US Regulation: What a Tangled Web We Weave

On 17 January 2013 the US Internal Revenue Service issued final regulations under the Foreign Account Tax Compliant Act of 2009 (FATCA), which was enacted as a revenue enhancement scheme to pay for some of the cost of the Hire Act 2010 (regarding increasing US employment). FATCA requires foreign financial institutions to enter an agreement with the IRS regarding withholding on US persons unless an exception applies. Some countries are expressing an interest in reciprocity.

The IRS has proposed, and a number of OECD countries have indicated their interest in entering into bi-lateral or multi-lateral agreements to enforce FATCA compliance. The US Treasury takes the position that these are merely ‘administrative agreements’ and not treaties - if they are merely intergovernmental agreements then the IRS can proceed without obtaining Senate consent.

FATCA has already shaken the international financial community. Virtually every country in the world is still assessing the implications, costs, and benefits. Practical concerns by many industries in the global community are mounting. Few countries, if any, have ever experienced, as US tax practitioners deal with every day, a tax law that requires learning a new language or regulations that are hundreds of pages long, consisting of cross-references to the US Internal Revenue Code and Regulations.

This comes at a time when Congress has concurrently assigned to the IRS a major responsibility in implementing and administering important parts of the Patient Protection and Affordability Care Act (PPACA). For clarity, the PPACA is commonly referred to by many as ‘Obamacare’. It may be remembered that the then Speaker of the House of Representatives, Congresswoman Nancy Pelosi (D-California) urged passage of the 2700 page PPACA by saying that it must be passed first in order to understand what is in it. Apparently, even after passage it is not yet understood.

The PPACA has dramatic and profound implications. It impacts at least 1/6 of the US GDP. Moreover, every non-US corporation or country that touches upon the US health care system is deeply impacted in ways that are now just barely being understood. One small part, the new tax on medical devices, alone is causing quite serious problems in all healthcare services. The PPACA requires some 120 or so new agencies, boards, and commissions to be formed. Regulations will then follow for each and every one of them. These regulations will not necessarily all come from the IRS, but all will impact the IRS’s record-keeping and tax compliance in its portion of the administration of the PPACA.

This article is not intended to rehash at length the provisions of FATCA or PPACA. There are already legions of lawyers, accountants, consultants, and other professional service providers of every kind and description who have websites, articles, publications, computer systems, conferences, and seminars doing that every hour if not minute of the day. All are based, however, on the premise that all countries, foreign financial institutions and medical providers have no choice but to buy their services and products to comply fully with the requirements. It’s a bit like a Star-Trek movie where the fictional Borg threaten: “You will be absorbed.”

There is a growing resistance movement. Tepid perhaps, but definitely increasing, as more is understood about the benefits and detriments in being absorbed into and regulated by the IRS. It is one thing for service providers and product sellers to say or show how to comply; it is quite another to make the determination by the person, institution, or country facing the decision of whether signing on is a good idea or a bad idea.

While international tax enforcement - a world tax order approach - is being foisted on the world by the OECD, as a policy matter is important to accept the reality that the United States and other countries of the OECD countries have demonstrated rather convincingly that their tax and economic policies have led to utter bankruptcy. The value of the US dollar, the Euro, and the Pound Sterling as the accepted currency is becoming questionable.

Companies as well as individuals (some very high profile) are fleeing their home countries and obtaining residency or citizenship someplace else that has less of a tax impact and to avoid tax servitude. My characterisation of this, definitely not a view held by some others, is that the OECD is the repository of bad ideological ideas and policies. A free-market economy works when there is competition and respect for private property rights and personal liberties. If tax competition is harmful, private property rights ignored, and personal liberties severely limited to enforce a tax system based on social justice and not the principles of equal justice, then a question should arise in the minds of people impacted by the OECD initiatives as to the legitimacy and credibility of the OECD to create economic cooperation and development.

Ideological tax policy, which ignores the reality of analysing cost and benefit, is not good for international economic stability. It has been estimated, for example, that the cost for a bank to comply with FATCA might be US$10.00 per account. For a bank with 25 million accounts that cost is US$250 million. The indirect costs are unknown. None of these costs are income producing and, in fact, will cause a loss of yet unknown amounts of customers and clients. On a world-wide basis, some articles I have read say the cost could run into the hundreds of billions of US$. All of this so the US congress can create, as a revenue offset to justify more spending, some theoretical US$8.7 billion over a 10 year period.

A threshold question, seemingly overlooked by the ‘gold rush’ of FATCA professionals, is whether as a pragmatic matter the US tax authority, the IRS, even has the ability to institute and administer the global FATCA compliance program and provide reciprocity to the other countries that require equal treatment. Other than opinion and conjecture, there exists credible and reliable analysis of the IRS’s questionable capability of administering the US income tax regime before FATCA and PPACA are blended into the mix. Cybersecurity is no longer a theoretical threat to millions of people whose most detail financial information and (for those in the U.S.) health records are exposed to identity theft and other evils.

The latest annual report by the National Taxpayer Advocate NTA (the Taxpayer Advocacy Service—TSA - is a part of the IRS) states that the IRS is already underfunded, overburdened, and undermanned. Effectively, congress assigns vast new responsibilities to the IRS and then does not provide the funding that will enable it to do the job. This can be seen, for example, in the latest two required annual reports of the NTA. These are required by law and they are delivered directly to the House Committee on Ways and Means without any prior review or comment by the Commissioner of the IRS, Secretary of the Treasury, or the Office of Management.

