On the first day of Federal Income Taxation class, my law students read this phrase, written in large letters upon the whiteboard: “The Force is Complex, Opaque, Uncertain, and Changing”. I exclaim, “For the students in the room serious about becoming tax lawyers, repeat this phrase as a mantra before class. And then continue repeating it throughout your life each day before work.”
Hoping the millennials understands my Star Wars reference, I continue, “The Force will take care of you with high salaried private firm and corporate employment as well as employment in a government position, or a policy thinktank, and even as an academic.” Inevitably a student brings up tax simplification to which I respond, “Young Skywalker,” “once a Jedi, always a Jedi.” Elaborating, I explain, “Legislation and regulations are written by Jedi, known as tax staffers and Treasury counsel, who have become one with the Force and the Force is strong.”
Two years ago, the U.S. Congress narrowly passed tax ‘reform’ legislation called the Tax Cut and Jobs Act, or just TCJA. Proponents stated that the TCJA offers ‘tax simplification’. One measure of whether simplification has been achieved is whether the tax preparation services industry had experienced a decline in revenues post TCJA. For the year 2017, Market Research.com determined the industry’s 17, 908 companies generated US$7.1 billion of revenue. In 2018, the industry had grown to 18,301 companies and revenue of US$7.4 billion. Employment within the accounting industry is growing at six per cent, according to the 2019 Bureau of Labor Statistics. Tax practices of the Big 4 and AmLaw 100 have reported record revenue years. Richard Rubin of The Wall Street Journal reported that within the tax industry, TCJA stands for the Tax Jobs and Cuts Act.
In 2019, the American Action Forum, (AAF) a free market ‘center right’ policy think tank, published its annual tax compliance costs study. The AAF found that the TCJA has led to higher tax compliance costs. Part of the cause is that of from 2018 to 2019, the number of forms issued by the IRS potentially required to be filed by taxpayers to comply with the TCJA rose from 1,186 to 1,337. The AAF points out that businesses’ and individuals’ tax returns correspond to 423 and 200 additional potential applicable tax return forms. Most relevant, business that drives the US economy and creates employment, including for tax Jedi, suffers the brunt of the compliance costs: 11.3 million filers for the 2019 tax season, averaging 279 hours, in the attempt of compliance with the potential 423 tax forms, for a total cost of US$58.1 billion. The Force is indeed strong.
The Force is FATCA and FATCA is the Force
Why did Congress choose to leave out of the TCJA any mention of the Foreign Account Tax Compliance Act (FATCA) that most impacts the readers of the IFC Review, US persons living in a foreign country? Even in the face of strenuous lobbying and fundraising efforts of Republican Overseas, the political organisation recognised by the Republican National Committee (RNC) representing nonresident Republicans, Congress rejected the repeal or the simplification of FATCA. At the bequest of Republican Overseas, in 2014 the RNC had adopted a resolution to repeal the 2010 Foreign Account and Tax Compliance Act. In 2017, the RNC adopted a resolution that the Republican-controlled Congress support a Republican filed- bill before the Ways and Means tax writing committee to reform FATCA by including a provision for the territorial taxation for U.S. nationals that are non-residents. While not supporting outright repeal or territorial taxation for individuals, Democrats Abroad agreed that FATCA harmed US non-residents and thus proposed four simplification FATCA reforms:
1. A "Same Country Exemption" that exempts from FATCA the accounts of Americans living overseas in banks and brokerage houses in their country of legal residency.
2. Index the FATCA reporting threshold to inflation.
3. Merge the Foreign Bank Account (FBAR) reporting requirement with FATCA reporting legislation to eliminate duplication in filings.
4. Offer amnesty to overseas Americans who are delinquent taxpayers that they may pay what they owe without the draconian FBAR penalties.
In her 2016 annual report to Congress, the Taxpayer Advocate Nina E Olsen concluded that the IRS’s approach to FATCA implementation created significant compliance burdens and risk exposures to a variety of impacted parties including non-resident aliens, US citizens living abroad, and foreign financial institutions (FFIs). Yet, both parties turned their backs on the lobbying by their respective official party apparatus for out-of-country voters, on the testimony provided in hearings by witnesses across the aisle, and reports from non-partisan government agencies, rejecting the idea of even bringing FATCA reform up for a discussion among the tax writing committees, much less a vote.
Was it a scoring cost that including FATCA reform would have required it be paid for with a revenue raiser? No; FATCA has arguably generated a negative return on investment when considering the lack of additional tax revenue and the additional compliance costs directly attributable to the law and its more than 2,000 pages of implementing regulations, forms and instructions, notices, and related documentation. W. Gavin Ekins, a research economist at the non-partisan Tax Foundation, stated in a 2016 Washington Post interview that the Tax Foundation estimated it may cost Treasury five dollars for each dollar of tax evasion recovered because of the mountains of FATCA regulatory data required to be collected and then sifted. In 2019, the Government Accountability Office (GAO) reported that the IRS had given up on pursuing a comprehensive plan to leverage FATCA data to improve taxpayer compliance.
