US Tax Enforcement – A New Decade Begins

With the exception of the decade-long push to pursue American taxpayers with undeclared foreign assets, tax enforcement has waned, especially with the US Congress reducing funding to the Internal Revenue Service (IRS). That slowdown is, however, gradually changing. With the United States joining other governments in need of revenue to shore up budget shortfalls from the COVID-19 global pandemic, and with the US political climate trending toward a greater allocation of resources to tax enforcement, we forecast an upswing in US tax enforcement actions across numerous areas of tax law. Given the US government’s longstanding proclivity to “export” tax enforcement worldwide, moreover, this trend is likely to impact global financial centres, expatriates, and foreign individuals and companies doing business with the US.

Context For Current Enforcement Efforts

Even in 2020, many actions undertaken by the IRS and the US Department of Justice’s Tax Division (DOJ) continue to flow from the ramp up in 2008 and 2009 of aggressive enforcement actions aimed at Americans hiding assets and accounts abroad.  The United States has acted on multiple fronts – prosecuting taxpayers, banks, bankers, and other “enablers,” engaging in widespread civil audit activity, imposing significant monetary penalties, and implementing voluntary disclosure programmes for both individuals and a large number of Swiss banks.  These efforts resulted in a massive amount of data that the government is now mining with sophisticated analytics.  Cases continue to emerge that can be sourced to the long running crackdown on undisclosed foreign accounts. 

The US Congress opened a different front, passing the Foreign Account Tax Compliance Act (FATCA) in 2010.  FATCA imposed on foreign financial institutions, foreign trust companies, and foreign entities, among others, an obligation to disclose “US related accounts” to the IRS or face withholding on all US source payments.  FATCA’s principal objective was to give the IRS the ability to match the data provided by foreign financial institutions against individual tax filings.   

The IRS has faced a rocky start matching the FATCA data received over the last six years to individual returns, but it obviously intends to enforce the statute.  In September 2018, after an undercover investigation, a former executive of a UK bank pleaded guilty to conspiring to defraud the United States by seeking to circumvent FATCA reporting, and DOJ has obtained a guilty plea in a related case.  See U.S. v. Baron and Kyriacou, No. 18-CR-102 (S-1) (E.D.N.Y.).  US prosecutors promise more such actions, creating a need for robust KYC/AML protocols.

Another catalyst of US tax enforcement has been various, and enormous, leaks of private financial data, beginning with the “Panama Papers” in 2016 and the “Paradise Papers” in 2017.  These searchable databases included the names of individuals and service providers, along with documents from the law firm Mossack Fonseca, Appleby and Estra in Bermuda, and Asiaciti Trust in Singapore.  Although the Panama Papers yielded audits and grand jury subpoenas, the US government brought only one headline-grabbing case against Mossack principals and others.  Part of this case culminated recently in the guilty plea and four year prison sentence imposed on Harald Joachim Von Der Goltz (a former US resident), age 83.  See U.S. v. Von Der Goltz, No. 18-CR-693 (S.D.N.Y.).

The Tax Man Cometh

Over the past few years, the IRS has been under-funded and under-manned.  The number of full-time examinations and collections employees dropped from 41,095 in 2008 to 29,701 in 2019 (an almost 28 per cent decline).  IRS budgetary woes and other pressures have also resulted in declining fraud enforcement and a decline in prosecution recommendations by the IRS Criminal Investigation (CI) unit, from 3,289 in fiscal year 2015 to 1,893 in fiscal year 2019, and a corresponding drop in the number of indictments.  With new IRS leadership in place and a somewhat changed political environment, however, the US Congress appears to recognise the value of money spent on tax enforcement, so the tax enforcement pendulum is starting toward action. 

First, the IRS’s Large Business and International Division (LB&I) has moved towards issue-based tax examinations and “compliance campaigns.”  The campaigns target specific issues with low compliance and are selected through data analysis, suggestions from IRS compliance employees, and feedback from the tax community.  The campaigns are intended to combine an educational and compliance function with enhanced audit and collection activities.

Current campaigns include:

• Captive Service Provider: Ensuring multinationals make arm’s length payments to their captive service providers.
• Expatriations: Ensuring that individuals who expatriated complied with filing requirements (certifying five years’ compliance and filing Form 8854) and tax obligations.
• NRA Investments in US Real Property: Targeting FIRPTA withholding compliance for US real property sales by nonresident aliens, and also ensuring they comply with filing requirements for receiving rental income.
• TCJA Transition Tax: Ensuring individuals and corporations paid and accurately reported the mandatory repatriation tax (section 965) that was part of tax reform in 2017. The tax, required of US shareholders in controlled foreign corporations and certain other foreign companies, was a necessary part of the United States’ shift to a participation exemption-like regime.
• Form 3520 & 3520-A: Ensuring filing compliance (Forms 3520 and/or 3520-A) by foreign trusts “owned” by US persons (under sections 671-679) and US persons receiving distributions from a foreign trust.   

