With tax filing season in full swing many clients are having bad dreams and becoming concerned about a possible audit. Americans abroad do have a greater chance of an audit than the average taxpayer. I suspect this trend will increase as the Internal Revenue Service (IRS) obtains information from non-US financial institutions under the Foreign Account Tax Compliance Act (FATCA) that does not "match" what a taxpayer has reported on his income tax return or FBAR (FinCEN Form 114). The IRS uses a combination of processes when selecting tax returns for audit – generally these are based on statistical norms that the computerized system will utilize as it processes tax returns; those returns with anomalies that are flagged by the computer system will then undergo various layers of review by IRS personnel. Foreign income and foreign accounts have now become favorite targets for the IRS, so making sure that these items are fully and accurately reported is critical.
I can tell from client inquiries that many simply do not know what to expect when faced with an IRS audit. They envision being called to the nearest US Embassy or Consulate to meet with a brutal-looking IRS agent. Relax! That is not how an audit will usually go down. The vast majority of IRS audits are what are called "correspondence audits", which means the IRS requests information by mail instead of questioning a taxpayer in person. The IRS agent will render his or her decision based on the answers to the questions presented and the documentation submitted by the taxpayer. Sometimes, phone calls may be part of the audit, and rarely, will an in-person interview be required.
An audit of an overseas American may involve questions and request information designed to determine if the taxpayer qualifies for the Foreign Tax Credit (Form 1116), the Foreign Earned Income (FEIE) and/ or Housing Exclusions (Form 2555). In addressing these queries the professional will need copies of the foreign tax return filed for the year under audit, proof of the taxpayer's residency (for example, the residency visa and its terms, copy of the passport, home purchase or lease agreement for the residence overseas and so on), the employment contract or letter from the employer and income statements.
The IRS uses certain questionnaire-type forms when auditing expatriates who claim the FEIE or Foreign Tax Credit. As part of the audit, the IRS will likely request completion of some or all of the following forms: IRS Form 9209 (Bona Fide Residence/Physical Presence Questionnaire), 9211 (Foreign Earned Income Exclusion Questionnaire), and 9213 (Foreign Tax Credit Questionnaire).
Questions about eligibility for the FEIE often arise in the case of pilots, air or sea hostesses or stewards, seamen or others working in or over international waters. This issue arises since compensation apportioned to work in or over international waters is not eligible for the exclusion since it is not considered to be for services "performed in a foreign country". These types of cases can be very long and drawn out causing expensive professional fees.
A particular challenge for Americans abroad who are facing an IRS audit involves the typical request by the IRS that all documents be sent with a certified translation. This can easily become a very expensive proposition. In addition, and rightly so in today's day and age, many taxpayers will have concerns about providing personal and confidential information to the third party translation service. It may be possible to bypass the translation route by indicating in the English language any words that are necessary to provide an explanation of the items (thus, one can provide the English words alongside the foreign language words). The IRS will request clarification of any document it cannot understand.
Do not ignore an IRS audit letter. If you do, the IRS may automatically assess the tax and you may risk loss of your US passport. At an early stage you should determine if you need professional help. Most taxpayers provide too much information to the IRS when dealing with the agent without professional representation. This can be dangerous and it is likely the IRS may ask more and more probing questions if the agent realizes a taxpayer is unrepresented. Always be cooperative, courteous and professional but do not provide more information that what is being directly asked. If you cannot find the required documentation requested by the IRS, always explain this to the agent rather than continuing to delay in your response.
In the typical case of overseas Americans with offshore assets, the law now provides the IRS with a very long "statute of limitations". A statute of limitations is a law that prescribes the length of time permitted to the IRS to enforce the tax rules. If the length of time runs out for a particular tax year, then the IRS is forever barred from claiming that you owe more tax in that year.
The general rule is that the IRS has three years after the later of the date the tax return was due or the date the return was filed, in order to assess tax. Only if a tax return is filed will the statute of limitations begin. This three-year rule applies if the tax return is timely filed or if it is filed late - the important point to remember is that a tax return must be filed to start the statute running.
The statute can be extended to six years if there is a "substantial understatement" of income. This means the taxpayer omitted from gross income an amount properly includible in his income and that amount is more than 25% of the amount of gross income stated in the tax return. Under a special rule added to the tax law in 2010 by FATCA, the statute can also be extended to six years if the taxpayer omits over $5,000 from gross income that is attributable to certain kinds of foreign financial assets. Under another FATCA provision, the statute of limitations does not begin to run until the taxpayer has complied with all mandatory foreign reporting – e.g., information returns regarding ownership in foreign corporations, foreign partnerships, foreign trusts, "specified foreign financial assets" on Form 8938 and many other transactions in the offshore context. Only when all proper foreign information reporting has been made will the statute of limitations "clock" start to "tick". You can read more on this topic at my tax blog post here.
The law is complex. For example, there are different statute of limitations time periods for civil versus criminal actions. As another example, the statute of limitations for FBAR purposes is different than for tax returns. If you are concerned about possible criminal exposure do not attempt an audit on your own.
When the audit has been completed, the taxpayer will typically receive a notice in the mail that will state the outcome - i.e., that further tax was assessed and the taxpayer has an outstanding balance to pay that includes interest and penalties, or that no change was made or, (alleluia) that the taxpayer will receive a refund. Generally, the taxpayer will be advised of his rights to appeal the IRS' decision.Back to Articles Back to Virginia La Torre Jeker J.D.
The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.
Virginia La Torre Jeker J.D.
Virginia La Torre Jeker J.D., is based in Dubai. Virginia has been a member of the New York Bar since 1984 and is also admitted to practice before the United States Tax Court. She has over 30 years of experience specializing in the international aspects of US tax, including FATCA. She has been quoted in the New York Times and Newsweek, and is regularly quoted in many local news articles and publications."
Maastricht University - 5th Global Tax Policy Conference: Tax Policy after BEPS, what can be expected? On 6 September 2019 at the Royal Museums of Arts and History in Brussels, Prof. Dr Hans van den Hurk, chairman of the Annual Global Tax Policy Conference of the Maastricht Centre for Taxation (Maastricht University) with his esteem speakers are addressing the above question.Read more