Menu
Tax Notes logo

TIGTA Recommends More Enforcement of Expatriate Provisions

SEP. 28, 2020

2020-30-071

DATED SEP. 28, 2020
DOCUMENT ATTRIBUTES
Citations: 2020-30-071

More Enforcement and a Centralized Compliance Effort Are Required for Expatriation Provisions

September 28, 2020

This report has cleared the Treasury Inspector General for Tax Administration disclosure review process and information determined to be restricted from public release has been redacted from this document.

Redaction Legend:

1 = Tax Return/Return Information1

2 = Law Enforcement Techniques/Procedures and Guidelines for Law Enforcement Investigations or Prosecutions.

HIGHLIGHTS

Final Audit Report issued on September 28, 2020

Why TIGTA Did This Audit

With the rising number of taxpayers giving up or abandoning their U.S. citizen or resident status, it is important that the IRS have controls in place to enforce the tax provisions applicable to expatriates. This audit was initiated to determine the effectiveness of the IRS's efforts in ensuring compliance with the expatriation tax provisions under Internal Revenue Code Sections 887 and 877A and related efforts to reduce taxpayer burden.

Impact on Taxpayers

There may be tax consequences when taxpayers (expatriates) relinquish their citizenship or when long-term residents terminate their U.S. residency. Pursuant to Section 877A, expatriates are required to conduct a deemed sale of their worldwide assets and pay an “exit tax” on the net unrealized gain as if the property had been sold for its fair market value on the day before expatriation.

What TIGTA Found

Since the Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART Act), the number of taxpayers expatriating increased significantly from Calendar Year 2008 through Calendar Year 2018. During the same period, TIGTA found that the IRS did not have a centralized compliance effort aimed at enforcing the expatriate rules. Instead, TIGTA found that the IRS is primarily focused on collecting and publishing data on expatriates as required under Section 6039G.

Expatriates are required to file Form 8854, Initial and Annual Expatriation Statement, to certify that they have been in compliance with all Federal tax laws during the five years preceding the year of expatriation. TIGTA found that the IRS database of expatriates was incomplete for 16,798 expatriates who did not file Form 8854. In addition, TIGTA found instances of potential nonfiling, underreporting of income, and/or payment compliance issues by expatriates. From a sample of 26 expatriates who did not file a Form 8854, five had potential unreported income over $6 million. From a sample of 61 expatriates who filed a Form 8854, 15 had potential unreported income over $17 million. Lastly, TIGTA also found that expatriates with high net worth appear to not be paying their exit tax. Without a centralized compliance effort, Congress's attempts to create disincentives to expatriate via Section 877A will not be effective.

What TIGTA Recommended

TIGTA recommended that the IRS: 1) contact the Department of State, via the Federal Intergovernmental Program, for the Social Security Number data field to be added to the Form DS-4083, Certificate of Loss of Nationality of the United States, and explore the feasibility of obtaining the Certificate of Loss of Nationality electronically; 2) update the Letter 2399C Failure to File — Initial Form 8854, and Letter 4135C, Failure to Respond to Initial Form 8854 Request, for compliance under the HEART Act, and develop Internal Revenue Manual procedures to use these letters to obtain Form 8854 when a Certificate of Loss of Nationality is received and no Form 8854; 3) evaluate the information reported on Form 8854 and determine what data fields should be added to the expatriate database to ensure tax compliance of taxpayers who expatriate, e.g., Form 8854, Part IV, Section B, Property Owned on Date of Expatriation; 4) develop Internal Revenue Manual procedures for transcribing Form 8854 data, correcting Form 8854 data when information as filed by expatriates is missing or incomplete, and preparing analysis as needed to determine if the expatriate is a covered expatriate and subject to tax under Internal Revenue Code Section 877A; and 5) establish a process to compile information on all expatriates whether they filed Form 8854 with their individual tax return Form 1040-NR, U.S. Nonresident Alien Income Tax Return, or filed Form 8854 with the Philadelphia Campus and use this information to identify the highest risk expatriate returns for tax compliance. The IRS agreed with TIGTA's recommendations.


September 28, 2020

MEMORANDUM FOR:
COMMISSIONER OF INTERNAL REVENUE

FROM:
Michael E. McKenney
Deputy Inspector General for Audit

SUBJECT:
Final Audit Report — More Enforcement and a Centralized Compliance Effort Are Required for
Expatriation Provisions (Audit # 201930016)

This report presents the results of our review to determine the effectiveness of the Internal Revenue Service's efforts in ensuring compliance with the expatriation tax provisions under Internal Revenue Code Sections 877 and 877A and related efforts to reduce taxpayer burden. This review is part of our Fiscal Year 2020 Annual Audit Plan and addresses the major management and performance challenge of the Impact of Global Economies.

Management's complete response to the draft report is included as Appendix IX.

Copies of this report are also being sent to the Internal Revenue Service managers affected by the report recommendations. If you have any questions, please contact me or Matthew A. Weir, Assistant Inspector General for Audit (Compliance and Enforcement Operations).


Table of Contents

Background

Results of Review

The Philadelphia Campus Does Not Perform Tax Compliance Activities Related to Expatriates

Many Expatriates Are Not Filing a Form 8854 With the Philadelphia Campus

Recommendation 1:

Recommendation 2:

The Expatriate Database Is Not Sufficient to Enforce the Exit Tax

Recommendations 3 and 4:

Some Expatriates With High Net Worth Appear to Not Be Paying Their Exit Tax

Examination Rate of Expatriate Last Tax Return Is Low

Recommendation 5:

Appendices

Appendix I — Detailed Objective, Scope, and Methodology

Appendix II — Outcome Measures

Appendix III — Tax Liability and Exclusion Amounts by Tax Year

Appendix IV — U.S. Tax Expatriation — Timeline of Tax Law Changes

Appendix V — Form 8854 — Tax Year 2007

Appendix VI — Form 8854 — Tax Year 2018

Appendix VII — Certificate of Loss of Nationality of the United States

Appendix VIII — Letter 2399C — Failure to File Initial Form 8854

Appendix IX — Management's Response to the Draft Report

Appendix X — Glossary of Terms

Appendix XI — Abbreviations


Background

When citizens of the United States relinquish their citizenship or when long-term residents terminate their U.S. residency, there may be tax consequences. These taxpayers must file Form 8854, Initial and Annual Expatriation Statement, by which they must certify that they have been in compliance with all Federal tax laws during the five years preceding the year of expatriation and determine if they are a “covered expatriate.” Internal Revenue Code (I.R.C.) Section (§) 877A defines a covered expatriate as someone who expatriated on or after June 17, 2008, and meets one of the following expatriation rules:

  • Tax Liability Rule — Average annual net income tax liability for the five years ending before the date of expatriation or termination of residency is more than a specified amount that is adjusted for inflation ($165,000 for Tax Year (TY) 2018).1

  • Net-Worth Rule — Net worth is $2 million or more on the date of expatriation or termination of residency.

  • Certification Rule — Failure to certify on Form 8854 compliance with all U.S. Federal tax obligations for the five years preceding the date of expatriation or termination of residency.

If taxpayers are determined to be covered expatriates, then they are deemed to have sold all their worldwide property and are subject to income tax (exit tax) on the net unrealized gain as if the property had been sold for its fair market value on the day before expatriation.2 Gains from deemed sales are taken into account without regard to other U.S. Internal Revenue laws. Losses from deemed sales are taken into account to the extent otherwise allowed under U.S. Internal Revenue laws. The net gain is reduced by a specified amount that is adjusted for inflation but not below zero ($711,000 for TY 2018).3

If these taxpayers do not file as required, they are also considered a “covered expatriate” under the law.4 The history of Congress's attempts to create disincentives to tax-motivated expatriation is lengthy, with significant legislation in 1966, 1996, 2004, and 2008.5 A description of these legislative approaches is provided in Appendix IV; however, in general, the prior attempts at curbing tax-motivated expatriation failed because they were difficult for the Internal Revenue Service (IRS) to administer because they required proof of the taxpayer's intent for expatriating and also failed to create a disincentive for expatriation because the expatriation tax regime did not reach foreign-owned property.6

With the rising number of U.S. citizens and U.S. lawful permanent residents giving up or abandoning their U.S. citizen or resident status, it is important that the IRS has controls in place to enforce the tax provisions applicable to expatriates. Since the enactment of the Heroes Earnings Assistance and Relief Tax Act of 2008 (hereafter referred to as the HEART Act), the number of names published in the Federal Register increased from 312 in Calendar Year (CY) 2008 to a peak of 5,405 in CY 2016. Figure 1 shows the trend in expatriation once the HEART Act was implemented.7

[Editor's Note: The reference mark for footnote 8 appears in the image above.]

