In the past decade, Congress and the IRS have made numerous efforts to close the international tax gap. This is the amount of taxes the Treasury loses each year from U.S. taxpayers abroad not reporting income, paying taxes, or filing tax returns.
In recent years, the IRS has tried to close the international tax gap with the Foreign Account Tax Compliance Act (FATCA) and a series of offshore voluntary disclosure programs—all aimed at enforcing proper reporting of foreign financial accounts and overseas income.
In December 2015, Congress tried to add another tool to help the IRS address the underpayment part of the tax gap. The provision, Sec. 7345, would give the government the ability to restrict the passports of individuals who owe "seriously delinquent tax debt" (Sec. 7345(a)).
The new compliance enforcement is supposed to roll out sometime in 2017, according to the IRS website, although the specific timeline for it has not been disclosed.
Restrictions affect expats and foreign travelers with serious tax debt
This passport-restriction law will affect the expatriate community and foreign travelers who haven't established an agreement with the IRS to pay their seriously delinquent tax debt. Right now, more than 15.6 million individual taxpayers owe the IRS back taxes. Hundreds of thousands of them owe more than $50,000 (according to IRS information on individual master file returns from individual taxpayers as of September 2015). The exact number of taxpayers who owe greater than $50,000 is not known. However, as of Sept. 30, 2015, 453,470 individuals owed more than $100,000, and 1.4 million owed between $25,000 and $100,000. The number of taxpayers who owed more than $50,000 was a portion of the 1.4 million plus the 453,470.
The law defines seriously delinquent tax debt as a legally enforceable federal tax liability of more than $50,000 (unpaid taxes, penalties, and interest combined) that has been assessed and for which:
- A lien has been filed and all administrative remedies for lien relief have lapsed or been denied; or
- A levy has been issued.
People with alternative agreements to pay can still travel
Most of the time, taxpayers will still be able to travel if:
- They are paying their debt in a timely manner under an installment agreement—an IRS payment plan.
- They are paying their debt in a timely manner under an offer in compromise—an arrangement that applies in rare circumstances for taxpayers in financial hardship situations to settle their taxes for less than they owe (Form 656, Offer in Compromise).
- Collection has been suspended on their debt because they have requested innocent spouse relief—release of liability from a spouse's portion of tax debt in certain situations (Form 8857, Request for Innocent Spouse Relief).
- Collection has been suspended on their debt because they have requested or have pending a Collection Due Process hearing—an appeal with the IRS to contest a levy issued (requested by timely filing Form 12153, Request for a Collection Due Process or Equivalent Hearing).
The IRS has also indicated that taxpayers in currently not collectible status, which is deferred payment for taxpayers in financial hardship situations, will not be subject to passport restrictions. The IRS may set more exclusion rules as it implements the passport restrictions. For example, the IRS will need to explain whether its 60- to 120-day extensions to pay will be an exclusion from being certified as having seriously delinquent tax debt.
What's going to happen to taxpayers who owe seriously delinquent tax debt?
First, the IRS will send a notice to every person with seriously delinquent tax debt. CP508C, Notice of Certification of Your Seriously Delinquent Federal Tax Debt to the State Department, advises these individuals to get right with the IRS or suffer passport restrictions.
The IRS will also provide the list of individuals certified as having seriously delinquent tax debt to the State Department. Using that list, the State Department will deny a passport to any new or renewal passport applicants with seriously delinquent tax debt. The State Department can also revoke or limit existing passports.
Expatriates should take notice
According to the State Department, 40% of all U.S. citizens have a passport, and 9 million U.S. citizens live overseas (State Department statistics). Most U.S. citizens who live overseas also earn income working overseas—about 7.5 million, according to a 2014 Treasury Inspector General for Tax Administration (TIGTA) study. Those individuals are required to file U.S. tax returns and pay taxes in the United States.
