IRS Adds 4 More International Tax Issues to Its Audit Campaigns
Previously, we’ve blogged about the IRS’s selection of a group of international tax compliance issues that became part of its issue-focused audit strategy. The IRS has since added more international issues to the list, including the new Section 965 transition tax for foreign company owners.
Most recently, the IRS added 4 new international tax compliance issues to its audit strategy. The new issues include:
1. The Individual foreign tax credit (phase II).
According to the IRS, this campaign will focus on taxpayers who have claimed the foreign tax credit but do not meet the requirements.
Foreign taxes eligible for the foreign tax credit are generally limited to income taxes imposed by a foreign country. It is important to note that often certain foreign taxes may appear as income taxes but will not qualify as income taxes for purposes of taking the foreign tax credit. For instance, foreign real estate taxes, sales taxes, luxury taxes, turnover taxes, value-added taxes, and wealth taxes, are generally not creditable.
Your foreign tax credit is the amount of foreign tax you paid or accrued during the tax year. The foreign tax credit can be limited by the so-called “foreign tax credit limitation,” under which your foreign tax credit cannot be more than your total U.S. tax liability multiplied by a fraction. The numerator of the fraction is your taxable income from sources outside the United States, while the denominator is your total taxable income from U.S. and foreign sources.
If the foreign taxes available for credit exceed your foreign tax credit limitation, you may be able to carry the credit back to the previous tax year and forward to the next 10 tax years. It is important to keep in mind that the foreign tax credit needs to be calculated both for regular tax purposes and for Alternative Minimum Tax (AMT) purposes.
The IRS stated that it will address noncompliance with the foreign tax credit requirements and reporting rules through a variety of actions, including examinations of international returns.
2. Offshore service providers
This campaign will address U.S. taxpayers “who engaged offshore service providers that facilitated the creation of foreign entities and tiered structures to conceal the beneficial ownership of foreign financial accounts and assets, generally, for the purpose of tax avoidance or evasion.”
For expats, this campaign again shows the importance of engaging a trusted tax professional, especially when confronting international tax issues and when contemplating structure planning.
3. FATCA filing accuracy
According to the IRS, this campaign will focus on entities (e.g., foreign financial institutions) that have FATCA reporting obligations but do not meet all their compliance responsibilities.
The main objective behind FATCA, which was enacted in 2010, is to combat offshore tax evasion by: (1) requiring U.S. citizens, including those living abroad, to report their holdings in foreign financial accounts and their foreign assets on an annual basis to the IRS, and (2) requiring foreign financial institutions (“FFIs”) (which include just about every foreign bank, investment house and even some foreign insurance companies) to report to the IRS the balances in the accounts held by customers who are U.S. citizens.
If U.S. tax return filers don’t comply with the FATCA rules, they can be subject to severe penalties, and if foreign banks and other institutions don’t comply, they and their account holders can be subject to an automatic 30% withholding tax on U.S.-source payments such as interest and dividends.
The IRS stated that it will address noncompliance through a variety of actions, including the termination of FATCA-compliant status for an offending entity.
4. 1120-F delinquent returns campaign
The purpose of this campaign will be to encourage foreign entities to timely file the corporation tax return, Form 1120-F, to report and pay tax on income that is effectively connected with a trade or business within the United States.
In this regard, the more prudent foreign companies who are confident, but not absolutely sure, that they do not have a trade or business within the United States, will file a so-called “protective” income tax return showing no income. This practice is motivated by Treasury regulations stating that if an income tax return is filed too late (defined in the regulations as 18 months following the due date of the return), the taxpayer loses the ability to utilize deductions and certain credits in the event that a trade or business within the United States is in fact found to have been created. The protective return preserves these potential deductions and credits without subjecting the foreign seller to U.S. federal income taxation by virtue of filing the return.
What This Means for US Expats
As the IRS begins to focus more heavily on international tax compliance issues, it will become more important than ever for expats to file their U.S. taxes timely and accurately.
At Expat Tax Professionals, our team of experts will carefully prepare your tax return, so that if you end up getting audited, your return will withstand the scrutiny of the IRS. If you are a U.S. expat who needs help with tax return preparation, please contact us and we’ll get the process started immediately.
By Joshua Ashman, CPA & Nathan Mintz, Esq.