The Tax Gap and International Taxpayers
International Tax Gap Series
Most U.S. citizens and residents voluntarily file and pay their U.S. taxes. Whether it is because they want to pay their fair share to support our country or because they fear getting caught, our voluntary compliance system of taxation works well in the United States.
But what about U.S. citizens and residents who live and work abroad? What about the nonresidents who come to the U.S. to work, invest or trade? And what about the foreign corporations who do business in the United States? Are they also voluntarily filing and paying their U.S. taxes?
As globalization continues to grow, international non-compliance is a significant area of concern and focus for the Internal Revenue Service. The ease of utilizing complex international structures and cross border transactions results in constantly evolving compliance issues. To address these challenges, the IRS has developed a Servicewide Approach to International Tax Administration to improve voluntary compliance with the international tax provisions and to reduce the tax gap.
Who Must File US Tax Returns?
U.S. citizens and residents are taxed on their worldwide income. This applies whether a person lives inside or outside the United States. Foreign income must be reported on a U.S. tax return whether or not the person receives a Form W-2, Wage and Tax Statement, a Form 1099 (information return) or the foreign equivalent of those forms. Foreign source income includes but is not limited to earned and unearned income, such as wages and tips, interest, dividends, capital gains, pensions, rents, and royalties.
Nonresident aliens are generally subject to U.S. income tax only on their U.S. source income. They are subject to two different tax rates, one for effectively connected income, and one for fixed or determinable, annual, or periodic (FDAP) income. Effectively connected income (ECI) is earned in the U.S. from the operation of a business in the U.S. or is personal service income earned in the U.S. (such as wages or self-employment income). It is taxed for a nonresident at the same graduated rates as for a U.S. person. FDAP income is passive income such as interest, dividends, rents or royalties. This type of income is taxed at a flat 30% rate, unless a tax treaty specifies a lower rate.
Generally, a foreign corporation must file a U.S. tax return if it is engaged in a trade or business in the United States, whether or not it had income from that trade or business. It must also file if it had income, gains, or losses treated as if they were effectively connected with a U.S. trade or business, and if it had income from any U.S. source (even if its income is tax exempt under an income tax treaty or code section).
How Does the IRS Get Information About Foreign Source Income and Foreign Transactions?
While the IRS does not have the same level of information reporting on foreign source income as it does for U.S. source income, they do have several means by which they can secure information on foreign source income and transactions. The U.S. has over 60 bilateral tax treaties with other countries, and over 20 Tax Information Exchange Agreements (TIEA) in effect with various countries and jurisdictions where a bilateral tax treaty is not in place. These treaties and agreements facilitate the exchange of information, and generally allow for mutual assistance for both civil and criminal investigations. The tax treaties allow for information exchange by specific request, and in most cases, through spontaneous and automatic exchanges as well.
Specific requests allow treaty partners to request and exchange information relative to a specific tax investigation or tax administration matter. A spontaneous exchange allows a country to spontaneously share information relative to tax administration that might be of interest to its treaty partner, even when a request has not been made. And the automatic exchange program allows treaties partners to routinely share information they maintain about income sourced in one country and paid to a resident of the other treaty partner country.
As part of the IRS Servicewide Approach to International Tax Administration, there is a concerted effort to make better use of these information exchange tools and to coordinate with treaty partners to share information about international tax compliance issues.
What Should You Do If You Have Not Filed Your Tax Returns?
Taxpayers should file all tax returns that are due, regardless of whether or not full payment can be made with the return. Depending on an individual’s circumstances, a taxpayer filing late may qualify for a payment plan. All payment plans require continued compliance with all filing and payment responsibilities after the plan is approved.
Taxpayers who continue to not file a required return and fail to respond to IRS requests for a return may be considered for a variety of enforcement actions. Continued non-compliance by flagrant or repeat nonfilers could result in additional penalties and/or criminal prosecution. A taxpayer’s timely voluntary disclosure of a substantial unreported tax liability has long been an important factor in deciding whether the taxpayer’s case should ultimately be referred for criminal prosecution.
How Will IRS Measure the International Tax Gap?
While there is currently no specific data to indicate what portion of the tax gap is attributable to international taxpayers, the IRS has included a segment of this taxpayer base in its current individual National Research Program (NRP). NRP was created to measure payment, filing and reporting compliance and to deliver the data needed to support the development of strategic plans and improve workload identification.
Individual international taxpayers will be included in this study for the first time in 2008 with the examination of tax year 2006 returns. This NRP study is the first of an ongoing series of annual individual studies using an innovative multi-year rolling methodology, beginning with tax year 2006. An advantage of using this method, which combines results over rolling three-year periods, is the IRS will be able to make annual updates to compliance estimates and develop more efficient workload plans on an annual basis,
Tools and Links
International Customer Service: 215-516-2000 (Not a toll-free number)
International Information on irs.gov
Publication 54, Tax Guide for US Citizens and Residents
Publication 519, US Tax Guide for Aliens
Publication 901, US Tax Treaties.
The International Tax Gap Series