Expatriates are required to include information on the expatriation rules previously discussed on Form 8854 and attach the Form 8854 to their income tax return (Form 1040, U.S. Individual Income Tax Return, or Form 1040-NR, U.S. Nonresident Alien Income Tax Return) for the year of expatriation. The income tax return is to be filed by the due date (including extensions). The instructions also state that taxpayers are required to send a copy of the Form 8854, marked "Copy," to the IRS Philadelphia Campus in Philadelphia, Pennsylvania.9 There, the Small Business/Self-Employed (SB/SE) Division's Examination function Low-Income Housing Credit (LIHC) unit enters the information into the expatriate database.10 We obtained an extract of this expatriate database on August 30, 2019, which contained 46,275 records dating back to June 4, 2004. Figure 2 shows the 41,058 records in the expatriate database from June 18, 2008, through December 31, 2018, and the number of Forms 8854 the Philadelphia Campus received.11

Figure 2. Expatriate Database from June 18, 2008, Through December 31, 2018

Forms 1040-NR filed for the year of expatriation with a related Form 8854 attached are edited during processing with an Audit Code K.12 We determined that for Processing Years 2017 through 2019, 8,861 returns had an Audit Code K for TY 2016 through TY 2018 compared to the 14,511 expatriates reported in the Federal Register for CY 2016 through CY 2018.13 Procedures for using Audit Code K do not apply to expatriates attaching Form 8854 to their Form 1040.

Results of Review

As previously shown, the number of names published in the Federal Register increased significantly from CY 2008 through CY 2018 after enactment of I.R.C. § 877A as part of the HEART Act. During the same period, we found that the IRS did not have a centralized compliance effort aimed at enforcing the expatriate rules. The IRS has an expatriate database, but it was not used to identify and/or address expatriates who have not complied with their exit tax obligations under I.R.C. § 877A. Instead, we found that the IRS is primarily focused on collecting and publishing data on expatriates in the Federal Register as required under I.R.C. § 6039G.

We also found that the IRS has a process that identifies expatriates who attached a Form 8854 to a Form 1040-NR, but this Form 8854 information is not in the expatriate database unless the taxpayer also mailed a copy of the Form 8854 to the Philadelphia Campus. Additionally, the IRS does not transcribe the Form 8854 when attached to a paper Form 1040-NR or attached as a Portable Document Format file to an electronically filed return. In addition, the IRS does not have a process to identify expatriates attaching Form 8854 to their Form 1040. Without a centralized compliance effort, Congress's attempts to create disincentives for tax-motivated expatriation via I.R.C. § 877A will not be effective.

We analyzed the data in the expatriate database and selected two random samples of covered expatriates who met the tax liability and/or net worth rule. We also analyzed the filing and reporting compliance history of 26 covered expatriates who did not file a Form 8854 with the Philadelphia Campus. Overall, we found that:

  • The Philadelphia Campus does not perform tax compliance activities related to expatriates.

  • Many expatriates are not filing Form 8854 with the Philadelphia Campus.

  • The expatriate database is not sufficient to enforce the exit tax.

  • Some expatriates with high net worth appear to not be paying their exit tax.

  • The examination rate of expatriate last tax returns is low.

The Philadelphia Campus Does Not Perform Tax Compliance Activities Related to Expatriates

During CY 2008 through CY 2018, the IRS had no process with the Philadelphia Campus to ensure that taxpayers qualifying as “covered expatriates” were in compliance with the expatriation “exit tax” Form 8854 filing requirements. As previously stated, Form 8854 provides the information the IRS needs to identify covered expatriates who are required to complete a deemed sale of their worldwide assets and pay an exit tax on the unrealized gain from the deemed sale.

When a taxpayer expatriates, Form DS-4083, Certificate of Loss of Nationality of the United States (CLN), is completed by the Department of State (hereafter referred to as the State Department).14 The State Department transmits these forms to the IRS. The SB/SE Division's Examination function has assigned the responsibility for compiling information related to expatriates to LIHC unit tax examiners (Philadelphia Campus), who enter the taxpayer name, date the CLN was received, expatriate address, and expatriation date into the expatriate database. At one point, the SB/SE Division had the expectation that the LIHC unit would take compliance actions as well; however, the LIHC unit at the Philadelphia Campus does not take compliance actions.

For tax purposes, the usefulness of the CLN is limited because it does not contain the Taxpayer Identification Number, i.e., Social Security Number (SSN), which is essential for the IRS to verify filing and payment compliance. The IRS has not developed Internal Revenue Manual (IRM) procedures related to expatriates. LIHC unit tax examiners sometimes research for the expatriate's SSN on the IRS's Individual Master File. However, our review of the expatriate database showed that, in a 10-year period from June 2008 to December 2018, LIHC unit tax examiners did not research for an SSN in 56 percent (9,463 of 16,798) of the records in which only a CLN was received.

In addition, the CLN does not satisfy the expatriate's reporting obligation under I.R.C. § 6039G, nor does it provide any of the financial information, i.e., five-year prior year tax liability and/or net worth, required by the IRS to determine whether the expatriate is a covered expatriate under I.R.C. § 877A. As subsequently discussed, it is vital that the IRS works with the State Department to have the expatriate's SSN added to the CLN so the IRS can identify expatriates.

As previously stated, expatriates are required by I.R.C. § 6039G to include information on the expatriation rules on Form 8854 and mail the form to the IRS Philadelphia Campus. There, the LIHC unit enters the information to the expatriate database. While the LIHC unit enters the information into the expatriate database, other than reporting the expatriates into the Federal Register, the LIHC unit is not responsible for any compliance activity, such as pursuing expatriates who did not file Form 8854. Pursuant to the HEART Act, the IRS no longer needed a Form 8854 to publish the names in the Federal Register. Due to LIHC unit resource constraints and other priorities, the LIHC unit stopped pursuing expatriates who did not file Form 8854.

The primary responsibility of the LIHC unit is the LIHC. As stated in the IRM, the LIHC unit is responsible for maintaining the LIHC database, including transcribing data from submitted forms, correcting errors, and preparing analyses of documents as required under I.R.C. § 42.15 In addition, the LIHC unit supports the classification of returns pertaining to the LIHCs by using predetermined criteria to identify specific noncompliance issues (for referrals to examination).

The workload pertaining to expatriation is a collateral duty for the LIHC unit, and similar IRM procedures do not exist for its Form 8854 and expatriate workload. The Large Business and International (LB&I) Division provided the LIHC unit with a job aid (Expatriate Database — Job Aid) pertaining to its work on expatriates. However, it was last updated July 7, 2006, before enactment of the HEART Act. There are no current IRM documented procedures pertaining to compliance activity because it was set up for collecting and publishing data on expatriates, not as a compliance function. Accordingly, the LIHC unit at the Philadelphia Campus is not performing any compliance activity related to expatriation. As a result, expatriates who do not file Form 8854 are not pursued by the SB/SE Division LIHC unit for noncompliance with the law. Expatriates who do not file Form 8854 are addressed in more detail below.

Those expatriates attaching Form 8854 to their Form 1040-NR filed for the year of their expatriation are identified on the Individual Master File with an Audit Code K. The IRS does not transcribe the Form 8854 regardless if attached to paper returns or provided with electronically filed returns, and the procedures for Audit Code K do not apply to expatriates attaching Form 8854 to their Form 1040. In addition, information from Forms 8854 attached to Forms 1040-NR is not reconciled with the expatriate database data in which a CLN was received but no Form 8854. As a result, expatriates who do not attach Form 8854 to their Form 1040-NR and do not file Form 8854 with the LIHC unit are not identified and pursued by the IRS. Expatriates who file Form 8854 with Form 1040-NR and receive an Audit Code K are discussed below.

The IRS cannot effectively identify and address expatriates who fail to file Form 8854 without consolidating information from the expatriate database and Individual Master File Audit Code K data. Specifically, the expatriate database has the names of known expatriates via CLN data and, combined, the expatriate database and Individual Master File Audit Code K data have the data to support expatriates who filed Form 8854.

Many Expatriates Are Not Filing Form 8854 With the Philadelphia Campus

Pursuant to I.R.C. § 6039G, individuals who expatriate are required to send a statement to the IRS (Form 8854) detailing the individual's income, assets, and liabilities. Expatriates use Form 8854 to certify compliance with tax obligations in the five years before expatriation. Form 8854 is critical in determining whether the expatriate is a covered expatriate who is required to comply with I.R.C. § 877A.

Figure 2 shows that, in a 10-year period, from June 2008 to December 2018, 16,798 (or 41 percent) of those individuals who received the CLNs did not send a copy of Form 8854 to the Philadelphia Campus as required. These 16,798 expatriates failed to file a Form 8854 with the Philadelphia Campus to report their prior income tax liabilities and net worth and certify compliance. We identified these expatriates in the expatriate database via analysis that primarily focused on the data field “8854 REC'D” and then determined these records had data field “DATE CLN REC'D” (which is the date the Form DS-4083 (CLN) was received by the IRS from the State Department). By not filing Form 8854, these taxpayers are considered as not certifying their tax compliance as required and are also a covered expatriate under the law.16

CLN data are not being used to obtain Form 8854

By filing a complete and valid Form 8854, assuming they are in compliance with all Federal tax laws, the expatriates avoid covered expatriate treatment if the other two tests are not met. While no longer used, the IRS had developed two letters for use when a CLN is received from the State Department and a Form 8854 was not received by the Philadelphia Campus:

  • Letter 2399C, Failure to File — Initial Form 8854, which should be sent to notify the expatriates that they are receiving the letter because IRS records show loss of U.S. citizenship or terminated lawful permanent resident status, but have not properly given notice to the IRS and that such notice is given by filing an initial Form 8854.

