
excess of $10,000. The reporting also applies if it is not your account but you
nonetheless have authority to sign: think about a foreign employer bank account.
It should be fun when you explain to your foreign employer that you are
required to provide information on their account to the IRS.
(4) Requiring foreign banks to both
obtain and forward to the IRS information about your accounts. Technically the
foreign banks have a choice, but fail to make the “correct” decision and the
IRS will simply keep 30% of monies otherwise going to them.
To add further
insult, all this reporting has some of the harshest penalties in the tax Code.
Fail to file a given tax form, for example, and take a $10,000 automatic
penalty. Fail to file that report with
the Treasury Department and forfeit half of your account to the government.
Now, some of
this might be palatable if the government limited its application solely to the
bigwigs. You know the kind: owners of companies and hedge fund managers and
inherited wealth. But they don’t. There cannot be ten thousand people in the
country who have enough money overseas to justify this behavior, so one is left
wondering why the need for overreach. It would be less intrusive (at least, to
the rest of us 320 million Americans) to just audit these ten thousand people
every year. There is precedence: the IRS already does this with the largest of
the corporations.
Did you know
that – if you fail to provide the above information – the IRS will deem your
tax return to be “frivolous?” You will be lumped in there with tax protestors who
believe that income tax is voluntary and, if not, it only applies to residents
of the District of Columbia.
There is yet
another penalty for filing a frivolous return: $5,000. That would be on top of
all the other penalties, of course. It’s like a party.
Many
practitioners, including me, believe this is one of the reasons why record
numbers of Americans overseas are turning-in their citizenship. There are
millions of American expats. Perhaps they were in the military or foreign
service. Perhaps they travelled, studied, married a foreign national and remained
overseas. Perhaps they are “accidental” Americans – born to an American parent
but have never themselves been to the United States. Can you imagine them having
a bank close their account, or perhaps having a bank refuse to open an account,
because it would be too burdensome to provide endless reams of information to a
never-sated IRS? Why wouldn’t the banks just ban Americans from opening an
account? Unfortunately, that is what is happening.
So I am glad
to see the IRS lose a case in this area.
The taxpayer
timely filed his 2011 tax return. All parties agreed that he correctly reported
his interest and dividend income. What he did not do was list every interest
and dividend account in detail and answer the questions on Schedule B (that is,
Interest and Dividends) Part III. He invoked his Fifth Amendment privilege
against self-incrimination, and he wrote that answering those questions might
lead to incriminating evidence against him.
Not good
enough. The IRS assessed the penalty. The taxpayer in response requested a
Collections Due Process Hearing.
Taxpayer
said he had an issue: a valid Fifth Amendment claim. The IRS Appeals officer
did not care and upheld the penalty.
Off to Tax
Court they went.
And the
Court reviewed what constitutes “frivolous” for purpose of the Section 6702
penalty:
(1) The document must purport to be a tax
return.
(2) The return must either (i) omit
enough information to prevent the IRS from judging it as substantially correct
or (ii) it must clearly appear to be substantially incorrect.
(3) Taxpayer’s position must demonstrate
a desire to impede IRS administration of the tax Code.
The first test
is easy: taxpayer filed a return and intended it to be construed as a tax
return.
On to the
second.
Taxpayer
failed to provide the name of only one payer. All parties agreed that the total
was correct, however. The IRS argued that it needed this information so that it
may defend the homeland, repair roads and bridges and present an entertaining
Super Bowl halftime show. The Court asked one question: why? The IRS was unable
to give a cogent reply, so the Court considered the return as filed to be
substantially correct.
The IRS was
feeling froggy on the third test. You see, the IRS had previously issued a
Notice declaring that even mentioning the Fifth Amendment on a tax return was
de facto evidence of frivolousness. Faciemus quod volumus [*], thundered the
IRS. The return was frivolous.
The Court however
went back and read that IRS notice. It brought to the IRS’ attention that it
had not said that omitting some information for fear of self-incrimination was
frivolous. Rather it had said that omitting “all” financial information was
frivolous. You cannot file a return with zeros on every line, for example, and
be taken seriously. That however is not what happened here.
The IRS could not make a blanket
declaration about mentioning the Fifth Amendment because there was judicial
precedence it had to observe. Previous
Courts had determined that a return was non-frivolous if the taxpayer had
disclosed enough information (while simultaneously not disclosing so much as to
incriminate himself/herself) to allow a Court to conclude that there was a
reasonable risk of self-incrimination.
The Court
pointed out the following:
(1) The taxpayer provided enough
information to constitute an accurate return; and
(2) The taxpayer provided enough
information (while holding back enough information) that the Court was able to
conclude that he was concerned about filing an FBAR. The questions on Schedule
B Part III could easily be cross-checked to an FBAR. Given that willful failure
to file a complete and accurate FBAR is a crime, the Court concluded that the
taxpayer had a reasonable risk of self-incrimination.
The Court
dismissed the penalty.
The case is Youssefzadeh v Commissioner, for the
at-home players.
I am of
course curious why the taxpayer felt that disclosure would be
self-incrimination. Why not just file a complete and accurate FBAR and be done
with it? Fair enough, but that is not the issue. One would expect that an
agency named the Internal “Revenue” Service would task itself with collecting
revenue. In this instance, all revenue was correctly reported and collected.
With that backdrop, why did the IRS pursue the matter? That is the issue that
concerns me.
[*] Latin for “we do what we want”
