The IRS needs to change its regulations with respect to American taxpayers' obligations to report on their overseas account holdings by "eliminating duplication" of the FBAR and FATCA reporting requirements, as well as by "excluding accounts maintained by U.S. persons in countries where they are bona fide residents," National Taxpayer Advocate Erin M. Collins has told Congress, in her annual report.
Collins, who just completed her second year as National Taxpayer Advocate, argues in her annual so-called "Purple Book" of 68 legislative recommendations that "many U.S. taxpayers, particularly those living abroad, face increased compliance burdens and costs because the FATCA reporting obligations significantly overlap with the FBAR filing requirements."
(FATCA, formally known as the Foreign Account Tax Compliance Act, is a 2010 tax-evasion prevention law, while the FBAR, or Report of Foreign Bank and Financial Accounts, is an information-reporting law that's become well-known in expat circles in recent years for its significant penalties, particularly for those whose failure to file FBARs is deemed to have been "willful" rather than accidental.)
Among the many other points Collins makes this year is that the way FBAR violations are defined, and the penalties for failure to comply properly, need to be addressed.
As in previous years, this year's National Taxpayer Advocate's report is actually a package of documents, including the 166-page "Purple Book"; a 58-page executive summary; 11 pages of "introductory remarks"; three pages of "Most Serious Problems"; a four-page press release; and even a blog. One page that has links to most of these documents may be found by clicking here.
In her blog, Collins writes that the 2021 tax season saw the IRS deliver "the worst" service to U.S. taxpayers ever, as "the combination of processing delays and questions about new programs, such as the AdvCTC [Advance Child Tax Credit] payments, caused IRS telephone call volumes to almost triple to 282 million calls," of which IRS customer service representatives answered "just 11%."
"Along the same lines, the IRS took months to process taxpayer responses to notices, further delaying refunds," Collins adds, still in her blog.
"It took an average of 199 days for the IRS to process taxpayer responses to proposed adjustments, up from 74 days in fiscal year 2019, the most recent pre-pandemic year.
"In many cases, if the IRS did not process a taxpayer response, automated processes took adverse action or did not release the refund."
What's more, Collins warns U.S. taxpayers at home and abroad, the IRS is beginning the new tax reporting season with a backlog of at least 10 million unprocessed tax returns from last year, most of which, she adds, are paper returns.
"Paper is the IRS's kryptonite, and the agency is still buried in it."
'Harmonize Reporting Requirements'
As some regular AXF readers might realize, Collins's call this year for the U.S. tax authorities to "harmonze reporting requirements for taxpayers subject to both the Report of Foreign Bank and Financial Accounts [FBAR] and the Foreign Account Tax Compliance Act [FATCA] by eliminating duplication" was also one of her main calls on behalf of expat taxpayers last year, when, as reported, this was Recommendation No. 9 out of her "Purple Book" for the 2020 tax year.
(This year it's Legislative Recommendation No. 8.)
Meanwhile, Collins notes that while the IRS "has provided an exception from the reporting rules for bona fide residents of U.S. territories for financial accounts held in such territories...[it] has not adopted the recommendations of the National Taxpayer Advocate that are also supported by other stakeholders, including the Government Accountability Office, to eliminate duplicative FATCA reporting where assets have been filed on an FBAR.
"Although FBARs are filed with FinCEN [the U.S. Treasury's Financial Crimes Eforcement Network], the IRS has access to the information on those forms.
"We understand the IRS is concerned that FinCEN could change the FBAR, leaving the IRS without access to information about foreign accounts that are not required to be reported on a Form 8938 [the form taxpayers use to report their foreign bank account information to the IRS with].
"However, this should not be a concern if only accounts actually reported on an FBAR may be omitted from a Form 8938, on which they would otherwise have to be reported."
At this point, Collins goes on to point out that the IRS has also ignored previous National Taxpayer Advocate's recommendations to "provide an exception from FATCA reporting for financial accounts held in the country in which the U.S. taxpayer is a bona fide resident," a measure that many expat advocacy groups, including the American Citizens Abroad, have long called for.
The reluctance by the IRS to address this issue, Collins adds, "makes it difficult for U.S. citizens to open bank accounts in certain countries."
'Adjust the Filing Threshold for Taxpayers
Filing as Married Filing Separately'
Picking up on another issue that's been frustrating expats – and one that she also mentioned last year – Collins devotes her Legisative Recommendation No. 9 to married U.S. taxpayers who, for efficiency reasons, file their tax returns separately, as well as to "non-resident alien individuals".
Such taxpayers, she notes, were hit by President Trump's 2017 Tax Cuts and Jobs Act, with the result that these married-filing-separately and non-resident alien individuals are now required to "file tax returns if they have gross income equal to or greater than zero dollars, even if, after taking into account allowable deductions and other adjustments, their taxable income is zero and they owe no tax."
As this and other publications have reported consistently since the TCJA came into force in January, 2018, the TCJA introduced numerous issues for expats and their businesses that, for the most part, have yet to be fixed.