  • Letter 4135C, Failure to Respond to Initial Form 8854 Request, should be sent to notify the expatriates that they are receiving the letter because IRS records show that they lost their U.S. citizenship or terminated lawful permanent resident status, but have not properly given notice to the IRS.

Our analysis of the expatriate database shows that the LIHC unit mailed 25 Letters 2399C (17 mailed prior to CY 2008 and eight mailed between November 2008 and November 2016), while no Letter 4135C was mailed to secure missing Forms 8854 from expatriates. We also observed that the letters were last revised in July 2005 and 2006, respectively. Thus, the letters have not been updated to reflect tax law changes from the HEART Act. For instance, the Letter 2399C states that the “taxpayer is receiving the letter because our records show you have lost U.S. citizenship but have not properly given notice to the IRS by filing an initial Form 8854” and then cites the law from the American Jobs Creation Act of 2004 (AJCA).17 When we asked why the letters were not used to secure missing Forms 8854, the IRS stated that it can publish the names in the Federal Register based on the CLN without obtaining Form 8854 from the expatriate and therefore does not follow up in these situations.18 Prior to the HEART Act, the IRS stated that it needed both a CLN and Form 8854 to publish the names in the Federal Register. Because the IRS is only using CLN information to update and report names quarterly for the Federal Register as required by I.R.C. § 6039G and not for tax compliance purposes, the letters for failure to file Forms 8854 have not been updated or used to obtain Forms 8854 for compliance purposes.

The IRS did not have procedures for the LIHC unit to mail letters to secure Forms 8854 for tax compliance purposes because, according to management, that was not the purpose of the unit when it was established. As a result, the LIHC unit did not take any action to obtain a Form 8854 on the 16,798 records in the expatriate database in which only a CLN was received.

The SSN is vital for tax compliance 

We previously stated that LIHC unit tax examiners sometimes research for the expatriate's SSN using the Individual Master File, and that, in a 10-year period from June 2008 to December 2018, LIHC unit tax examiners did not research for a SSN for 9,463 (56 percent) of the 16,798 records in which only a CLN was received. For the 7,335 records for which the LIHC unit researched the Individual Master File and identified an SSN, we found that LIHC unit tax examiners researched the Individual Master File and recorded in the expatriate database one or more prior tax liabilities (expatriates are required to provide information for five prior years) for 3,315 (45 percent) of 7,335 of the expatriates. Based on this research, 55 records met the tax liability rule as a covered expatriate from June 18, 2008, through December 31, 2018.19

We selected the 26 of the 55 cases that were from CY 2016 through CY 2018 for further analysis. We researched information return documents filed with the IRS and the Individual Master File for these 26 cases to determine if receipt of the SSN would help the IRS to identify instances of potential tax compliance issues, e.g., nonfiling, underreporting, and/or nonpayment. Figure 3 provides a breakdown of CLN records with no Form 8854 for which the LIHC unit researched and either found an SSN or did not find an SSN and, for the records in which the LIHC unit found an SSN, whether or not it recorded at least one prior tax liability for CY 2008 through CY 2018.

Figure 3: Analysis of CLN Records With No Form 8854 for CY 2008 Through CY 2018

Calendar Year of Expatriation

UHC Unit Did Not Identify an SSN

UHC Unit Identified an SSN

No Form 8854

Average Five-Year Tax Liability of $0.00

UHC Unit Researched and Recorded at Least One Prior Year Tax Liability

UHC Unit Determined Five-Year Average Tax Liability Over Specified Amount

2008

191

61

252

35

26

1

2009

386

128

514

69

59

3

2010

500

239

739

120

119

6

2011

606

239

845

125

114

3

2012

836

465

1,301

243

222

7

2013

1,071

850

1,921

492

358

3

2014

1,503

987

2,490

572

415

4

2015

1,182

817

1,999

449

368

2

2016

1,135

876

2,011

502

374

7

2017

1,028

856

1,884

510

346

2

2018

1,021

1,814

2,835

900

914

17

No Date20

4

3

7

3

0

0

Totals

9,463

7,335

16,798

4,020

3,315

55

Source: Our analysis of the expatriate database CLN records with no Form 8854 received by the IRS for CY 2008 through CY 2018.

We found tax compliance issues with 10 of 26 cases:21

  • Seven of 26 cases had potential unreported income, and five of these seven cases had an unfiled tax return either in the year of expatriation or the subsequent tax year. The potential unreported income is based on information return documents filed with the IRS in the year of expatriation or subsequent tax year.22 After using an aggregate threshold of $25,000 for the information return documents, we determined that five of the seven cases had potential unreported income over $6 million, including dividends and/or stock proceeds. The expatriates in these five cases are covered expatriates and should be subject to income tax (exit tax) on the net unrealized gain. The IRS did not identify these cases because it did not have a compliance and/or referral process in place using CLN data. Additionally, the IRS does not have a systemic matching program to compare information return documents to the Form 1040-NR to identify potential unreported income and/or nonfilers.

  • Four of 26 cases had a balance due on their tax modules. * * * 1 * * * of the four cases had balances due from multiple tax modules which totaled nearly $8 million, and the accounts were notated with “certified seriously delinquent tax.”23

Overall, we found instances of potential nonfiling, underreporting of income, and/or payment compliance issues for the few cases for which the LIHC unit identified an SSN, researched, and recorded prior tax liabilities in which the expatriate met the tax liability rule. As a result, the IRS should work with the State Department to have the SSN added to the CLN to assist in identifying and addressing tax compliance issues for expatriates.

We also found that not all of their income came from information return documents; some of these taxpayers are involved in more complex entities. For instance, eight of the 26 cases had a Schedule E, Supplemental Income or Loss, in a prior tax year, which is used to report income or loss from rental real estate, partnerships, etc. Due to the complexity, these types of taxpayers need to be referred to the Examination function for further analysis. When we asked if any referrals were made for examination by the LIHC unit, we were informed that the expatriate database is not used to make referrals for examination because, according to management, that was not the purpose of the unit when it was established.

Delays in receiving the CLNs from the State Department affect timely reporting in the Federal Register and tax compliance

 The IRS has a requirement to timely report the expatriates in the Federal Register per I.R.C. § 6039G. For the 26 CLN cases with no Form 8854 received, we compared the date the IRS received the CLN from the State Department to the date that taxpayers expatriated and determined that it took an average of 179 days for the IRS to receive the CLN from the State Department. When we asked the IRS about these delays, we were informed that the State Department may accumulate the CLNs until it has a sufficient number to mail to the IRS. We also located the expatriates in the Federal Register and determined that, for these 26 cases, seven were timely reported in the same quarter and 12 were reported in the subsequent quarter. However, in six of the 26 cases, the expatriates were reported in the Federal Register a year after they expatriated. For example, a taxpayer expatriated in June 2018, but the IRS did not receive the CLN from the State Department until April 2019 and subsequently reported the expatriation in the Federal Register for the period ending June 30, 2019. This type of delay to receive the CLN from the State Department affects tax compliance and/or timely issuing letters to expatriates when the IRS has not received a Form 8854 and the IRS's requirement to timely report the expatriates in the Federal Register as required by I.R.C. § 6039G. The IRS should work with the State Department to receive the CLN electronically and also to add a data field to the database to indicate the quarter and year the taxpayer is recorded in the Federal Register.

The Commissioner, LB&I Division, should:

Recommendation 1: Contact the State Department, via the Federal Intergovernmental Program, for the SSN data field to be added to the CLN and explore the feasibility of obtaining the CLN electronically.

Management's Response: IRS management agreed with this recommendation and will contact the State Department, via the Federal Intergovernmental Program, to request the SSN data field be added to the CLN. They also agreed to explore the feasibility of obtaining the CLN electronically.

Recommendation 2: Update the Letter 2399C and Letter 4135C for compliance under the HEART Act and develop IRM procedures to use these letters to obtain Form 8854 when a CLN is received and no Form 8854.

Management's Response: IRS management agreed with this recommendation and will update Letters 2399C and 4135C to include the requirements of I.R.C. § 877A and remove any language no longer applicable under the HEART Act. They also agreed to develop IRM or other procedures on how, and when appropriate, to obtain Form 8854 when a CLN but no Form 8854 is received while taking into consideration an initial assessment of Expatriation Campaign results, compliance risks, resource availability, and organizational priorities.

The Expatriate Database Is Not Sufficient to Enforce the Exit Tax

We previously stated that the primary responsibility of the LIHC unit is the LIHC. As stated in the IRM, it is responsible for maintaining the LIHC database, including transcribing data from submitted forms, correcting errors, and preparing analyses of documents as required under I.R.C. § 42.24 The LIHC unit is also responsible for maintaining the expatriate database, including transcribing data from Form 8854 for purposes of I.R.C. § 6039G. However, we observed that the LIHC unit does not transcribe from Form 8854 the following significant fields for purposes of enforcing I.R.C. § 877A:

  • Part IV, Section B, Property Owned on Date of Expatriation, Line 8, which computes gain or loss on the deemed sale of property.

  • Part V, Schedule A, Balance Sheet, includes assets and liabilities to compute net worth.