Second, LB&I is also focusing on high net-worth individuals, announcing a large enforcement effort against non-filers, and several hundred new examinations through its Global High-Wealth Program.  These audits take a holistic approach — focusing on a taxpayer’s total structure, including pass-through entities and private foundations, in addition to individual income tax returns.  In general, the IRS is training agents to uncover non-compliance even on complex issues, so we expect more focused and thorough audits of US taxpayers and those investing in US property and assets. 

Third, a recent series of IRS public statements, personnel moves, and other initiatives reflect an aggressive push to bring more fraud cases.  Fraud cases can be civil, where significant penalties are imposed, or criminal; tax criminals in the US often go to prison.  The IRS has touted its increasingly specialised ability to harvest data to better direct tax enforcement resources and develop criminal cases.  It contracted with Palantir Technologies to develop artificial intelligence toward this end.  The IRS Whistleblower Office receives and screens tips from individuals reporting the tax violations of others and can pay a financial reward if the information results in additional revenue.  The Service now has an office dedicated solely to the role of “enablers” i.e., lawyers, fiduciaries and the like, in taxpayer non-compliance, and many of the IRS executives responsible for this new fraud initiative have substantial expertise in international issues.

Finally, in connection with all of these efforts, the IRS is engaged in enhanced coordinated action with tax agencies worldwide.  It cooperates with foreign tax authorities, and vice-versa, in pursuing leads on tax evasion throughout the world.  The IRS and DOJ engage in robust information exchange including “spontaneous disclosures” and the application of new data analytic techniques may well lead to yet more enhanced interaction with other tax authorities. 

Enforcement And The Digital Revolution

Bitcoin emerged in direct response to the 2008 financial crisis.  Many wondered whether blockchain and public ledgers would be ubiquitous or merely a tool for illicit or illegal commerce (see, e.g. Silk Road, the online black market), but today it appears public acceptance of cryptocurrency is on the horizon. 

There are no US federal laws, and few regulations, regarding cryptocurrency.  IRS guidance is limited to Notice 2014-21 (treating cryptocurrency as “property” for US tax purposes), Revenue Ruling 2019-24 (regarding the tax treatment of “airdrops” and “forks”), and a list of frequently asked questions and answers.  Questions regarding the ownership and/or acquisition of cryptocurrency now appear on the individual tax return (Form 1040) and other IRS forms. 

Because cryptocurrency is treated by the US as property, a taxpayer must recognise gain or loss upon its sale or exchange.  The type of gain depends on whether the cryptocurrency is a capital asset in the hands of the taxpayer.  Treating cryptocurrency as property has required users to track the basis of their cryptocurrencies (generally, the price paid for each coin or fraction thereof) and the amount realised on a sale or exchange. 

Widespread noncompliance with cryptocurrency tax reporting obligations has unleashed IRS enforcement efforts.  It served a "John Doe" summons on Coinbase, requesting information relating to its US customers, in 2016, and, after receiving the response, it announced in July 2019 that, as part of a broader enforcement campaign, it had begun sending what it characterised as educational letters to more than 10,000 taxpayers regarding the potential failure to report income and pay tax from, or improperly reporting, cryptocurrency transactions.  

The IRS also has been using algorithms and artificial intelligence to comb cryptocurrency transaction ledgers to generate leads for criminal tax cases.  The IRS is using the information derived from analysing the blockchain, together with other data in its possession, to identify the owners of anonymous public addresses.  DOJ recently indicted John McAfee, creator of the eponymous anti-virus software, for tax evasion and willful failures to file tax returns, alleging, among other things, that he used cryptocurrency exchange accounts in the names of nominees to evade tax.  See U.S. v. McAfee, No. 20-CR-10029 (W.D. Tenn.).

Conclusion

With the exception of the IRS’s and DOJ’s actions in the area of unreported foreign accounts and assets, US tax enforcement has been on the decline during the previous decade.  This is changing.  With greater financial resources, better IT, enhanced international cooperation and information exchange, and new analytical techniques, the IRS will likely be auditing and prosecuting more taxpayers, and a central focus of these cases will be in the international arena.  To prepare for this, multinational companies and high net worth individuals with footprints in the United States would be wise to pause and re-evaluate the status of their US tax compliance functions.  Forewarned is forearmed. 

Scott D. Michel
Scott has been a member of Caplin & Drysdale for 39 years. His work focuses on Tax Controversy, including criminal tax, sensitive audit matters, and voluntary disclosures. He is also Adjunct Professor for the University of Miami Graduate Tax Program; and Regent and Fellow of the American College of Tax Counsel.

Victor A. Jaramillo
Victor's work focuses on Tax Controversy (including criminal tax, sensitive audit matters, and voluntary disclosures), Tax Planning (including expatriation, pre-immigration planning, and cross-border investments), and cryptocurrency issues (representing exchanges and investors). He previously worked for McKee Nelson/Bingham McCutchen (now Morgan Lewis), and General Electric; and has undergraduate degrees from Florida State University and a law degree from Emory University School of Law (with honors).