January 19, 2010 - Phil Hodgen

IRS interim guidance for dealing with foreign tax officials

This post is about “outbound” disclosure of information. When will the IRS report back to your home country about your financial activities in the United States?

One of the long term trends in tax administration will be that there will be increased government-to-government information sharing. That country over there (wherever that is) will feel increasingly emboldened to share with the U.S. government, and the information shared will be about you. And vice versa. This will be done under the guise of the Bogeyman du Jour (drug cartels, terrorists, etc.) but it will be done.

The IRS updated the Internal Revenue Manual in late December 2009 with a Memorandum titled “Interim Guidance on Interactions with Foreign Tax Officials.” Let’s look at what it says about government-to-government information sharing.

You can download a PDF of the Memorandum from the IRS website. [Warning: PDF]. I’m also reproducing it (without the Exhibit) below and glorious HTML. I’m experimenting on how to share information like this (lengthy text that is important but dull) — by housing it on my own blog or linking out to other places. Feedback welcome.

And I’m going to summarize the important stuff for you so you don’t have to read if you don’t want to.

Requests for information from foreign country

There are four categories of information that is shared by the IRS with foreign countries. The only kind of information we really care about? “Taxpayer-specific information.” When does the IRS give specific information about you to a foreign country?

In order for there to be outbound sharing of your information with a foreign government, there has to be a treaty between the USA and that country. It can be an income tax treaty, a tax information exchange agreement, or some other treaty (and there are a whole family of odd little treaties that can be used). From the memo:

Returns and return information, as defined under IRC section 6103(b), and other sensitive information, generally may not be provided to foreign tax officials unless the exchange is made under the provisions of an income tax convention, tax information exchange agreement, or other bilateral agreement relating to the exchange of tax information (collectively referred to as “tax information sharing agreements”). Examples of other bilateral agreements relating to the exchange of tax information include certain mutual legal assistance treaties (MLATs), which generally apply to the enforcement of criminal laws, as well as tax implementation or coordination agreements between the United States and the U.S. territories of American Samoa, Guam, the Northern Mariana Islands, Puerto Rico, and the U.S. Virgin Islands.

Emphasis added.

The gatekeeper for outbound information sharing is the Deputy Commissioner (International), LMSB. This means that whenever an IRS person wants to get information about you from overseas, the request works its way through the people in that office.

If the foreign country wants information about you, it will request it via the relevant tax information sharing agreement.

Spontaneous sharing of information by the IRS

Yeah, the IRS can do this all by themselves, if they want to. In an audit the agent comes across something. Thinks it might be useful to your home country, or maybe there is an alternate motive lurking in the agent’s heart. The IRS can drop the information on your home country’s tax agency. This goes through the Deputy Commissioner (International), LMSB’s office. There has to be a treaty between the US and your country to give the legal authority for sharing this information.

From the memo:

This program involves the exchange of information that has not been specifically requested but, in the judgment of the providing Competent Authority, may be indicative of noncompliance with a treaty partner’s tax laws and requirements. U.S. initiated spontaneous exchanges generally begin when IRS personnel (revenue agent, special agent, revenue officer, tax compliance officer, etc.) develop information during the course of an audit or investigation.

Automatic sharing of information by the IRS

Think of this like email on a Blackberry. Your tax information is pushed to the foreign government systematically. The kind of information provided? Anytime there is a point of data in the Federal tax system that shows payment to you, I think you have to figure that this information will be sent to your home country. This could be payments reported on Form 1042-S, various types of income paid to you, and U.S. real estate sales.

From the memo:

The Automatic Exchange of Information Program concerns information about one or various categories of income that is systematically exchanged with a treaty partner. It may be considered a type of spontaneous exchange insofar as information about a particular taxpayer is not specifically requested by the receiving country. In terms of the information the U.S. provides to treaty partners, it currently includes information extracted from Form 1042-S, relating to U.S. sourced fixed or determinable income (such as dividends, royalties, etc.) paid to persons claiming to be residents of the receiving treaty country. Generally, the information that the IRS automatically exchanges (provides and receives) consists of hundreds of thousands of records exchanged by way of magnetic media. Other automatic information that may be of interest to treaty partners may also be exchanged under this program, such as real estate sales of residents of the receiving treaty country.

Long term trend

The IRS is most efficient at collecting tax when it has control over information on both sides of the transaction. Interest income is reported correctly by you because your bank issues Form 1099 to you. Your wages are fully reported on your tax return because you get a W-2.

Look for the same thing to happen in the international arena. At present the IRS doesn’t have both ends of the transaction nailed down. But they will get that done, slowly. We’re seeing foreign trusts spontaneously receive Federal employer identification numbers, for instance. Conclusion = obvious.

  • Watch for the IRS to continue pushing for easier sharing at the government-to-government level.
  • Watch for Congressional action, aimed at amending the Internal Revenue Code to adjust the level of privacy extended to taxpayer information inside the IRS. Congress will invoke the usual bogeymen.
  • Watch for treaties being renegotiated to give additional information-sharing leeway to both governments.
Foreign Business Activities in the USA