  • Part V, Schedule B, Income Statement, which is used to verify income from the final tax return for expatriates.

This information is needed for either the LIHC unit and/or the IRS to analyze and determine if the expatriate is meeting requirements under I.R.C. § 877A and paying income tax (exit tax) on the net unrealized gain for the deemed sale of worldwide assets.

When we discussed these concerns with IRS management, (i) they restated that the LIHC unit is not involved with tax compliance activities; (ii) they do not want to add additional data fields to the expatriate database until they evaluate the campaign results and the data fields that were used from the Form 8854 to compute the exit tax and/or tax adjustments for the examinations; and (iii) if it is determined additional data fields from the Form 8854 are needed for tax compliance purposes, then they will determine who will be responsible to collect and capture these data. As discussed later, the IRS recently announced a compliance campaign for taxpayers who expatriated and plans to conduct * * * 2 * * * examinations.

We also observed that the expatriate database and the Form 8854 included:

  • No annual Form 8854 filed from expatriates who elected to defer exit taxes. If an expatriate elects a tax deferral, the taxpayer has to submit a bond or a letter of credit for “collateral” that is deemed acceptable by the IRS and conditioned upon payment of the amount of tax due. When we inquired with the IRS if any expatriates elected a tax deferral, it stated that only three were received over the years and that the requests were denied.

  • The data fields based on the AJCA and Form 8854 lines for TY 2007. Based on a review of the expatriate database, the data fields match the outdated job aid (Expatriate Database — Job Aid, last updated July 7, 2006) and the Form 8854 lines for TY 2007, which are based on the AJCA. For example, the Form 8854 for TY 2007, Line 7 (see Appendix V) states “Enter your net worth on the date of your expatriation for tax purposes” whereas this request is listed on Part IV, Line 2, for TY 2018 (see Appendix VI), and the expatriate database data field states “Line 7 Net Worth.” When we asked IRS management why the Job Aid and the expatriate database data fields as used by the LIHC unit have not been updated for the HEART Act or TY 2018 Form 8854 lines, they said that IRS Office of Chief Counsel agreed that updates to the expatriate database were not necessary for purposes of I.R.C. § 6039G. The IRS should consider revisions to the expatriate database, based on the HEART Act and items required for enforcement of I.R.C. § 877A.

Form 8854 LIHC unit, or a unit as determined by the IRS responsible for tax compliance of expatriates, procedures along with the expatriate database need to be updated so the IRS can properly transcribe Form 8854 and the expatriate database can be analyzed for compliance purposes to enforce I.R.C. § 877A.

The LIHC unit does not have procedures for correcting errors with Form 8854

We previously stated that the LIHC unit is responsible for correcting errors related to the LIHC but does not have the same procedures for correcting errors with the Form 8854. Based on a review of the expatriate database, we found:

  • In 8,619 (36 percent) of the 24,260 records in which a Form 8854 was received by the Philadelphia Campus, the average five-year tax liability was zero. Since in all five years tax liabilities were zero, it appears that the expatriates did not self-report prior year tax liabilities, and the LIHC unit did not research prior tax liabilities for these expatriates.

  • In 1,534 (6 percent) of the 24,260 records in which a Form 8854 was received by the IRS, the taxpayers' net worth was zero; the LIHC unit does not have procedures to correspond with expatriates to obtain missing information.

The IRS needs to develop procedures for correcting and obtaining specific Form 8854 data when the information is found to be incomplete or missing. Without this information, the IRS is unable to determine if the expatriate is a covered expatriate subject to income tax (exit tax) under I.R.C. § 877A.

The Commissioner, LB&I Division, should:

Recommendation 3: Evaluate the information reported on Form 8854 and determine what data fields should be added to the expatriate database to ensure tax compliance of taxpayers who expatriate, e.g., Form 8854, Part IV, Section B, Property Owned on Date of Expatriation.

Management's Response: IRS management agreed with this recommendation and will evaluate the information reported on Form 8854 and determine what data fields should be added to the expatriate database to best evaluate the tax compliance of taxpayers who expatriate while taking into consideration an initial assessment of Expatriation Campaign results, compliance risks, resource availability, and organizational priorities.

Recommendation 4: Develop IRM procedures for transcribing Form 8854 data, correct Form 8854 data when information as filed by expatriates is missing or incomplete, and prepare analysis as needed to determine if the expatriate is a covered expatriate and subject to tax under I.R.C. § 877A.

Management's Response: IRS management agreed with this recommendation. They will develop IRM or other procedures for inputting and correcting certain Form 8854 data when information as filed by expatriates is missing or incomplete, as appropriate, and prepare an analysis as needed to determine if the expatriate is a covered expatriate and subject to tax under I.R.C. § 877A following the initial assessment of the Expatriation Campaign results, compliance risks, resource availability, and organizational priorities.

Some Expatriates With High Net Worth Appear to Not Be Paying Their Exit Tax

Filing Form 8854 only satisfies the expatriate's information reporting obligations under I.R.C. § 6039G. Expatriates must still compute any tax due (including I.R.C. § 877A exit tax, if applicable) and file applicable Federal income tax returns. We determined that the IRS * * * 2 * * * Figure 2 showed that 59 percent of the expatriates filed a Form 8854 with the Philadelphia Campus. Specifically, 24,260 expatriates filed a Form 8854 with the Philadelphia Campus to report their five prior income tax liabilities and net worth from June 18, 2008, through December 31, 2018.

For the 24,260 who filed a Form 8854:25

  • 712 (3 percent) were covered expatriates based on the tax liability rule, of which 68 expatriated during the period from January 1, 2017, through December 31, 2018, with average income tax liability for the five preceding taxable years ending before expatriation date over $570,000. Of the 68 taxpayers, we selected 26 cases reporting a combined net worth of $925 million, capital gains of over $126.3 million, and over $584,000 in five-year average tax liability.

  • 2,222 (9 percent) were covered expatriates based on net worth over $2 million, of which 347 expatriated in the period from January 1, 2017, through December 31, 2018. The total net worth of these expatriates was over $4 billion. Of the 347, we selected 35 cases reporting a combined net worth of $289 million and capital gains of nearly $3.3 million.

We reviewed these 61 cases for compliance with I.R.C. § 887A deemed sale of worldwide assets and potential tax noncompliance issues, such as nonfiling, underreporting, and/or payment issues. As we previously stated, Form 8854, Part IV, Section B, Line 8, includes the expatriate's calculation of the gain or loss on the deemed sale. Further, the information on Form 8854, Part IV, is not transcribed on the expatriate database. We used information return documents for actual sales and compared to the expatriate's Form 1040 or Form 1040-NR last tax return. These taxpayers reported a combined net worth of $1.2 billion on Form 8854 and capital gains of $129.6 million, which were identified from either Form 1040 or Form 1040-NR as follows:

  • Capital Gain or Loss — Line 14.

  • Other Gains or Losses — Line 15.

Without an examination of the expatriates' last tax return or their calculation of the gain or loss on the deemed sale from the Form 8854, we cannot determine with certainty whether the taxpayers who reported capital gains or losses on Form 1040 or Form 1040-NR are in compliance under I.R.C. § 877A. For the 61 cases, we determined that 39 cases reported gains or losses and 22 cases did not report any gain or loss. Specifically, for the 26 tax liability cases:

  • In 12 cases, the expatriates reported combined net worth of nearly $852 million and capital gains of $126 million, or 15 percent in capital gains compared to net worth.

  • In 14 cases, the expatriates either did not report any gain on Form 1040 or Form 1040-NR yet reported a combined net worth over $73 million (an average of over $5 million) on their respective Form 8854 or did not file a tax return.

For the 35 net worth cases:

  • In 29 cases, the expatriates reported combined net worth of nearly $224 million and capital gains of nearly $3.3 million, or nearly 1 percent in capital gains compared to net worth.

  • In six cases, the expatriates did not report any gain on Form 1040 or Form 1040-NR yet reported a combined net worth over $65 million (an average of nearly $10 million) on their respective Form 8854.

However, the capital gains reported were based on actual sales of assets and not from the deemed sale provisions of I.R.C. § 877A. Given the high net worth of these 61 covered expatriates with combined net worth of $1.2 billion, it appears that these taxpayers failed to pay the required exit tax. The expatriate is also allowed to reduce net gain by a specified amount ($711,000 for TY 2018) that is adjusted for inflation but not below zero. At a minimum, the 20 of 61 taxpayers who failed to report any gains or losses (14 tax liability and six net worth cases) are not in compliance with I.R.C. § 877A and may have owed exit tax. It is critical that the IRS establish an effective strategy to strengthen enforcement efforts pertaining to the exit tax by actively identifying individuals who relinquish citizenship or terminate residency.

