It’s the letter no one wants to receive. A white business envelope with your name in the cellophane window and the return address of the IRS. Attention from the Internal Revenue Service can mean only one thing: They want your money.
In Israel, with approximately 250,000 citizens with US citizenship, according to recent figures from the Overseas Vote Foundation, many American expatriates receive notices from the IRS. Sometimes it’s just routine mail, checking on income tax filings or address changes. But a growing number of American Israelis have been audited over the last few years, and local accountants are trying to figure out why.
“I have over 30 years of experience on the table, of operating in this market, and the audits have increased tenfold, if not more,” said Philip Stein, an American-trained tax accountant. “We do believe it is from the fact that there was a lot of fraud over the child tax credits.”
Since 2001, US citizens have been able to file for a tax credit of up to $1,000 per child. While many US citizens in Israel had filed income tax reports since living in Israel and began requesting the tax credits when the law went into effect, there were others who didn’t file taxes, but began requesting the child tax credits without declaring their income accurately, surmised Stein.
“The IRS doesn’t believe anybody now,” said Stein. “They’re throwing everything out the window, starting the audits without even asking people to confirm their information. They don’t believe anything, just assume that you made the money and send a bill and then make you go through this very painful process to make you show that you have kids — to show tuition bills, medical receipts — and law-abiding citizens are having to spend thousands of shekels on these audits.”
“The IRS knows this [Israel] is fertile ground,” added Alan Deutsch, another tax accountant. “I would think it’s one of the highest concentrations of expatriate Americans in the world.”
The IRS did not respond to repeated requests for a response for this article. Yet it appears that a combination of new US bills, the unscrupulous tax filings of a few and a lack of expatriate information is contributing to more awareness on the IRS’s part of Americans living abroad, and, concurrently, a reported rise in audits.
According to Professor Stanley Grossman, a member of Democrats Abroad-UK and the Democratic National Committee, the increased incidence of IRS investigation into expatriate income tax could be the result of two tax bills, one old and one new. The FBAR — the Foreign Bank and Financial Account Report — created in 1975, established that any US citizen with an offshore bank account had to report the existence of the account if the sum of money in the account exceeded $10,000 at any time.
FATCA — the Foreign Account Tax Compliance Act — which is a more recent tax bill, requires every bank outside the US to report to the IRS names of any American citizens with a certain amount of money in the bank. For US citizens living in the US, a minimum of $50,000 in an offshore account has to be reported, while for someone living outside the US, $200,000 is the threshold.
“Applying that to everybody [living outside the US] is killing the mouse with a tractor, because the assumption is that all Americans living overseas are criminals, laundering money,” said Grossman, speaking from his office in London. “It has enormous consequences for American citizens living outside the country.”
The IRS is interested in Americans with Israeli bank accounts, said Deutsch. “They consider that hidden money and they want to tax the income from those accounts. I tell my clients they are obligated to tell me about those accounts, but it’s becoming more of a hot potato for people who have been lax about it.”
Nevertheless, what is vital for any American living abroad is to file US income tax on an annual basis, revealing their sources of income, the accountants agreed. Grossman pointed out that anyone with a US passport, even if he or she was merely born to one or two American parents and has never set foot in the US, is required to file a US tax return. Moreover, Israeli spouses of US citizens whose information is included in the tax return in order to make the American eligible for more benefits, are “also treated like a US citizen,” and their financial information could be subject to IRS investigation, Deutsch said.
Still, despite the complications of filing US tax returns when living outside the US, “I would guess that 99% of Americans outside the US, assuming they are filing income tax, owe no money,” surmised Grossman. “Still, there may be a lot of Americans overseas who never file tax returns. A lot of people are unaware of the requirement.”
Therein lie two of the problematic areas for the IRS with regard to US citizens in Israel. There are no exact figures, but it is assumed that a large percentage of American citizens in Israel have never filed or do not regularly file their annual income tax, and, in addition, others may have falsified their filing in order to receive the child tax credits. Both groups have helped raise a red flag for the IRS.
Do you file income tax?
It’s clear that most US citizens in Israel have not abused the child tax credit, said Deutsch, but some did and now the IRS is taking a punish-all approach. He figured the normal rate of audits in the US is one to two percent, and if many more than that are getting audited in Israel, “that’s staggering.”
“We’re defending clients on this and having good results,” he added, “but there were people who did abuse [the child tax credit].”
There was also an unconfirmed rumor, added Stein, that the IRS had sent a task force to Israel to sit at the Israeli Tax Authority and compare notes on what American Israelis were earning and claiming in Israel versus in the US. Deutsch remembers hearing in 2009 about an IRS task force of 12 to 15 people arriving in Israel to look into Americans with Israeli bank accounts.
According to the Income Tax Authority, Israel does exchange information according to the treaty between Israel and US.
“Usually, the US sends us a request on a specific case and vice versa,” said an authority spokesperson. “In the request, the sender must outline the basis of the request and the information he is looking for. We do not enable to the IRS to come to Israel and perform investigations in our territory.”
What’s difficult about the US-Israel tax treaty is that it’s outdated, said Stein. It was negotiated in the 1970s and ratified 20 years later, and “doesn’t really deal with the realities of living in a global village,” he said, referring to the ease with which people live outside the US, maintaining several bank accounts and income across borders.
It was after 2009, said Stein, that the IRS began sending gentle notices asking US citizens in Israel to confirm and verify their income, but “unscrupulous accountants” told clients to ignore the notices, “which got the IRS more upset.”
“We’re very careful to prepare returns accurately,” added Deutsch. “The problem was firms that did not do that. They just inflated income to get more child credits.”
The falsified filings of a few enraged the IRS, said Stein, and they then “threw off the gloves and went to war, assuming that everyone in Israel is a liar, and that’s the environment we’re living in today.”
“The IRS is understaffed and doesn’t have the skill or ability to really distinguish among good guys and bad guys,” he said. “It doesn’t have the staff to investigate these things so it just does it blanketly.”
A solution afoot
For now, the Democrats Abroad committee is speaking to the US Senate, concerned senators and the US Treasury, with the goal of incorporating FBAR into FATCA. They want to raise the reporting threshold, as well as change the definition of an offshore account to be an account that is both outside the US as well as outside the country in which the US citizen is residing.
“The intention of Congress with FATCA was going after Americans with offshore accounts, who may have been trying to hide some money,” said Grossman. “We want to find a solution to this, and the good news is that we have congresspeople and others who recognize the problem. Democrats Abroad think it’s terrible to launder money or hide taxes, but the intent was never to go after ordinary American citizens living abroad.”
Stein has also been active in efforts to work with the IRS, and is planning to speak with the head of IRS foreign compliance, whom he met at a conference.
“She said, ‘You don’t like our one-shot-fits-all approach?’” he said. “I told her I want to tell her what I’m seeing in the field, speaking on behalf of honest people who want to follow the law but don’t want their filing of tax returns to be an opportunity for abuse.”