IRS fishing for U.S. tax dodgers in Israel

The United States Internal Revenue Service is gearing up for a widespread campaign to identify federal income tax scofflaws living outside the United States.

The United States Internal Revenue Service is gearing up for a widespread campaign to identify federal income tax scofflaws living outside the United States. Tens of thousands of them are estimated to be living in Israel.

The Feds will presumably require banks worldwide to report on all customers with U.S. citizenship or residency, even if they hold a foreign, including Israeli, passport.

U.S. tax law requires all American citizens, including those living abroad, to file annual income tax returns reporting their worldwide income.

According to a report submitted to Congress, more than seven million U.S. expatriates are obliged by law to file income tax returns, but IRS figures show only 7% of them filed returns for 2009.

IRS figures puts the number of Americans living in Israel who must file returns at about 100,000.

Darlene Hart of U.S. Tax & Financial Services, a European accounting firm with offices in London, Geneva, Zurich and Tel Aviv, says that the duty to report to the IRS goes beyond those who hold U.S. citizenship.

Only 34% of those who are required to file income tax returns with the IRS or required to report their worldwide income, she claims. "U.S. income tax returns have to be filed by U.S. citizens, holders of green cards and by people who are residents under the substantial presence test of the Internal Revenue Code," explains American tax lawyer Jo Anne Adlerstein, who consults in Israel and is counsel to Cohen Tauber Spievack & Wagner PC in New York. "People who work in the U.S. or have income from the U.S. may also be required to file income tax returns."

The obligation to report income in tax returns does not necessarily entail an obligation to pay U.S. income tax: Israel is one of many countries that has a tax treaty with the United States, providing for a foreign tax credit and foreign income exclusion.

Hart explains that people who pay income tax in Israel do not generally have to pay tax in the United States as well, with the exception of certain situations¬ such as inheritance tax and self-employment tax.

"Amazingly, U.S. citizens who work overseas and are self-employed with a profit of over $400 a year have to file U.S. income tax returns. They may not have to pay U.S. income tax but will have to pay self-employment tax," says Adlerstein.

Hart stressed, however, that anyone who is legally required to file an annual income tax return must do so, even if they do not owe Washington a penny.

There are civil and criminal penalties for not filing tax returns.

"People who are required to file income tax returns as residents or citizens are among those who may have to file annual FBARS, Reports of Foreign Bank and Financial Accounts," says Adlerstein. "You don't have to have income. It’s about having money in bank accounts, pension funds, and investment vehicles. An FBAR isn’t an income tax return. It’s a form created by the 1970s Bank Secrecy Act to combat money laundering by organized crime, then used to fight global drug trafficking, and since 9/11 to detect terrorist financing.”

U. S. citizens and residents who have in excess of $10,000 in all of their offshore bank and financial accounts in a given year have to file an FBAR with the Department of the Treasury in Detroit. It doesn't go to the IRS or with the tax returns. The 2010 FBAR is due in Detroit today.

As part of its compliance push, IRS is running the 2011 Offshore Voluntary Disclosure Initiative—OVDI. The goal is to get scofflaws to file income tax returns and FBARs for 2003 through 2010.

“Under OVDI people who are required to file U.S. income tax returns and have filed and paid any taxes for 2003 to 2009, but haven’t filed FBARs, can escape penalties by filing them before August 31, 2011 with an explanatory letter. People who haven't reported all their income, and haven't filed returns or FBARs may have to agree to penalties ranging from 5% to 25% of the highest amount in all their accounts put together between the years 2003 and 2009," says Adlerstein.

"Hopefully people can manage to get into compliance this year," says Adlerstein. "Why now? Because of what's coming next year."

“The penalty for non-willful failure to file an FBAR is $10,000 for each year: that's the minimum penalty,” she stresses.

The Foreign Account Tax Compliance Act, signed into law in March 2010, makes several changes. Starting in 2013, FATCA requires all banks and financial institutions worldwide to tell the IRS the names, addresses, social security numbers, account numbers and account balances of their U.S. citizen and U.S. resident clients.

U.S. authorities are negotiating agreements with banks and financial institutions to become Participating Foreign Financial Institutions. Banks that choose not to become PFIIs may drastic encumbrances on business done with the U.S., possibly 30% withholding on money transfers from the U.S. to them.

It is believed that IRS agents are already in Israel, discussing terms of agreements with the banks ahead of making them PFIIs.

"In 2012, thanks to FACTA, in addition to FBARs, people filing income tax returns will have a new schedule for reporting any account they have valued at more than $50,000," says Adlerstein.

The law obliges overseas banks to ask their clients to supply the required information. If a client refuses, the bank is more likely to end its relationship with the customer than to risk getting in trouble with the IRS.

The Banking Association of Israel has hired a major Washington law firm to advise it on the ramifications of FATCA, as the new law is known. The Bank of Israel is also studying the act's implications for local banks.

A previous version of this article contained certain inaccuracies. TheMarker regrets the errors.