While it used to be that “custom holds” were the main weapon used by the government to interrupt international travel for individuals who may have significant tax liabilities (especially involving international and offshore accounts), the IRS has upped the ante.
There is a law currently pending that would actually deny and/or revoke passports to individuals who have significant tax debt. Although the law is still currently pending, if it is passed, then any taxpayer who has more than $50,000 in unpaid federal taxes 0 including penalties and interest – may be subject to having their passport denied or revoked.
The following is a list of real-life situations that could result in such an outcome, with serious repercussions:
- Passport Revocation/Denial Example 1: David is a US Citizen who likes to travel the world visiting friends and family. David finds out that one of his parents who resides in China is sick. Unfortunately, due to a downturn in the economy David’s business is floundering and he finds himself $75,000 in tax debt to the IRS before he has a chance to enter an installment agreement – according to this new law, the IRS could revoke his passport, preventing him from traveling.
- Passport Revocation/Denial Example 2: Michelle is a US citizen who resides overseas and works for a large company. Michelle was unaware of the requirement to file US taxes and therefore has not filed a U.S. tax return for nearly 8 years (although she would qualify for either the Foreign Earned Income Exclusion or Foreign Tax Credit which reduce eliminate her tax liability). The IRS gets wind of this and charges her account $100,000. As a result, the US government could revoke her passport, leaving her stranded in a foreign country – all because she was unaware of the requirement to file a tax return even though she resided overseas 365 days out of the year.
- Passport Revocation/Denial Example 3: Scott is a US citizen who is currently residing in Italy. Like the prior example, Scott was also unaware that there was a requirement to file US taxes but he has more than enough money saved to pay it off. Unfortunately, the IRS does not have Scott’s current address and therefore Scott never received notice of the tax bill. According to the new law, if Scott’s tax bill exceeds $50,000 he could have his passport revoked without ever receiving notice.
The point of these examples is that there are numerous circumstances in which a taxpayer could be unaware (Negligence) of the requirement to pay US Tax and still have his or her tax passport revoked. As such expats and other U.S. citizens living in a foreign country and/or unaware of the requirement to pay US will undoubtedly get caught in the mix without having any intent to defraud or otherwise avoid paying US tax – resulting in U.S. citizens losing the right to freely travel the world.
For individuals who are stranded in countries with significant dangers, this is almost equivalent to a debtor’s prison, but the IRS does not care. It appears in preparing the cost-benefit analysis of an individual being stranded in a country where their life and their family’s life is in jeopardy versus an unpaid tax, that the unpaid tax debt is the more serious concern for the US government.
*While the IRS indicated it could make accommodations for people whose life is in serious jeopardy – do you really want your lifeline to be depending on IRS?
International Tax Compliance & Tax Debt
For most US citizens who travel internationally, foreign tax compliance will be the main issue that can result in tax debts and tax liens exceeding $50,000. The following is a summary of some of the more common types of international tax forms that must be filed.
- 1120F: Use Form 1120-F to report the income, gains, losses, deductions, credits, and to figure the U.S. income tax liability of a foreign corporation. Also, use Form 1120-F to claim any refund that is due, to transmit Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b), or to calculate and pay a foreign corporation’s branch profits tax liability and tax on excess interest.
- 3520: U.S. persons (and executors of estates of U.S. decedents) file Form 3520 to report: Certain transactions with foreign trusts, Ownership of foreign trusts under the rules of sections 671 through 679, and Receipt of certain large gifts or bequests from certain foreign persons.
- 5471:Generally, all U.S. persons described in Categories of Filers below (in the 5471 instructions) must complete the schedules, statements, and/or other information requested in the chart, Filing Requirements for Categories of Filers, on page 2. Read the information for each category carefully to determine which schedules, statements, and/or information apply.
- 5472: Generally, a reporting corporation must file Form 5472 if it had a reportable transaction with a foreign or domestic related party.
