Tax Planning

IRS Targets U.S. Citizens Living Abroad

As part of its continuing crackdown on U.S. taxpayers with offshore dealings, the IRS has cranked up its tax enforcement efforts for Americans living abroad.  Apparently, it believes that a large number of the millions of Americans that live offshore aren't paying U.S. taxes.  And, they're probably right.

I've met dozens of U.S. citizens living abroad who honestly didn't believe they were subject to U.S. tax since they were paying taxes where they lived.  But since the U.S.—alone among major countries—imposes tax on the basis of citizenship, Americans living abroad must file tax returns, too.

For more than a decade, the IRS has been trying to figure out how to force these non-resident citizens to start paying tax.  One prong of this effort is its ongoing crackdown against offshore banks with U.S. correspondent accounts.  The IRS demands that these banks enter into one-sided "qualified intermediary" agreements that force the banks to disclose the names of their U.S. customers.  In response, many offshore banks simply closed the accounts of all their U.S. customers—even those living offshore.

But now, the IRS is going further.  Back in 2001, the IRS commissioned a study of an obscure international agreement called the "Hague Convention on the Service Abroad of Judicial and Extra Judicial Documents in Civil and Commercial Matters."  Basically, the IRS wanted to know if it could issue a demand for information in the United Kingdom that would be enforceable through U.S. courts.  Its legal analysis concluded that it could.  In other words, once the IRS has completed some procedural formalities, it can serve notice to a U.S. citizen living in the U.K. with a legally binding demand to produce documents, testimony or other information.

I'm not aware of the IRS using the Hague Convention in this manner until very recently, but I've now learned that the IRS has issued administrative subpoenas in both the U.K. and Switzerland.  Their initial targets appear to be accounting firms in those countries that prepare U.S. tax returns for wealthy Americans. In addition, the IRS is using the information exchange provisions of a new "joint tax shelter" initiative to obtain tax return from the Inland Revenue, the U.K. tax authority.  Besides the U.S. and U.K., the other participants in this treaty are Australia, Canada, and New Zealand.

The U.S. Department of State (DOS) estimates that more than six million U.S. citizens live outside the United States.  But no one knows for certain—and it's likely the numbers are higher than the DOS estimate.

Back in 2004, the Census Department tried to make a head count of Americans living in Kuwait, Mexico, and France.  They gave their effort the catchy name of the "Overseas Enumeration Test."  Perhaps that's why the program was such a colossal failure.  For instance, the DOS estimates that approximately 300,000 Americans live in Mexico.  Groups representing Americans living overseas say the number is closer to one million.  But only 250 Americans completed the Census form.  Clearly, at least some of the remainder had no desire to be "enumerated."

If you're an American living abroad, the IRS has you in its sights.  This is particularly true if you live in the U.K. or Switzerland.  If you live in a country that doesn't have a tax treaty or tax information exchange agreement with the U.S., your immediate risk is probably somewhat lower.   However, if you haven't been filing tax returns annually with the IRS, you need to begin doing so—pronto.

I think this strategy could easily blow up in the face of the IRS.  Yes, it may force wealthy Americans living abroad to fess up and begin paying tax.  But, I suspect a lot more Americans—particularly those who have lived abroad most of their lives, or have never even set foot in the USA—to simply give up their U.S. citizenship and passport.  It could also lead to fewer and fewer wealthy foreigners being willing to invest in the United States.  That can't be healthy for the U.S. economy—or the U.S. dollar.

Copyright © 2010 by Mark Nestmann

(An earlier version of this post was published by The Sovereign Society,

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