updated 6:36 PM CET, Mar 18, 2023

Expats worry about IRS crackdown, as Congress sends Inflation Reduction Act to Biden for enactment

Friday's approval by the House of Representatives of the Inflation Reduction Act had been expected, but this was scant reassurance to many expatriate Americans who, after years of dealing with the taxation complexities that go with living abroad as a result of such laws as the Foreign Account Tax Compliance Act, are wondering if the additional millions of fresh money that the act sets aside for the IRS will mean even more headaches for them. 

As has been reported for weeks now, the Inflation Reduction Act (or IRA, as some have taken to calling it) includes targeted business tax increases, added funding for the IRS  – intended to boost compliance and enforcement – and  incentives aimed at helping to "save the planet" and reducing carbon emissions.

But of all the numbers mentioned in the bill, the "special allocation" of US$80 billion over the next decade to fund IRS compliance and enforcement is probably the one that has been mentioned the most in recent days, as it's more than six times the current IRS budget of US$12.6 billion.

The Act is also is described as providing substantially more funding for IRS enforcement activity (US$45.6 billion) than for "taxpayer services" (such as, one assumes, answering the phones) (US$3.2 billion). The hefty enforcement allocation is to address what IRS officials have said is an estimated US$600 billion in taxes that go unpaid every year, much of it said to be owed by wealthy individuals who under-report their income.

President Biden is expected to sign the bill in the next few days. 

Aware that the amount of money earmarked to be poured into the IRS was likely to freak out many taxpayers (and voters), Treasury Secretary Janet Yellen last week made public a letter she wrote to IRS commissioner Charles Rettig, in which she stressed that the IRS's added enforcement resources were to "focus on high-end non-compliance", and that "small business[es] or households earning US$400,000 per year or less" were not to see "an increase in the chances that they [will be] audited." 

Referring to the added US$80 billion in IRS funding, Yellen told Rettig, "This historic investment in our tax system will accomplish two critical objectives. It will raise substantial revenue to address the deficit, and it will create a fairer system, where those at the top who do not today comply with their tax obligations find it far less easy to do so, and where all taxpayers receive the service from the IRS that they deserve, and that your dedicated workforce is eager to deliver.

"The importance of the work ahead cannot be overstated."

Tax experts and journalists, meanwhile, considered how taxpayers might best prepare for a future with a better-funded IRS. 

The Wall Street Journal's Laura Saunders quoted a former IRS Commissioner, Charles Rossotti, who said he supported the stated new focus on higher-earning tax-payers since "most under-reporting is from upper-income people, because that's where most of the income is."   

Paul Atkinson, a Paris-based member of the board of the Association of Americans Resident Overseas, whose previous employers have included the Organisation for Economic Co-operation and Development, says he was struck by how "big" the revenues that the added funding being given to the IRS are being forecast to generate will  be.

"These revenues appear to account for around two-thirds of the total promised deficit reduction," he said.

"Resource increases allocated to improving taxpayer services are welcome, particularly if a reasonable share is directed to support for overseas filers," he added, while "substantial funding for modernizing the IRS's IT systems is long overdue.

"But these items are reported to make up barely 10% of the package, leaving the remainder for what appears to be general administration and overheads (over 30% of the total), and enforcement (57% of the total)." 

In other words, he says, it's unclear "who or what will be targeted by the increased enforcement resources.

"President Biden has promised no increase in enforcement efforts directed at people with incomes below US$400,000, and Commissioner Rettig has written to the Senate that 'These resources are absolutely not about increasing audit scrutiny on small businesses or middle-income Americans.'

"And in various reports about the 'tax gap' the IRS has been clear that it wants to target high-income and high-net-worth individuals, 'offshore' financial accounts and 'passthrough' entities (essentially most small businesses that are not C corporations).

"On this basis, the main concerns the IRA should raise for most sub-billionaire expats will be (1) the campaign against “offshore accounts” could be poorly targeted and catch ordinary expats’ accounts in the net; and (2) small businesses will be targeted by the likely campaign against 'passthrough' entities.

"Note that passthrough entities are typically small businesses not affected by the Transition Tax and GILTI."

Atkinson ends by saying that he is personally "sceptical that the promised large pools of easy, i.e. recoverable, money really exist", and that "it is likely that, as with FATCA, where the promised revenues have yet (i.e. 12 years on) to materialise, the campaigns targeting offshore accounts and pass-through entities will deliver little actual tax revenue.

"The campaign against the super-rich is also likely to be disappointing.

"The big question is what will IRS do with all these enforcement resources if they do not deliver new tax revenues as promised, [since] it will face pressure to justify the expenses it incurs."

'10 strategies to help expat taxpayers remain in control'

Derren Joseph, a Singapore-based Enrolled Agent, posted a complete plan for expats on LinkedIn, in which he began by spelling out the reasons they might not want to be too cheerful ("the Inflation Reduction Act puts US$80 billion towards the IRS; the IRS [is to] hire up to 87,000 employees, more than DOUBLING the size of the agency and giving the IRS more employees than the number of Pentagon, State Department, FBI and Border Patrol agents combined; even if you win an audit, the time and money consumed often make it a pyrrhic victory") – which he followed with 10 strategies he said would help expat taxpayers to remain in control, even in the face of an even more terrifying than usual IRS.

Joseph's 10 strategies for expats:

a. Always file returns on time. File even if you can't pay. Never ghost the IRS

b. As a business owner, be aware of industry averages for your expenses

c. As a business owner, if necessary, do attach additional statements and comments on your income and expenditure

d. If possible, [try to] avoid schedule C. That schedule is a magnet for audits. Consider S Corps or Partnerships instead

e. Issue your 1099s to your contractors on time

f. Avoid round numbers

g. File payroll reports, and do withholding

h. Do not inflate the home office deduction

i. Avoid excessive dining and travel expenses

j. Don't ignore IRS notices.