Similar to prior CLN sample results, we also found instances of potential nonfiling and underreporting when a Form 8854 was received by the Philadelphia Campus. Specifically, we found that, in 19 cases of the 61 cases, the expatriate did not report taxable income and/or did not file a subsequent year tax return. The potential unreported income is based on information return documents, e.g., interest, dividends, capital gains, filed with the IRS. When discussed these cases with IRS executives, they had concerns with four cases that included real estate sale transactions. Specifically, that real estate sale transaction information returns do not include the cost basis and that taxpayers who used the property as a personal residence may qualify to exclude up to $250,000 or $500,000 for married filing jointly. After using an aggregate threshold of $25,000 for the information return documents, and excluding cases with real estate sales transactions of nearly $5 million, we determined that 15 of 61 cases had potential unreported income over $17 million of which seven had an unfiled return in the subsequent tax year. These cases were not identified because the expatriate database information is not used to identify potential unreported income or nonfilers, and * * * 2 * * *

Management Action: The IRS recognizes that some U.S. citizens and long-term lawful residents may have expatriated without complying with the expatriation tax rules or may not be aware of their Federal tax obligations upon expatriation. On July 19, 2019, IRS LB&I Division management announced a new compliance campaign focusing on U.S. citizens and long-term residents (lawful permanent residents in eight out of the last 15 taxable years) who expatriated on or after June 17, 2008, and did not meet their filing requirements or tax obligations with the IRS.26 Under the Expatriation Campaign, IRS LB&I Division management states that they are selecting varying degrees of covered expatriates through different treatment streams consisting of soft letters, outreach and education, and examinations.27

The LB&I Division plans to use a two-pronged approach in developing cases. First, the LB&I Division will use soft letters sent to expatriates who do not have a Form 8854 on file with the IRS. The IRS plans to send out *2* soft letters.

Second, the campaign will use examinations of expatriates' tax returns to address potential underreporting of income or nonfiling of income tax returns. The campaign will conduct *2* examinations derived from campaign-developed filters. These filters use Individual Master File (income tax returns) and expatriate database (Forms 8854) information to identify cases for classification and assignment to international examiners for examination. We were provided a status of the campaign plans in June 2020 and were advised that:

  • The soft letter (Letter 6272) has been finalized and is listed in the IRS catalog. The letters are expected to be issued during the week of July 12, 2020, depending upon resource availability and organizational priorities.

  • As of the end of May, there are four returns under examination in the field for the Expatriation Campaign. Additional cases will be sent to the field during the week of July 12, 2020, depending upon resource availability and organizational priorities

We believe that the information from the expatriate database and any data that the LB&I Division's compliance campaign compiles from case classification, case building, and assignment to international examiners for examination can and should be leveraged to develop an effective compliance program that identifies and addresses expatriates who have not complied with their income tax requirements under I.R.C. § 877A.

Examination Rate of Expatriate Last Tax Returns Is Low

IRS examinations of expatriates are tracked on the Audit Information Management System using a special project code of 0504. Using this special project code, we identified closed examinations of expatriate cases for Fiscal Year (FY) 2015 through FY 2018. As Figure 4 shows, 18,790 citizens expatriated from CY 2015 through CY 2018, while 63 expatriation examinations were closed, with * * * 1 * * * expatriation examinations resulting in additional tax adjustments from FY 2015 through FY 2018.28

Figure 4: Closed Examinations of Special Project Code 0504 Cases

Year

Number of Expatriates Published in the Federal Register

Year

Number of Closed Expatriate Examinations 

Those Closed with Tax Adjustments

Change Rate29

Average Adjustment Amount 

CY 2015

4,279

FY 2015

20

3

15%

$4,803

CY 2016

5,405

FY 2016

17

* * * 1 * * *

12%

$35,371

CY 2017

5,132

FY 2017

14

5

36%

$70,809

CY 2018

3,974

FY 2018

12

3

25%

$156,803

18,790

63

 * * * 1 * * *

 

 

Source: Federal Register CY 2015 through CY 2018 and Audit Information Management System for FYs 2015 to 2018.

Though the number of returns examined is small, the IRS had some success examining the expatriate tax returns; however, some of these returns examined were not identified from the expatriate database or as part of any special expatriation examination program. The examination numbers in Figure 4 are of expatriates who attached their Form 8854 to their Forms 1040-NR. Specifically, we determined 48 of 63 closed expatriation examinations and * * * 1 * * * closed cases with additional tax adjustments had an Audit Code K. Expatriates attaching Form 8854 to their Form 1040-NR filed for the year of their expatriation are edited during processing with an Audit Code K. The information from the Form 8854 is not transcribed, that only occurs if an expatriate mails a Form 8854 to the Philadelphia Campus. As previously stated, there also is no match of this information to the expatriate database maintained in the Philadelphia Campus or reconciliation between these data and expatriate database data in which a CLN was received but no Form 8854 was received. As a result, expatriates who do not file Form 8854 are also not identified or pursued by the Austin Campus.

We determined that, for Processing Years 2017 through 2019, 8,861 Forms 1040-NR were coded with an Audit Code K. As previously stated, the IRS does not transcribe the Form 8854 when attached to a paper Form 1040-NR or attached as a Portable Document Format file to an electronically filed return. The Audit Code K does not identify expatriates attaching Form 8854 to their Form 1040. Returns with an Audit Code K are automatically established on the Audit Information Management System and routed to Philadelphia Centralized Files and Scheduling, Campus Examination.

Centralized Files and Scheduling at the campus assembles the case file, updates Audit Information Management System controls, and suspends processing the return until the LB&I Division classifies it. From this population, we determined that 5,810 returns had a Transaction Code 420 (return has been referred for examination) for TY 2016 through TY 2018, and that most of these returns (97 percent) were ultimately surveyed (with a Transaction Code 421) within an average of 43 days.30 The returns are also systemically surveyed if the LB&I Division does not classify them. However, expatriates who do not * * * 2 * * * or do not * * * 2 * * * with the Philadelphia Campus, or * * * 2 * * * are not reviewed for examination potential. As a result, thousands of taxpayers expatriating annually have largely gone unchecked. Overall, we found that the IRS did not have a centralized compliance effort aimed at enforcing the expatriate rules. Without a centralized compliance effort, Congress's attempts to create disincentives to expatriate via I.R.C. § 877A will not be effective until the IRS strengthens its enforcement efforts.

The Commissioner, LB&I Division, should:

Recommendation 5: Establish a process to compile information on all expatriates whether they filed Form 8854 with their Form 1040-NR or filed Form 8854 with the LIHC unit and use this information to identify the highest risk expatriate returns for tax compliance.

Management's Response: IRS management agreed with this recommendation and stated that the Expatriation Campaign was established to compile information on all expatriates, whether they filed Form 8854 with their Form 1040-NR or filed Form 8854 with the LIHC unit, and they will use this information to identify expatriate returns with high risk of noncompliance.


Appendix I

Detailed Objective, Scope, and Methodology

The overall objective of this review was to determine the effectiveness of the IRS's efforts in ensuring compliance with the expatriation tax provisions under I.R.C. Sections (§§) 877 and 877A and related efforts to reduce taxpayer burden. To accomplish our objective, we:

  • Obtained an extract of the expatriate database to assess its reliability. We accomplished this by analyzing our extract of the database to determine whether the information is complete, accurate, and usable with regards to:

    • Critical information reported on Form 8854 and the CLNs.

    • Procedures in place to update the information when applicable.

    • Identification of taxpayers not in compliance with the provisions established for expatriating.

  • Determined that the expatriate database and its Job Aid were not updated to match the current Form 8854 and I.R.C § 877A provisions. We reviewed current IRMs, Job Aids, I.R.C. sections, and other guidance to ensure that procedures were in place to collect information for input into the expatriate database. We interviewed personnel who review and input taxpayer data into the expatriate database to assess what is involved in the process of receiving and entering information into the expatriate database and any timeliness standards or rules pertaining to the receipt and entering information into the database. We assessed any controls or procedures in place to ensure that the information input is complete and accurate.

  • Determined whether the expatriate database is used for compliance activities that ensure that expatriates are compliant with I.R.C. § 877A. We assessed the effectiveness and/or limitations of the database's reporting capabilities and any procedures in place that verify/ensure that the information reported by expatriating taxpayers is complete and accurate. We assessed procedures in place that use the database to actively monitor expatriating taxpayers' compliance with the rules for expatriation.

    • Judgmentally selected a sample of 61 expatriates from a population of 415 expatriates who met the tax liability and net worth rules and expatriated during the period from January 1, 2017, through December 31, 2018.1

    • Identified 55 expatriates who met the tax liability rule from June 18, 2008, through December 31, 2018, for which LIHC unit tax examiners researched the Individual Master File and recorded in the expatriate database one or more prior tax liabilities (expatriates are required to provide five prior years). We judgmentally selected the 26 expatriates who expatriated from CY 2016 through CY 2018.

  • Determined the scope and status of the expatriation tax campaign and assessed the progress of the implementation of the campaign.

Performance of This Review

This review was performed at the SB/SE Division Philadelphia Campus in Philadelphia, Pennsylvania, and with information obtained from the LB&I Division Headquarters in Washington, D.C., during the period October 2019 through June 2020. We conducted this performance audit in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objective. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objective.

Major contributors to the report were Matthew Weir, Assistant Inspector General for Audit (Compliance and Enforcement Operations); Christina Dreyer, Director; Robert Jenness, Acting Director; Timothy Greiner, Audit Manager; Charles Nall, Lead Auditor; and Victor Taylor, Senior Auditor.