Was it the expected increase in non-compliance resulting in the weakening of the law? In 2018, the Treasury Inspector General (TIGTA) published a report, the title summing up the complexity of FATCA: “Despite Spending Nearly $380 Million, the Internal Revenue Service Is Still Not Prepared to Enforce Compliance With the Foreign Account Tax Compliance Act”. TIGTA reported that from a pool of 293,020 foreign financial institutions (FFIs) registered with Treasury, only 104,692 FFIs submitted FATCA reports to the IRS. Approximately half the 8.8 million records received as of September 30, 2017 were defective because of missing or erroneous taxpayer identification numbers.
Interestingly, over the same time period, the IRS received only 896,320 FATCA forms (Form 8938) from individual taxpayers, about 10 per cent of the records submitted by FFIs. Moreover, though the FBAR form has a substantially lower dollar amount filing threshold than the FATCA form (US$10,000 versus US$200,000 for a single US nonresident person), in 2016, the GAO found that only 73 per cent of US persons who filed a FATCA form with their tax return also filed an FBAR with the Financial Crimes Enforcement Network (FinCEN).
In 2016, almost 7.8 million individual taxpayers claimed US$20 billion of foreign tax credits on their foreign income. 949,167 individuals filed FBARs this same year, and 404,791 filed a FATCA form of which 87,915 lived outside the US Assume that all FBAR filers sought a tax credit for foreign tax paid on foreign income for a moment. Is it likely that the other seven million taxpayers who earned foreign income that attracted foreign tax did not also own or have signatory authority over foreign accounts with a cumulative balance of US$10,000 (the FBAR filing threshold)?
Moreover, in 2016, the foreign income exclusion was claimed by 476,275 U.S. taxpayers residing at least 330 days outside the U.S. Presumably, most of these U.S. non-resident taxpayers meet the FBAR filing US$10,000 threshold. Are a majority of the non FBAR or non FATCA form filers or mis-filers tax evaders? But why did they file the Form 1040 and seek a foreign tax credit, exposing their potential noncompliance? In its 2019 report on FATCA, the GAO identified the likely culprits for the lack of reporting, misreporting, and unnecessary reporting: complexity, duplication, and confusion, with the opaqueness of lack of taxpayer assistance for overseas US persons.
Duplicative And Opaque Reporting Procedures
The GAO (2012) and Taxpayer Advocate (2014) both called upon Treasury to address the duplicative reporting and opaque reporting procedure of the FBAR and FATCA 8938 form. Most alarming, both agencies uncovered the abusive implementation of the FBAR penalties. Rather than acting as a proportional penalty based upon the nonpaid tax liability that may rehabilitate a taxpayer back into compliance, the IRS imposed an asset forfeiture penalty model irrespective of tax debt often reducing the economic status of the taxpayer and even potentially leading to insolvency (without the ability to seek a clean slate through the US bankruptcy system because FBAR penalties are not dischargeable).
According to the respective agency reports, for small accounts of less than US$100,000 that over a six-year period had only an average US$17 per year of additional tax revenue, the IRS imposed a FBAR penalty of US$13,320 (i.e. US$2,220 a year FBAR penalty) as well as the maximum penalty based on the tax owed and interest on the tax debt (which was relatively low given the low level of the tax debt). The 25th percentile of noncompliant taxpayers paid on average a US$5,945 FBAR penalty for an average annual US$277 tax understatement. The IRS imposed a median FBAR penalty of US$17,991 a year for US$2,125 a year tax understatement. The analysis uncovered that the FBAR penalties imposed on taxpayers with the smallest accounts (i.e., those in the 10th percentile with accounts of US$78,315 or lower) were 575 per cent of the actual tax, interest, and tax penalty owed for their unreported income.
As of 2015, the Taxpayer Advocate noted that over 170 tax code provisions imposed potential taxpayer penalties. Two decades prior, Congress itself recommended to the IRS to develop better information concerning the administration and effects of penalties to ensure such penalties promote voluntary compliance. However, the IRS’ opaqueness assured that such recommendations would not percolate into policy. The IRS Office of Service-wide Penalties (OSP), according to the Taxpayer Advocate report, “consists of six analysts buried three levels below the Small Business/Self-Employed Division Commissioner”, provided insufficient resources, insufficient staffing, employees with the wrong skillsets, and a lack of access to penalty-related data as barriers to conducting penalty research.
With overwhelming evidence of its harm to the livelihood of U.S. persons living in a foreign country, the abuse of FBAR penalty implementation, and bipartisan support for reform, why has FATCA and related reporting compliance been ignored? I think the answer is exposed in the Wall Street Journal April 2, 2017 FATCA opinion piece aptly titled “A Corporate-Welfare Bonanza for Tax-Compliance Firms”. I am a tax Jedi: my Guide to FATCA Compliance reached the #2 seller for print and digital revenue for Lexis Tax in 2015. Am I afraid of FATCA reform harming book sales? Young Skywalker, the Force is strong.
Professor William Byrnes
Professor William Byrnes is the Executive Professor of Law and Associate Dean for Special Projects at Texas A & M University School of Law. He developed Texas A & M University Law's International Tax Risk Management curriculum and is the author of Guide to FATCA and CRS Compliance, published annually by LexisNexis, eight other Lexis published tax and financial crimes compliance books, and a 10 volume International Trusts and Company Law Law compliance guide published by Kluwer.