When it comes to tax law,there is more than one way to bake a cake. The area is complex, and there is always more than one way to look at any given situation or interpret a particular case. Always remember, though, that the legal complexity also gives the I.R.S. a full bag of “tools” with which to come down on you. Their most recent tool, found in section 7345(a) of bill H.R. 22 which passed into law on December 4th, 2015, deserves special attention from U.S. citizens living overseas, investing abroad, or doing just about anything for which they’ll need a passport.
In a nutshell, the new rule stipulates that if you have $50,000 or more in unpaid taxes, your U.S. passport can be revoked or denied if you are applying for new one.
Harsh? I think so. But I also think I know where the I.R.S. is going with this initiative. I’ll share it shortly, but first let’s start with some quick background on how unpaid taxes can affect your travel plans.
In the Beginning, There Was a Tax Lien
Any story about the I.R.S.’ “cramping your travel style” will almost certainly include a Notice of Federal Tax Lien (NFTL), which is an official legal claim against your property when you neglect or fail to pay a tax debt.
Remember that the I.R.S. will generally avoid filing a tax lien against you unless they have no other option. That usually means, especially for overseas residents, that they have been unable to establish contact with you via normal postal correspondence to settle your tax bill.
The I.R.S. will usually file the tax lien in a court where you live or do business. If you live overseas they tend to file in Washington D.C. or sometimes where you lived or did business previously in the U.S. A Federal tax lien, if you ignore it or are unaware of it, will be the legal basis for the I.R.S. to take one or both of the following enforcement measures against you.
The TECS and the DHS Lookout Indicator
If you have at least $50,000 (for international cases) or $100,000 (for domestic cases) in unpaid taxes, the I.R.S. can request that your information be entered into the Treasury Enforcement Communications System (TECS) for a Department of Homeland Security (DHS) Lookout Indicator. The TECS is a database maintained by the DHS that will use a “lookout indicator” to alert DHS agents about your unpaid taxes when you pass through a border checkpoint.
If you cross the border with your name in the TECS, DHS agents have the authority to detain (but not arrest) you and ask questions about your contact information, the location of your assets, or other issues that may help the I.R.S. collect on your unpaid taxes.
An interesting point is that I.R.S. guidance (see §18.104.22.168 of the Internal Revenue Manual) suggests that you need to be residing outside the U.S., about to take up residence outside the U.S., or be difficult to contact inside the U.S. (presumably because of frequent travel) in order for your name to be placed in the database.
The TECS rules are still in effect. Before H.R. 22 passed into law, however, detention by the DHS was the worst travel-related consequence of unpaid taxes. DHS detention would be far from pleasant, of course, but would be more bark than bite, at least at that particular moment. Moreover, there is a chance that a U.S. resident traveling abroad only occasionally would not be affected by the TECS rule at all.
Now that H.R. 22 is law, though, the issue looks more like…
Since December 4th, 2015, if you have $50,000 or more in unpaid taxes, the I.R.S. can submit your information to the Department of State in order that your passport be either revoked or denied. That, of course, is a far more serious bite.
A Good Reason to Be Proactive
How many passports will actually be revoked or denied under the new rule? Nobody can say. But my guess is that the I.R.S. will prefer not to enforce it and rather hope that it will motivate those with disclosure liabilities to come forward and take proactive steps to get compliant. This is especially likely now that the Offshore Voluntary Disclosure Program (OVDP) and Streamlined Filing Compliance Procedures (SCFP) are defined paths for doing so.
In other words, I think the threat of passport revocation is more useful to the I.R.S. than following through and enforcing it. The penalty is simple and clear and seems to say “Let’s not go there; it’s better for everyone if we don’t have to chase you.”
It is Easier for Both Sides if You Are Proactive
If we take a look at what has been happening with the SFCP and OVDP since 2014, it seems clear that he I.R.S. a) wants to encourage compliance and punish tax evasion, especially by “big fish” offenders, and b) has a demonstrated interest in moving “civilians” through the process efficiently. The whole point of the SFCP is to place a lighter regulatory burden on non-willful violators with offshore assets.
The SFCP rules are not exactly a cake walk, but we can see that the I.R.S. is using a combination of the carrot, e.g. lower (sometimes zero) penalties and faster processes for voluntary disclosure, and the stick, e.g. financial penalties or passport revocation. This new passport “beast” from H.R. 22, in my opinion, is designed to make people sit up and take an interest in getting compliant whereas they might have conveniently ignored the threat of financial penalties.
A “Radar Warning Sign” To Get Compliant
Note that it will be too late to join the OVDP or follow the SFCP if you have received a letter from the I.R.S. requesting unpaid taxes, not to mention having a tax lien filed against you or your passport revoked. But, like I said, I think the real story here is about encouraging people to make the first move to come forward and get compliant before that letter or tax lien comes through.
Think, for example, about the difference between a radar warning sign and the actual radar unit itself. If the point is to penalize as many drivers as possible, operators will avoid using warning signs and camouflage the unit. Drivers may not slow down at all and just get a ticket in the mail later. If the point is to encourage driving at safe speeds, radar warning signs are likely to be more effective.
The I.R.S. prefers not to file tax liens (the equivalent of a ticket in the mail) until other options are exhausted. Also, I can’t see that revoking someone’s passport will be the fastest way for the I.R.S. to raise revenue. That’s why I think passport revocation is a “warning sign” to encourage people to slow down and get serious about compliance. The OVDP or SFCP compliance routes, for example, have been mapped out in advance and are more likely to result in easier revenue for the I.R.S. and faster compliance for taxpayers.
In closing, though, please remember that while theories about why the I.R.S. does what it does may be interesting, in practice what you should be concerned with is how they do it, i.e., what the law says. Professional, experienced advice is always recommended when exploring asset disclosure compliance.