Validity and Reliability of Data From Computer-Based Systems

During this review, we relied on expatriate data extracted from an Access database maintained at the Philadelphia Campus. Before relying on these data, we ensured that the file contained the specific data elements we requested. In addition, we tested a randomly selected sample of 101 records with a CLN date, expatriation date, and no Form 8854 received date. We reconciled this information with the physical case files also maintained at the Philadelphia Campus. In all 101 cases, the CLN information and expatriation date matched the information in the expatriate database. In addition, none of the 101 case files contained a Form 8854, which supported the fact that no Form 8854 received date was entered to the database. Further, as part of our fieldwork, we reviewed samples from the database and verified relevant data fields recorded against the IRS Individual Master File using the Integrated Data Retrieval System. We determined that the data were sufficiently reliable for purposes of this audit.

Internal Controls Methodology

Internal controls relate to management's plans, methods, and procedures used to meet their mission, goals, and objectives. Internal controls include the processes and procedures for planning, organizing, directing, and controlling program operations. They include the systems for measuring, reporting, and monitoring program performance. We determined that the following internal controls were relevant to our audit objective: controls over the processing of CLN documents and Forms 8854 and the processing of Forms 1040-NR with Form 8854 attached. We evaluated these controls by interviewing key personnel, analyzing data from the LIHC unit at the Philadelphia Campus, and performing analysis of tax return data from the Individual Returns Transaction File located on the Treasury Inspector General for Tax Administration Data Center Warehouse.


Appendix II

Outcome Measures

This appendix presents detailed information on the measurable impact that our recommended corrective actions will have on tax administration. These benefits will be incorporated into our Semiannual Report to Congress.

Type and Value of Outcome Measure:

  • Reliability of Information — Potential; information for 16,798 expatriates in the expatriate database is incomplete (see Recommendations 1 and 2).

Methodology Used to Measure the Reported Benefit:

Pursuant to I.R.C. Section 6039G, individuals who expatriate are required to send a statement to the IRS (Form 8854) detailing the individual's income, assets, and liabilities. Expatriates use Form 8854 to certify compliance with tax obligations in the five years before expatriation. Expatriates file Form 8854 with the Philadelphia Campus, where the information is entered to the expatriate database.

We obtained an extract of this expatriate database on August 30, 2019, which contained 41,058 records for expatriates who expatriated from June 18, 2008, through December 31, 2018. Form 8854 is critical in determining whether the expatriate is a covered expatriate who is required to comply with I.R.C. § 877A. However, 16,798 of the 41,058 expatriates failed to file a Form 8854 with the Philadelphia Campus to report their prior income tax liabilities and net worth and to certify compliance. We identified these expatriates in the expatriate database via the data field “DATE CLN REC'D,” which is the date the Form DS-4083 (CLN) was received by the IRS from the State Department. Because these taxpayers did not certify their tax compliance as required, they are also considered a covered expatriate under the law.

Type and Value of Outcome Measure:

  • Increased Revenue — Potential; $6 million in unreported income pertaining to five expatriates (see Recommendations 3 and 4).

Methodology Used to Measure the Reported Benefit:

LIHC unit tax examiners sometimes research for the expatriate's SSN using the Individual Master File, and LIHC unit tax examiners did not identify an SSN in 9,463 (56 percent) of 16,798 records in which only a CLN was received. For the 7,335 records for which the LIHC unit researched the Individual Master File and identified an SSN, we found that LIHC unit tax examiners researched and recorded one or more prior tax liabilities (when expatriates are required to provide five prior years) using the Individual Master File in the expatriate database for 3,315 (45 percent) of 7,335 expatriates.

Based on this research, 55 records met the tax liability rule, with average five-year tax liabilities more than the specified amount that is annually adjusted for inflation ($165,000 for TY 2018), as a covered expatriate from June 18, 2008, through December 31, 2018. We selected 26 of the 55 cases that were from CY 2016 through CY 2018 for further analysis. We researched information return documents filed with the IRS and the Individual Master File for these 26 cases to determine if receipt of the SSN would help the IRS to identify instances of potential tax compliance (nonfiling, underreporting, and/or nonpayment) issues. We determined that five of the 26 cases had potential unreported income of $6,674,546.

Type and Value of Outcome Measure:

  • Increased Revenue — Actual; nearly $17 million in unreported income pertaining to 15 expatriates (see Recommendation 5).

Methodology Used to Measure the Reported Benefit:

We determined that 24,260 expatriates filed a Form 8854 with the Philadelphia Campus to report their prior income tax liabilities and net worth and/or certify compliance, from June 18, 2008, through December 31, 2018. From the 24,260 expatriates:

  • 68 expatriated during the period from January 1, 2017, through December 31, 2018, with average income tax liability for the five preceding taxable years ending before expatriation date of over $570,000. Of the 68 taxpayers, we randomly selected 26 cases reporting a combined net worth of $925 million, capital gains of over $126.3 million, and over $584,000 in five-year average tax liability.

  • 347 expatriated in the period from January 1, 2017, through December 31, 2018, and the total net worth of these expatriates was over $4 billion. Of the 347, we randomly selected 35 cases reporting a combined net worth of $289 million and capital gains of nearly $3.3 million.

We reviewed these 61 cases for tax compliance and determined that 19 of the 61 expatriates did not report taxable income. We identified the potential unreported income using third-party information documents, e.g., interest, dividends, capital gains, filed with the IRS. When we discussed these cases with IRS executives, they had concerns with four cases that included real estate sale transactions. After using an aggregate threshold of $25,000 for the information return documents, and excluding cases with real estate sales transactions of nearly $5 million, we determined that the 15 expatriates did not report $17,502,462 in income.


Appendix III

Tax Liability and Exclusion Amounts by Tax Year

Figure 1: Tax Liability Amounts by Tax Year

Tax Year

Amount

2008

$139,000

2009

$145,000

2010

$145,000

2011

$147,000

2012

$151,000

2013

$155,000

2015

$160,000

2017

$162,000

2018

$165,000

2019

$168,000

Source: Instructions for Form 8854 for TYs 2008 through 2019.

Figure 2: Net Gain Exclusion Amounts by Tax Year

Tax Year

Amount

2008

$600,000

2009

$626,000

2010

$627,000

2011

$636,000

2012

$651,000

2013

$668,000

2014

$680,000

2015

$690,000

2016

$693,000

2017

$699,000

2018

$711,000

2019

$725,000

Source: Instructions for Form 8854 for TYs 2008 through 2019.


Appendix IV

U.S. Tax Expatriation — Timeline of Tax Law Changes

 

U.S. Tax Expatriation - Timeline of Tax Law Changes chart

The Foreign Investors Tax Act of 1966 established a 10-year "alternative tax" regime on U.S. source income for expatriates.1 Over the next four decades, the alternative tax regime was modified twice, first by the Health Insurance Portability and Accountability Act of 1996 and then by the AJCA. The Joint Committee on Taxation reviewed the effectiveness of the changes made by the Health Insurance Portability and Accountability Act of 1996. The Joint Committee on Taxation reported that there had been little, if any, enforcement of the expatriation rules by the responsible agencies, principally the IRS.2 The Joint Committee on Taxation Report made a number of specific recommendations within the framework of the existing regime that were generally intended to make the rules easier to administer and enforce. The AJCA generally adopted recommendations made by the Joint Committee on Taxation.

The AJCA left the 10-year alternative tax regime on U.S. source income in place while making a number of important changes. For example, the AJCA removed the requirement that an individual have a tax avoidance purpose, eliminated the ruling procedure, and established the income tax liability test threshold to "greater than" $124,000, indexed annually beginning in CY 2005. The net worth test standard increased to $2,000,000, not indexed.3 The AJCA added a third test which asked that an expatriate certify that they had fully complied with all U.S. tax requirements for the five years preceding expatriation.4 Exceptions to the provision were limited to certain dual nationals at birth having no "substantial contacts" with the United States and minors expatriating before age 18½ who were born in the United State to noncitizen parents and who have not been in the United States more than 30 days in any of the 10 years preceding expatriation.5


Appendix V

Form 8854 — Tax Year 2007

Form 8854 - Tax Year 2007


Appendix VI

Form 8854 — Tax Year 2018

Form 8854 - Tax Year 2018


Appendix VII

Certificate of Loss of Nationality of the United States

Certificat of Loss of Nationality of the United States


Appendix VIII

Letter 2399C — Failure to File Initial Form 8854

Top of Letter 23999C - Failure to File Initial Form 8854

Dear [-30V]

WHY WE ARE CONTACTING YOU

You are receiving this letter because our records show that you have lost your U.S. citizenship but have not properly given notice to the Internal Revenue Service. Such notice is given by filing an initial Form 8854, Initial and Annual Expatriation Information Statement. We [05 50V] initial Form 8854.

You are receiving this letter because our records show that you have terminated your lawful permanent resident status, having been a lawful permanent resident for 8 of the last 15 years (long term resident), but have not properly given notice to the Internal Revenue Service. Such notice is given by filing an initial Form 8854, Initial and Annual Expatriation Information Statement. We [06 50V] initial Form 8854.

