The TIGTA Report: Lessons From A Decade Of The Foreign Account Tax Compliance Act

Let’s talk about near misses. Not so long ago the Biden administration proposed a comprehensive financial account reporting regime.

Some observers labeled it a domestic version of the Foreign Account Tax Compliance Act. The reference was meant to be pejorative.

The proposal was eventually withdrawn. Lawmakers from both parties found something distasteful about authorizing the IRS to snoop on the details of people’s financial arrangements.

That’s despite the fact that third-party reporting is commonplace in other areas and already features prominently in the financial lives of U.S. taxpayers. It’s also despite the language in section 61 that defines gross income as being from “whatever source derived.” The opposition wasn’t rooted in tax policy or economics; it was cultural.

People in Washington appreciate that these kinds of enforcement measures tend to linger in the background, until the next occasion when Congress needs a convenient pay-for. In crass political terms, the appeal of focusing on the tax gap is that it allows lawmakers to raise revenue without technically voting for a tax increase.

The relevant taxes are already due under current law, we’re merely dabbling with newfangled ways to nudge voluntary compliance in the right direction and get the income to show up on tax returns.

Domestic financial institutions are familiar with the Form 1099 series. That includes forms 1099-DIV, 1099-INT, and 1099-MISC

SC
, to name a few examples. It would be an incremental step to subject domestic banks to something more expansive that parallels to Form 8966, which foreign financial institutions must file under FATCA.

That this extension hasn’t happened yet is down to amorphous privacy concerns that can quickly fall by the wayside when confronted by a particular kind of opposition — a 9/11-type national security event (which got us the PATRIOT

IOT
Act) or the misadventures of UBS private banker Bradley Birkenfeld (which helped get us FATCA).

This article takes as given that the opposing forces of tax enforcement and financial privacy do not coexist in fixed equilibrium. Their natural resilience against encroachment by the other is subject to ebbs and flows, shaped by the prevailing political winds. There’s a non-trivial chance that a domestic incarnation of some “FATCA-esque” regime will return at some point. We should prepare for the possibility so that we can avoid known problems associated with large-scale data dumps.

Enter TIGT

GT
A

There are lessons to be learned from FATCA, now in its second decade. Several were detailed in the April report of the Treasury Inspector General for Tax Administration.

The TIGTA report makes for good reading because it doesn’t sugarcoat identifiable deficiencies. FATCA receives criticism from many corners. When Treasury’s own experts choose to dish on the regime, it’s time to sit up and listen.

The picture that emerges from the TIGTA report is one of information overload. The IRS is portrayed as an underfunded agency, saddled with administration of a complex data-harvesting regime but denied the suitable budgetary resources to effectively deal with it.

IRS Commissioner Charles Rettig touched on a similar theme during a recent policy discussion hosted by Tax Analysts. While speaking about the possibility of new information reporting for cryptocurrencies, Rettig observed, “We need funding for that; otherwise, you’re just building a bigger haystack to be out in the yard, and by themselves, those haystacks aren’t helpful.”

The same thinking applies to the mainstream segments of the economy. FATCA might be the biggest haystack of all.

In revenue terms, FATCA has fallen short of expectations. At the time of enactment in 2010, the Joint Committee on Taxation forecast that FATCA would raise $8.7 billion over the next 10 years.

The regime didn’t come close to meeting those numbers through 2020. During that time, the IRS spent $587 million on implementation — to say nothing of the considerable implementation burden it placed on the global banking sector.

Along the way, the IRS decided to abandon its own FATCA “roadmap,” instead relying on a set of internal campaigns housed under the Large Business and International Division. With the benefit of hindsight, ditching the roadmap was a mistake. But given its limited funding, LB&I didn’t have much choice.

The TIGTA report contains six recommendations for how the IRS might deal with FATCA in the future. These are split between recommendations geared toward difficulties with Form 8938, implicating noncompliance on the part of individual taxpayers, and difficulties with Form 8966, implicating noncompliance by FFIs.

By way of a conclusion, I take the opportunity to make one additional recommendation to Congress. A sizable chunk of the problems with FATCA would go away overnight if the regime offered a same-country exemption. Administration of FATCA might be transformed into an easily manageable chore. The resulting efficiency gains would be in addition to the relief to affected taxpayers.

Recommendations 1 and 2

The IRS stepped away from its original FATCA compliance roadmap several years ago. In place of it, LB&I developed two compliance initiatives: Campaign 896, relating to individual taxpayers and directed at offshore private banking; and Campaign 975, relating to the accuracy of FFIs’ filings.

According to the TIGTA report, Campaign 896 initially focused only on taxpayers believed to have underreported foreign assets on Form 8938. This approach ignored taxpayers who didn’t file the form at all.

In 2018 the campaign resulted in the issuance of 830 education letters, which remind the recipients of their legal obligation and ask that they review their return information relevant to Form 8938.