The Tax Payer Advocate (‘the TA’) of the NTA, Nina Olsen, has dutifully issued the Annual Report for fiscal year 2012 in June of 2012, and a report entitled A Summary of the 20 Most Serious Problems Encountered by Taxpayers in December of 2012.

The December Report explains that the IRS “must balance demands from a trifecta of sources—the taxpaying public; congressional and other overseers; and the IRS itself which constantly struggles to meet its increasing workload with limited resources.” As to dealing with problems that are of concern, the TA is authorised to issue Taxpayer Advocate Directives (TADs) to change IRS procedures. These TADs can only be overruled by the Commissioner of the Internal Revenue Service or his Deputy. The TA states that IRS executives fail to respond to the TADS. In fact, the IRS is now questioning whether it has to respond at all in any event.

The TA Annual Report issued in December 2012, is more specific as to problems taxpayer’s are experiencing with the IRS.

The TA states: “The most serious problem facing taxpayers –and the IRS—is the complexity of the Internal Revenue Code (the ‘tax code’). Among other things, it takes excessive time, it necessitates the hiring of costly professional tax preparers and the use costly computer software, obscures comprehension, facilitates tax avoidance and undermines trust in the tax system.

The TA says to consider that if tax compliance were an industry, it would be one of the largest in the United States. Compliance cost is “huge” in absolute terms and “relative to the amount of tax revenue collected”. Since 2001, there have been 4,680 changes to the tax code. (How many countries have a tax code which is even close to 4,680 provisions altogether?).

Furthermore the TA states: “As discussed throughout this report, the IRS struggles to enforce the tax laws, and often burdens the taxpayers unnecessarily in attempting to do so. Simply put, the tax code strains the IRS’s ability to serve taxpayers…”

This occurs not because of the IRS but because the complex tax code enacted by congress is coupled with an IRS that is “significantly and chronically underfunded… However, lack of funding is the sole or significant cause of many of the problems identified in this report.” That results in lack of adequate and educated personnel, technology, and other support.

The IRS Oversight Board (‘the Board’) issued its annual Report on February 3, 2013. That Report highlights the challenges and risks faced by the IRS going forward. The Board recognised that the budget cuts has real world consequences on both “service and compliance” programs. Payroll is the agency’s biggest expense since the IRS is a highly labour intense organisation. To meet the reduced budget, the IRS instituted a hiring freeze, and offered to give buy-out to employees’ currently eligible or close to retirement. The IRS now has 7000 less personnel.

Other governmental reports, such as the General Accountability Office and the Taxpayer Inspector General for Tax Administration, have for years pointed out the systemic flaws in the US tax administration operations. In addition to recurring failures is the problem that nearly 40 per cent of the executive and non-executive management are eligible to retire within the next five years. This is a group of the most highly experienced managers with an invaluable historical memory. Clearly, even if the IRS hires hundreds of new employees, those will not be the most able, qualified and trained to step in immediately and take over an already massive and deficient organization.

The Board specifically is concerned about the latest increasing additions to IRS duties. The Report states: “The IRS Oversight Board has expressed concern over the IRS’ growing portfolio of duties. Recently, the IRS has been called upon to implement the tax portion of major pieces of legislation, such as the American Recovery and Reinvestment Act and the Affordable Care Act (the PPACA).”

There is one more daunting and colossal undertaking stemming from FATCA - even if it is not specifically mentioned by the Board – that cannot be overlooked. Even when “Congress provides additional funding for implementation of new responsibilities, the IRS still has to pull leadership and technical expertise from a dwindling pool of critical experienced staff that are needed for other pressing administration duties.”

Recognised by every governmental income tax oversight agency is the fact that the US congress has cumulatively, over the years, enacted an income tax administration and enforcement regime that is currently neither administrable by the government nor compliable by the taxpayers. The blame for this dilemma most times falls unfairly on the IRS when it belongs squarely on Congress. None-the-less, this is the reality that must be understood. Can informed decisions by all concerned be made to accept the direct and indirect costs of the yet unquantifiable new tax compliance regimes? If the cost is acceptable, then is it worth being subject to new civil or criminal liabilities? Is there any way to predict the future political and ideological whims of the US Congress?

It is not enough to know how to comply with the new US global tax enforcement regime. The threshold issues deal with analysing the factors underlying this proposed new world tax order. Logic seems to indicate that any profound inquiry would include, at the very least, determining who is promoting this regime, what is their background for sound tax policy, why are they doing it, where will it not be enforced, when is this to be accomplished, and what is in it for you. These are hard questions to ask and answer but are fundamental in making any common sense decision.

Denis Kleinfeld
Denis Kleinfeld is highly regarded as a lawyer, teacher and author. His private legal practice, Kleinfeld Legal Advisors, is located in North Miami Beach Florida. He is an Adjunct Professor at the LLM Wealth and Risk Management Program, Texas A & M School of Law. His private practice focuses on strategy planning of domestic and international tax, legal, financial, matters involving the wealth and risk management for private clients and private businesses. He is co-author of the two-volume treatise, “Practical International Tax Planning,” 4th Ed. published by Practicing Law Institute. He is the contributing author on Foreign Trusts published in “Administration of Trusts in Florida” by The Florida Bar and authored chapters for the American Bar Association’s in “Asset Protection Strategies: Wealth Preservation Planning with Domestic and Offshore Entities Vols. I and II.” He is a contributing author to the “LexisNexis Guide to FATCA”.