IRS to Put Audit Focus on These 5 International Tax Compliance Issues
In January of 2017, the IRS’s Large Business and International division (LB&I) selected a group of tax compliance issues that it determined would become part of its new issue-focused audit strategy. The IRS has since added to the list on several occasions. Thus far, the list has concentrated on mostly domestic issues, with some exceptions.
Most recently, the IRS added 5 new international tax compliance issues to its audit strategy. The five new issues include:
1. Foreign Trust (Form 3520) Compliance
The IRS plans to more closely scrutinize the reporting of foreign trusts and their activities. The foreign trust forms include Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, and Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner.
Form 3520 involves perhaps the most complex information reporting of all the information returns. In brief, U.S. individuals may be required to include Form 3520 with their tax return if they are an owner or beneficiary of foreign trusts (including certain foreign pensions) as well as a recipient of certain gifts from foreign individuals and corporations. Certain transactions between a foreign trust and a U.S. person need to be reported on Form 3520 and the trust itself may be required to file Form 3520-A if the trust settlor is considered an “owner” of the trust for U.S. tax purposes.
2. Tax Withholding (Form 1042) Compliance
The IRS plans to more closely scrutinize the reporting by withholding agents of payments made to foreign persons. Taxpayers who make U.S.-source payments to foreign persons must comply with certain withholding, deposit, and reporting requirements. The relevant forms include Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, and Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding.
3. Tax Treaty Exemptions for Nonresident Aliens
Nonresident aliens (“NRAs”) with certain income otherwise subject to U.S. income tax can utilize a provision of a U.S. income tax treaty to exempt the income. The IRS plans to more closely scrutinize this type of claim because, “Some NRA taxpayers may either misunderstand or misinterpret applicable treaty articles, provide incorrect or incomplete forms to the withholding agents, or rely on incorrect information returns provided by U.S. payors to improperly claim treaty benefits and exempt U.S. source income from taxation.”
4. Deductions Claimed by NRAs
The IRS plans to more closely scrutinize the utilization by NRAs of deductions of eligible expenses on Form 1040NR Schedule A. According to the IRS, “NRA taxpayers may either misunderstand or misinterpret the rules for allowable deductions under the previous and new Code provisions, not meet all the qualifications for claiming the deduction, and/or not maintain proper records to substantiate the expenses claimed.” The IRS did not single out any particular type of deduction.
5. Tax Credits Claimed by NRAs
The IRS plans to focus on dependent-related tax credits, which are often incorrectly claimed by NRAs, because the individuals either, “have no qualifying earned income, do not provide substantiation/proper documentation, or do not have qualifying dependents.”
In addition, the IRS will be paying closer attention to NRA taxpayers who erroneously claim education credits that are only available to U.S. persons.
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 Ephraim Moss, Esq. & Joshua Ashman, CPA