- 8938: Use Form 8938 to report your specified foreign financial assets if the total value of all the specified foreign financial assets in which you have an interest is more than the appropriate reporting threshold. See Reporting Thresholds Applying to Specified Individuals (described in detail in the IRS instructions).
- FBARs: FBAR or FinCEN 114 forms must be filed by any individual who has an annual aggregate that exceeds $10,000 for the combined value of all of their foreign applicable bank and financial accounts.
***The failure to file FBARs and 8938s can result in the most tax liability.
Unreported Foreign Income (Non-Willful)
If a taxpayer’s failure to file the FBAR was non-willful, then chances are the taxpayer may be in a position to have a reduction or elimination of penalties. If the taxpayer was non-willful, then that means the taxpayer did have any intent, malice or fraud in failing to comply with FBAR filing requirements — rather, the taxpayer is simply unaware of the requirement to file the FBAR.
Presuming that there was additional income from overseas that the taxpayer did not report and the taxpayer was under examination before the taxpayer had an opportunity to enter the IRS streamlined program, there are four levels of penalties that the IRS could issue:
The IRS has the authority to waive penalties and instead issue a warning letter.
The IRS has the authority to issue one $10,000 penalty for all the accounts for the entire audit period.
$10,000 Annual Penalty
The IRS has the ability to issue a $10,000 penalty for each year that the taxpayer did not file and FBAR. For example, if the audit period is three years, then the IRS could issue penalties in the amount of $30,000.
$10,000 per account/per year
If the IRS agent wants to – even though the taxpayer was non-willful – if the circumstances require it the IRS agent can penalize the taxpayer $10,000 per account, per year for the entire audit period.
**This is one of the key reasons why it is important that a taxpayer does not speak directly with the Internal Revenue Service regarding these types of international tax issues and retains an experience international tax lawyer.
Unreported Foreign Income (Willful)
If a person’s failure to file the FBAR was willful, which generally means intentional, then the stakes are much higher and the penalties much more severe. If a person intentionally failed to file their FBAR, it generally means they also intentionally failed to report their offshore income – which is a form of tax evasion and tax fraud.
The United States taxes individuals on their worldwide income; that means the United States does not care where you earned your income at, you must pay tax on it. For example, if you reside in the United States and earn $10,000 overseas in interest income (even if it was earned in a country that does not tax passive income) you are still required to pay tax on that money in the United States. Although, if you already paid tax in a foreign country already you may be entitled to a foreign tax credit.
In addition, if you sold the home in a foreign country and earn long-term capital gain or short-term capital gain, even if you do not have to pay capital gains enough for country, you have to report it on your US tax return as well. The intentional failure to report can have very serious consequences.
Willfulness May Result in a 100% Penalty of the Overseas Account Value(s)
If you are held to be in willful violation of FBAR filing requirements there can be significant penalties. Generally, the Internal Revenue Service recommends that agents penalize individuals 50% of their highest year balance during the “audit period”. So if you had three accounts overseas with $100,000, $200,000, and $400,000 – you would be penalized $200,000 (per year up to a total of $400,000) – and that is only the standard penalty.
While the IRS will not usually penalize you less than 50% of the highest balance, they could penalize you more. In fact, if you get an IRS agent who is having a bad day or bad week and you get on their bad side, the IRS could potentially penalize you 100% of the account balances. That’s right: the IRS can literally penalize you the full value of your offshore accounts just because you knew you were supposed to, but did not report them.
IRS Form 8938
What if I Do Not File the IRS Form 8938?
The failure to file IRS form 8938 can have a significant impact on the taxpayer. That is because according to IRS law the taxpayer may be penalized: “Up to $10,000 for failure to disclose and an additional $10,000 for each 30 days of non-filing after IRS notice of a failure to disclose, for a potential maximum penalty of $60,000; criminal penalties may also apply”
**If you believe you may have tax debts exceeding $50,000, it is time to “Lawyer-Up” with a