According to Collins, if the Tax Cuts and Jobs Act of 2017 (TCJA) had not been enacted, the exemption amount for a single taxpayer for tax year (TY) 2018 would have been US$4,150, meaning that these two groups of taxpayers would be required to file returns only if their incomes exceeded that amount."
The problem, she explains, is that "the TCJA suspended the personal exemption for tax years 2018 through 2025, effectively reducing it to zero."
Collins urges the government to "return the filing threshold for MFS [married-filing-separately] and non-resident alien individuals to an amount equal to the personal exemption prior to its suspension," which she says would "reduce the burden for both taxpayers and the IRS."
She adds: "Such a change would also be consistent with Congress's intent to preserve a minimum level of individual income exempt from tax."
Recommendation #38: Address FBAR
'willful' definition, maximum penalty amounts
One of Collins's most significant recommendations in her report this year, with respect to non-U.S. financial accounts, concerns an issue that has been hitting the headlines of most U.S. tax industry trade publications for the past year – often because the fines in question that U.S. taxpayers are being hit with are often for eyewateringly-huge amounts.
The issue is FBARs – specifically, the way violations of the FBAR rules are defined, and the scale of the penalties that are being assigned to those found to have failed to comply with them.
Collins's Legislative Recommendation No. 38 this year therefore calls on the U.S. authorities to "Modify the Definition of 'Willful' for Purposes of Finding Report of Foreign Bank and Financial Accounts Violations and Reduce the Maximum Penalty Amounts."
Indeed, Collins writes, below a sub-head reading "Reasons for change": "The maximum FBAR penalty is among the harshest civil penalties the government may impose.
"For example, if an account holder maintains a balance of US$25,000 in a foreign account that he willfully fails to report, the IRS may impose a penalty of over US$100,000 per year, and may go back six years, producing an aggregate statutory maximum penalty of over US$600,000.
"Some commentators have suggested the penalty is so severe that it might violate the U.S. Constitution’s prohibition against excessive fines."
And yet, she continues, "individuals who have lived in foreign countries or have immigrated to the United States often maintain foreign bank accounts, and may overlook this requirement for benign reasons."
Collins goes on to point out that even though the Internal Revenue Manual (IRM) limits the total amount of the penalties for non-willful violations to "50% of the highest aggregate balance (HAB) of all unreported foreign financial accounts for all years under examination," examiners "are still free to recommend a penalty of up to 100% of the HAB for willful violations if a manager approves."
She continues: "Even half the HAB can be more than the current balance if the account value has declined.
"Account holders have argued in many cases that the harshness of the maximum penalty, particularly the 'willful' penalty, is disproportionate to the reporting failure.
"While the distinction between willful and non-willful violations makes sense, it generates controversy because it can be difficult for taxpayers to establish that a violation was not willful."
For example, "Schedule B of Form 1040, U.S. Individual Income Tax Return, asks if the taxpayer has a foreign account and references the FBAR filing requirement.
"Taxpayers are presumed to know the contents of their returns when they sign [their tax] return, under penalty of perjury, [effectively] swearing [that] 'Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct and complete.'
"It may be considered reckless or 'willful blindness' for them not to learn about the FBAR filing requirement after having been directed to the FBAR form by Schedule B.
"For this reason, the government might reasonably argue (and a court might reasonably find) that any failure to file an FBAR form is 'willful' where a taxpayer filed a federal tax return that included a Schedule B, which directs taxpayers to the FBAR filing requirement.
"Account holders who do not file required FBAR forms due to negligence, inadvertence, or similar non-nefarious causes may be subject to penalties for non-willful violations (which have a reasonable cause exception).
"But they should not face uncertainty regarding the possible application of the potentially harsh penalties for 'willful' violations.
"The National Taxpayer Advocate recommends that Congress clarify that the IRS must prove a violation was 'willful' without relying so heavily on the instructions to Schedule B, or the failure to check the box on Schedule B, before imposing a willful FBAR penalty."
Collins's recommendations include that the government "clarify that the government has the burden to establish willfulness before asserting a civil willful FBAR
penalty, and that the government cannot meet this burden by relying primarily on the Schedule B attached to a return," and that the "statutory maximum civil penalty for a willful FBAR violation" be reduced "to the maximum penalty the IRM currently allows its examiners to assert without managerial approval (i.e., no greater than 50% of the highest annual asset balance in the unreported account during the years of noncompliance."
Among Collins's other recommendations that could affect expat U.S. taxpayers, were they to be acted upon, were her call for the IRS to be authorized "to establish minimum competency standards for federal tax return preparers (Recommendation No. 4), and "provide sufficient funding for the IRS to implement its Integrated Modernization Business Plan, so it can replace its 1960s technology systems, create an integrated case management system, develop robust online accounts for taxpayers and practitioners, deploy scanning technology that can machine-read paper returns (to reduce the need for manual data transcription) and implement customer callback technology on all of its telephone lines so taxpayers can elect to receive return calls without waiting on hold."
To achieve the latter recommendation (No. 2 in the Purple Book), Collins says "sufficient funding for the IRS" is needed, in order "to implement the Taxpayer First Act, which will change how the IRS engages with taxpayers and increase digital interactions", as well as "replac[ing] the current IRS budget structure with a new structure."
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