However, in 2011, the U.S. Government Accountability Office (GAO) reported significant noncompliance among U.S. taxpayers living abroad (GAO Rep't No. GAO-11-272, Potential for Using Passport Issuance to Increase Collection of Unpaid Taxes (March 2011)). For example, according to TIGTA, the IRS sent foreign-based U.S. taxpayers more than 855,000 notices and letters in 2014 (see here). Furthermore, the GAO found in 2008 that at least 224,000 U.S. passport holders owed back taxes. Many owed significant amounts.
Why the tax problems? Expats frequently have foreign financial accounts and must follow complicated tax filing and reporting rules. Some expats don't realize they must file a U.S. return. And, as part of the IRS focus on international noncompliance, expats have been clear targets. Most IRS enforcement has been centered on properly reporting foreign financial accounts and income. As the IRS starts using information it receives about foreign accounts under FATCA, compliance enforcement will only increase.
Bottom line: Expats who have been subject to compliance enforcement generally have large tax liabilities and penalties. In the past, the IRS hasn't been able to effectively reach many expats with its collection enforcement tools, such as liens and levies. However, with the new passport restrictions, the IRS will have the upper hand on many of these taxpayers to compel them to pay their back taxes.
Expats may not even know they're in trouble
Expats may be surprised that their passports are restricted when they take a business trip or vacation back to the United States and can't travel back home.
One cause of this surprise is unreliable international mail. In 2015, TIGTA cited considerable problems with foreign-based taxpayers receiving their IRS mail (TIGTA Rep't No. 2015-30-072).
The second cause is that some IRS procedures don't require the IRS to send mail to foreign taxpayers. For example, the IRS doesn't always have to send notices to taxpayers it has already warned before initiating enforcement actions for delinquent return investigations. Internal Revenue Manual Section 126.96.36.199 specifically informs IRS collection officers who are requesting delinquent returns that if the taxpayer is given a deadline and warned of enforcement action by telephone, a letter is not required to be sent.
In general, foreign-based and domestic taxpayers have few ways to check their status with the IRS. Recent account features added to IRS.gov allow taxpayers to look up how much they owe, but few taxpayers can set up the account because of an arduous authentication process. Foreign taxpayers are further hindered because the authentication process requires a U.S.-based phone number (country code +1).
Expatriates: Know your tax status
Expats who have or suspect that they may have unpaid taxes should confirm their status with the IRS. Call the IRS Collection division at 855-519-4965 or 267-941-1004 for international calls.
Once the IRS puts passport restrictions in place, taxpayers who think that they may be subject to passport restrictions can call the State Department's National Passport Information Center at 877-487-2778.
How to get right with the IRS
Affected taxpayers with pending or upcoming overseas travel should look to getting into an agreement with the IRS as soon as possible (see link for streamlined agreements here).
If taxpayers owe less than $100,000, they can easily set up most installment agreements as long as they're willing to allow the IRS to automatically deduct payments. All other agreements and hardship situations will require taxpayers to file detailed financial statements that document their financial situation (Collection Information Statement) to enter into an agreement and get in good standing with the IRS. These type of agreements take weeks, if not months, for the IRS to confirm.
Once a taxpayer is in good standing, the IRS will send a notification to the State Department within 30 days to remove the seriously delinquent tax debt status and lift passport restrictions (see here). Currently, there is no expedited process in place to lift passport restrictions for taxpayers who get back in good standing.
One important note: Paying the balance owed to under $50,000 without entering into an agreement with the IRS on the remaining balance will not lift the passport restrictions (again, see here for more information).
Moral of the story
If your client owes back taxes and isn't in an arrangement that exempts him or her from the passport restrictions, act now. Taxpayers should look to set up an installment agreement or another arrangement if they are in hardship situations.
U.S. taxpayers abroad who have no idea about their compliance status should avoid the surprise and contact the IRS right away to confirm that they are in good standing.
Jim Buttonow, CPA/CITP, directs H&R Block Tax Notice Services. He has more than 28 years of experience in IRS practice and procedure. Eric Scali, J.D., LL.M., manages quality assurance, training, and tax expertise within H&R Block Expat Tax Services. To comment on this story, contact Chris Baysden, senior manager of newsletters at the AICPA.