Specifically, information is missing from [07 91V]

WHAT DOES THE LAW REQUIRE

Internal Revenue Code (IRC) section 7701(n) requires that a citizen or long-term resident of the U.S. who otherwise stops being a citizen or resident will continue to be treated as such for federal tax purposes. The law requires this individual to be treated as a citizen or resident until the individual (1) gives notice of an expatriating act or termination of residency (with the required intent to relinquish citizenship or terminate such status) to the State Department or the Department of Homeland Security and (2) provides a statement to the IRS based on the revised requirements of IRC section 6039G, which can be done by filing a complete initial Form 8854. Until you comply with both 1 and 2 above, notification and information reporting requirements, you will continue to be treated as a citizen or resident of the United States for federal income tax purposes regardless of your status under U.S. immigration laws.

If IRC section 877 applies to you, IRC 6039G also states that you must file an annual Form 8854 for 10 tax years following the date of your expatriation, whether you owe taxes under IRC section 877 for each tax year or not. The first annual Form 8854 you file must include the date of your expatriation or termination of long-term resident status. This annual form will be due by the same due date of filing a Form 1040-NR (generally by June 15) or, if you are present in the United States following your expatriation and are subject to tax as a U.S. citizen or resident, by the due date of filing a Form 1040 (generally by April 15).

WHAT YOU NEED TO DO

If you want to establish that you are no longer to be treated as a U.S. citizen or resident for federal tax purposes and you have never submitted the initial Form 8854, please do so now. You will continue to be treated as a U.S. citizen or resident for federal tax purposes until the date you file your completed initial Form 8854 with us. The postmark date will be considered your date of expatriation for federal tax purposes. For your convenience, we have included a Form 8854 and the related instructions with this letter and ask that you complete all of the pertinent sections and return to the address at the top of this letter.

If you submitted an incomplete initial Form 8854, you will need to complete another one and mail it to the address at the top of this letter. You will continue to be treated as a U.S. citizen or resident for federal tax purposes until the date you file your completed initial Form 8854 with us. The postmark date will be considered your date of expatriation for federal tax purposes. For your convenience, we have included a Form 8854 and the related instructions with this letter and ask that you complete all of the pertinent sections and return to the address at the top of this letter.

If you are required to file an annual Form 8854 but fail to do so, do not include all of the information required by the form, or the form includes incorrect information, you could be assessed a penalty of $10,000 for each tax year that a required annual Form 8854 is not filed, unless you can show that your failure to file the form was due to reasonable cause and not willful neglect.

It is important to note! Filing an initial Form 8854 only satisfies your information reporting obligations resulting from your expatriation for tax purposes. You are still required to:

  • File an annual Form 8854 for the 10 tax years following the date of your expatriation for tax purposes, if:

    • Your net worth as of the date of your expatriation is $2 million or more;

    • Your annual net income tax liability for the 5 years ending before the date of your expatriation is greater than $[09 12$]; or 

    • You fail or are not able to certify on Form 8854, under penalty of perjury, that you met your tax obligations for the 5 years ending before the date of your expatriation.

  • Compute any tax due, if applicable, under IRC section 877.

HOW TO CONTACT US

If you have any questions, please call the contact person whose name and telephone number are shown at the top of this letter or refer to "The American Jobs Creation Act" information on our IRS.gov web site at http://www.irs.gov/businesses/small/international/index.html.

Sincerely yours,

[10 35S]

[11 35S]

Enclosures:

Form 8854

Instructions for Form 8854

NOTE: Use Sel. A for lost citizenship or use Sel. B for termination of permanent resident status.


Appendix IX

Management's Response to the Draft Report

September 8, 2020

MEMORANDUM FOR
MICHAEL E. McKENNEY
DEPUTY INSPECTOR GENERAL FOR AUDIT

FROM:
Douglas W. O'Donnell
Commissioner, Large Business and International Division

SUBJECT:
Draft Audit Report # 2019-30-016, More Enforcement and A Centralized Compliance Effort Are
Required for Expatriation Provisions

Thank you for the opportunity to review and comment on the draft report referenced above. Historically, 1RS audits of expatriates focused on noncompliance with expatriation tax law and high risk expatriates who filed Form 8854, Initial and Annual Repatriation Statement; soft letters were transmitted to certain expatriates who failed to file Form 8854. More recently, in July 2019, the 1RS announced a campaign to enhance these earlier efforts to ensure tax compliance of covered expatriates. This campaign evaluates filings of Forms 8854 and 1040-NR, U.S. Nonresident Alien Income Tax Return, utilizing numerous filters to identify those areas of potential risk for noncompliance. This has led to issuance of soft letters to expatriates who have not filed a required Form 8854 and examinations of covered expatriates with a high risk of expatriation tax noncompliance. We are assessing, and will continue to assess, initial campaign results, compliance risks, available resources, and organizational priorities to determine what modifications should be made to the campaign, to the Expatriation Database and/or to the Form 8854, as well as when to request additional information regarding missing or incomplete Forms 8854.

We have also begun assessing potential enhancements to the Expatriation Database that would expand the breadth and usability of the data; and strengthen our data analytics capabilities for identifying noncompliance in this area.

The attachment provides a response outlining our corrective actions for the recommendations. While the forms you reviewed included some reporting discrepancies, it does not necessarily follow that an examination of the relevant taxpayers will result in an increase of revenue.

Please contact me if you have any questions, or members of your staff may contact Deborah T. Palacheck, Director, Withholding & International Individual Compliance Practice Area at (202) 317-8451.

Attachment


Attachment I

The Commissioner, Large Business and International (LB&I) Division, should:

RECOMMENDATION 1:

Contact the Department of State, via the Federal Intergovernmental Program, for the Social Security number data field to be added to the Certificate of Loss of Nationality of the United States Form DS-4083 and explore the feasibility of obtaining the CLN electronically.

CORRECTIVE ACTIONS:

We will contact the Department of State, via the Federal Intergovernmental Program, to request the Social Security number data field be added to the Certificate of Loss of Nationality of the United States, Form DS-4083, and explore the feasibility of obtaining the CLN electronically.

IMPLEMENTATION DATE:

March 31,2021

RESPONSIBLE OFFICIAL(S):

Deborah Palacheck, Director, Withholding & International Individual Compliance Practice Area

CORRECTIVE ACTION(S) MONITORING PLAN:

We will monitor this corrective action as part of our internal management control system.

RECOMMENDATION 2:

Update the Letter 2399C and Letter 4135C for compliance under HEART Act of 2008 and develop I RM procedures to use these letters to obtain Form 8854 when a Certificate of Loss of Nationality is received and no Form 8854.

CORRECTIVE ACTIONS:

We will update letters 2399C and 4135C to include the requirements of I.R.C. § 877A and remove any language no longer applicable under the HEART Act of 2008. We will also develop IRM or other procedures on how, and when appropriate, to obtain Form 8854 when a Certificate of Loss of Nationality but no Form 8854 is received, taking into consideration an initial assessment of Expatriation Campaign results, compliance risks, resource availability, and organizational priorities.

IMPLEMENTATION DATE:

December 31,2021

RESPONSIBLE OFFICIAL(S):

Deborah Palacheck, Director, Withholding & International Individual Compliance Practice Area

CORRECTIVE ACTION(S) MONITORING PLAN:

We will monitor this corrective action as part of our internal management control system.

RECOMMENDATION 3:

Evaluate the information reported on Form 8854 and determine what data fields should be added to the expatriation database to ensure tax compliance of taxpayers that expatriate (e.g. Form 8854, Part IV, Schedule B. Property Owned on Date of Expatriation).

CORRECTIVE ACTIONS:

We will evaluate the information reported on Form 8854 and determine what data fields should be added to the expatriation database to best evaluate the tax compliance of taxpayers that expatriate, taking into consideration an initial assessment of Expatriation Campaign results, compliance risks, resource availability, and organizational priorities.

IMPLEMENTATION DATE:

December 31,2021

RESPONSIBLE OFFICIAL(S):

Deborah Palacheck, Director, Withholding & International Individual Compliance Practice Area

CORRECTIVE ACTION(S) MONITORING PLAN:

We will monitor this corrective action as part of our internal management control system.

RECOMMENDATION 4:

Develop IRM procedures for transcribing Form 8854 data, correcting Form 8854 data when information as filed by expatriates is missing or incomplete and prepare analysis as needed to determine if the expatriate is a covered expatriate and subject to tax under I.R.C. §877A. '

CORRECTIVE ACTIONS:

Following the initial assessment of the Expatriation Campaign results, compliance risks, resource availability, and organizational priorities, we will develop IRM or other procedures for inputting and correcting certain Form 8854 data when information as filed by expatriates is missing or incomplete, as appropriate, and prepare an analysis as needed to determine if the expatriate is a covered expatriate and subject to tax under I.R.C. §877A.

IMPLEMENTATION DATE:

December 31,2021

RESPONSIBLE OFFICIAL(S):

Deborah Palacheck, Director, Withholding & International Individual Compliance Practice Area

CORRECTIVE ACTION(S) MONITORING PLAN:

We will monitor this corrective action as part of our internal management control System.

RECOMMENDATION 5:

Establish a process to compile information on all expatriates whether they filed Form 8854 with their Form 1040-NR or filed Form 8854 with the LIHC unit and use this information to identify the highest risk expatriate returns for tax compliance.

CORRECTIVE ACTIONS:

The Expatriation Campaign is the process established to compile information on all expatriates, whether they filed Form 8854 with their Form 1040-NR or filed Form 8854 with the LIHC unit, and we will use this information to identify expatriate returns with high risk of noncompliance.

IMPLEMENTATION DATE:

Implemented

RESPONSIBLE OFFICIAL(S):

N/A

CORRECTIVE ACTION(S) MONITORING PLAN:

N/A


Appendix X

Glossary of Terms

Term

Definition

Audit Information Management System

The Audit Information Management System is a computer system used by the Small Business/Self-Employed Division Examination Operations function and others to control returns, input assessments/adjustments to the Master File, and provide management reports.

Calendar Year

The 12-consecutive-month period ending on December 31.

Campus

The data processing arm of the IRS. The campuses process paper and electronic submissions, correct errors, and forward data to the Computing Centers for analysis and posting to taxpayer accounts.

Classification

The process of determining whether a return should be selected for audit, the initial issues to be audited, and who should conduct the audit.

Data Center Warehouse

Provides data and data access services and a centralized storage, security, and administration of files. Also develops uniform and user-friendly interfaces for users to access data.

Disposal Code

Two digit code used to indicate the disposition of an examination. The codes are assigned by the Examination function.

Expatriate Database

IRS database used to collect information on expatriates.

Federal Register

The official daily publication for rules, proposed rules, and notices of Federal agencies and organizations, as well as executive orders and other presidential documents.

Fiscal Year

Any yearly accounting period, regardless of its relationship to a calendar year. The Federal Government's fiscal year begins on October 1 and ends on September 30.

Individual Master File

The IRS database that maintains transactions or records of individual tax accounts.

Individual Returns Transaction File

Contains data transcribed from initial input of the original individual tax returns during return processing.

Integrated Data Retrieval System

IRS computer system capable of retrieving or updating stored information. It works in conjunction with a taxpayer's account records.

IRS Catalog

Provides electronic and printed products and services that enable America's taxpayers to understand and meet their tax responsibilities and IRS employees to effectively and fairly administer the tax laws.

Master File

The IRS database that stores various types of taxpayer account information. This database includes individual, business, and employee plans and exempt organizations data.

Processing Year

The calendar year in which the tax return or document is processed by the IRS.

Tax Modules

Part of a taxpayer's account which reflects tax data for one tax class and one tax period.

Tax Year

The 12-month accounting period for keeping records on income and expenses used as the basis for calculating the annual taxes due. For most individual taxpayers, the tax year is synonymous with the calendar year.

Taxpayer Identification Number

A nine-digit number assigned to taxpayers for identification purposes. Depending upon the nature of the taxpayer, the Taxpayer Identification Number is an Employer Identification Number, an SSN, or an Individual Taxpayer Identification Number.

Transaction Code

A three-digit code used to identify actions being taken on a taxpayer's account.


Appendix XI

Abbreviations

AJCA

American Jobs Creation Act of 2004

CLN

Certificate of Loss of Nationality of the United States

CY

Calendar Year

FY

Fiscal Year

HEART Act

The Heroes Earnings Assistance and Relief Tax Act of 2008

I.R.C.

Internal Revenue Code

IRM

Internal Revenue Manual

IRS

Internal Revenue Service

LB&I

Large Business and International

LIHC

Low-Income Housing Credit

SB/SE

Small Business/Self-Employed

SSN

Social Security Number

TY

Tax Year

FOOTNOTES

1See Appendix III, Figure 1, for tax liability amounts for TYs 2008 through 2019. See Appendix X for a glossary of terms.

2I.R.C. § 877A (the HEART Act). There are special provisions applicable to deferred compensation items, specified tax-deferred accounts, and interests in a non-grantor trust of which the covered expatriate was a beneficiary on the day before the expatriation date.

3See Appendix III, Figure 2, for net gain reduction amounts for TYs 2008 through 2019.

4I.R.C. § 877A(g)(1).

5See Appendix IV for synopsis of legislative history.

6Congress, Have a Heart: Practical Solutions to Punitive Measures Plaguing the HEART Act's Expatriate Inheritance Tax, 26 Temp. Int'l & Comp. L. J. Pg. 69 (2012).

7Pub. L. No. 110-245.

8We were unable to validate the accuracy and completeness of the Federal Register. The IRS publishes the names in the Federal Register quarterly as it receives the information from the Department of State and may not correlate to the date when the taxpayer expatriated. For example, the IRS indicated that if the date on the Form DS-4083, Certificate of Loss of Nationality of the United States, is used to measure when expatriations occur (as opposed to when the Federal Register publishes the data), the highest year for expatriation was 2014 with 5,208 expatriations.

9When a tax return is not required to be filed, the Form 8854 is only filed with the IRS Campus and, as requirements are met, the name is reported in the Federal Register.

10When the expatriate database was established in the 1990s, the International Office responsible for enforcement of the expatriation provisions was in the SB/SE Division, and the SB/SE Division Campus in Philadelphia was responsible for handling documents and forms pertaining to International Tax Administration and has continued to maintain the expatriate database. The SB/SE Division International Office moved to the Large Business and International Division around 2010.

11The 41,058 records includes 13 records without an expatriation date.

12Audit Code K is entered for the following conditions: Disclosure Statement, Refund Scheme, Preparer Identified, and Forms 1040NR with Form 8854 attached. Because there are several conditions for when Audit Code K is used, it is not a method to identify expatriate examinations. Forms 1040NR are filed with the IRS Campus in Austin, Texas.

13The 8,861 represents returns in which the tax year ended in December. There were a total of 16 records not included in this count in which the tax year did not end in December. Further, these 8,861 returns were filed by 8,340 individual taxpayers.

14As shown in Appendix VII.

15IRM 4.19.11.2.19 (June 22, 2016).

16I.R.C. § 877(a)(2)(C).

17See Appendix IV for more details on the legislative history.

18New letters performing the same compliance function as part of the Expatriation Campaign will be considered, but not used by the LIHC unit. The Expatriation Campaign is discussed further in the report.

19See Appendix III, Figure 1, for tax liability amounts for TYs 2008 through 2019.

20A CLN was received for seven records but did not have a date of expatriation.

21The potential exception cases will not add to 10 because * * * 1 * * * case has both potential unreported income and aggregate balance due from all tax modules.

22The information return documents include Forms 1099-INT, Interest Income; 1099-DIV, Dividends and Distributions; and 1099-B, Proceeds From Broker and Barter Exchange Transactions, etc.

23I.R.C. § 7345, added by § 32101 of Fixing America's Surface Transportation Act of 2015, (Pub. L. No. 114-94). This Act requires the IRS to notify the State Department of taxpayers the IRS has certified as owing a seriously delinquent tax debt.

24IRM 4.19.11.2.19 (June 22, 2016).

25These populations are not mutually exclusive of each other as it is possible for an individual to be included in each of the two categories. For example, a person can average a taxable net income of $165,000 or more for the five years preceding taxable years before expatriation and have a self-reported net worth of $2,000,000 or greater.

26The LB&I Division has announced 65 campaigns. Campaigns are part of the LB&I Division's efforts to move towards more issue-based examinations, and they involve analysis of data to support the identification and evaluation of a compliance issue; a more deliberate consideration of potential treatment streams; decisions about the resources to be deployed; and identification of training, mentoring, networking, and tools needed as well as a robust feedback mechanism to ensure that all elements of a campaign are continuously improved.

27A soft letter is correspondence directed at a particular filing position taken by a taxpayer and seeks information or suggests a course of action.

28Special Project Code 0504 is used on examinations of expatriation taxpayers. Examination records are for FY 2015 through FY 2018. We notified the IRS of our audit in June 2019.

29Change rate represents the percentage of cases examined that had an adjustment.

30To “Survey” a return is to not initiate an examination. Most (91 percent) of the 61 sample cases we reviewed were surveyed with a Disposal Code 35, which is “Surveyed-Excess Inventory — Return has audit potential but time prohibits starting the examination.”

1A judgmental sample is a nonprobability sample, the results of which cannot be used to project to the population.

1These rules were contained principally in I.R.C. §§ 877, 2107, and 2501.

2Joint Committee on Taxation, Review of the Present-Law Tax and Immigration Treatment of Relinquishment of Citizenship and Termination of Long-Term Residency (JCS-2-03) (Feb. 2003).

3AJCA I.R.C. § 804(a)(1), amending I.R.C. § 877(a)(2).

4AJCA I.R.C. § 804(a)(1), adding new I.R.C. § 877(a)(2)(C).

5Under the new I.R.C. § 877(c)(2)(B), added by AJCA I.R.C § 804(a)(1), an individual will be considered to have "substantial contacts" with the United States if he or she ever held a U.S. passport, was a U.S. tax resident within the meaning of I.R.C. § 7701(b), or spent more than 30 days in the United States in any of the 10 years preceding expatriation. This exception is available only to individuals who were dual citizens at birth and remain a citizen of the other country.

END FOOTNOTES

DOCUMENT ATTRIBUTES
Copy RID