The letters may have resulted in some recipients filing amended returns with revised forms and schedules, but it doesn’t appear they resulted in any penalty assessments under section 6038D(d). In a tabulation of dollars in and dollars out, the TIGTA report assigns the campaign a zero-revenue score.

The report further explains there were at least 330,000 nonfilers of Form 8938 between 2016 and 2019 each holding foreign accounts of more than $50,000. At $10,000 a crack, that’s a source of $3.3 billion in untapped FATCA penalties. This hints at an identifiable “FATCA gap,” a distinct component of the more familiar tax gap.

TIGTA refers to the IRS as being “slow to identify” nonfilers as part of the campaign. Campaign 896 reports no revenue collected through June 2021. This doesn’t mean the rest of the IRS was sitting on its hands. Outside the scope of Campaign 896, the IRS assessed more than 900 FATCA penalties for the period of 2016 to 2019, totaling almost $14 million.

TIGTA’s first recommendation is that LB&I consider supplemental compliance actions against underreporters, as identified from matching exercises, including the assessment of penalties based on established variances. IRS management responds that the agency has already begun doing this.

Implementing the recommendation depends on the ability to match the information contained in a taxpayer’s Form 8938 with information derived from an FFI’s Form 8966. That exercise is useful for spotting variances in reported asset values, but it produces a dead end when the taxpayer doesn’t file Form 8938.

From a design perspective, a taxpayer’s circumstances under FATCA (or any compliance regime) shouldn’t improve when they don’t file at all.

TIGTA’s second recommendation is that a procedure be established to identify nonfilers of Form 8938, and to encourage compliance through the examination process and penalty assessments. IRS management responds that this recommendation is being implemented, with the development of a nonfiler filter starting from August 2021.

The filter has been applied to available data, beginning with the 2019 tax year. As a result, both civil and criminal examinations are in progress. Better late than never.

Recommendations 3 and 4

Here the focus shifts from U.S. taxpayers to FFIs. The point of Campaign 975 was to identify foreign banks that held specified accounts of U.S. persons but neglected to report them on Form 8966. Again, this comes down to a matching exercise of the unique institution names that appear on the collected forms. The first few years of the campaign, 2016 and 2017, produced consistent results, with 76% of the unique names culled from Forms 8938 matching what appeared on Forms 8966.

This required further investigation into the remaining 24% of FFIs that failed the matching. Initially, LB&I reviewed only those banks from jurisdictions that did not sign an intergovernmental agreement with the IRS.

A consequence of there being no IGA is that the IRS would be allowed to contact the FFI directly. For these early years, it’s not clear there was any follow up for FFIs located in IGA jurisdictions — although they represent the majority of FFIs that flunked the matching exercise.

In 2016, for example, 16,255 FFIs failed the preliminary matching exercise, providing an indicator of possible noncompliance. Only 995 of those entities (about 6%) were from non-IGA jurisdictions. That leaves 94% of potentially noncompliant FFIs off the hook, at least as far as this campaign was concerned. It’s possible those banks faced other consequences in a separate context, but the TIGTA report doesn’t comment.

TIGTA’s third recommendation is that LB&I expand the scope of Campaign 975 to include potential noncompliance by FFIs from IGA jurisdictions. Depending on which model IGA is involved, the IRS might not be able to contact the foreign bank directly — but that shouldn’t cause further scrutiny to grind to a halt.

IRS management responded that as of 2021 they have changed their policy to conform to the recommendation, so that FFIs from IGA jurisdictions are reviewed and identified for potential noncompliance.

The numbers contained in the TIGTA report reveal something else about the nature of matching data between forms 8938 and 8966. Consider the following: Of those 995 banks identified for possible noncompliance in the 2016 tax year, the IRS eventually determined that almost all of them were technically compliant — meaning the flunked matching was a false positive, attributable to some alternative explanation. As it turns out, only 12 “soft letters” were issued, resulting in five responses.

Because of TIGTA report redactions, there’s no information about what became of the five FFIs that responded to the soft letters — or the seven that didn’t respond.

The larger point is that getting flagged during the matching cycle is not as strong an indicator of noncompliance as one would hope. Frankly, it was a miserable indicator. The fact that only 12 cases merited follow-up, from a pool of 995 candidates, tells us something is wildly off.

The culprit is known to be the lack of mandatory common data fields shared between the two forms. The FFIs need to know their account holders’ U.S. taxpayer identification numbers. At the same time, the taxpayers need to know their foreign banks’ global intermediary identification numbers (GII

GII
Ns).

For several of the tax years covered by the campaign, Form 8938 included a data field for GIINs. It was not mandatory and (predictably) most filers left it blank. Similarly, Form 8966 contained a data field for TINs that foreign banks should have used to identify their U.S. account holders.

The TIN data field was mandatory, but the IRS bent to pressure from industry groups and granted an exemption (Notice 2017-46, 2017-41 IRB 275) that permitted some FFIs to leave it blank in some circumstances. The intention was to give banks enough time to obtain the TINs from reluctant clients. The special treatment was limited to FFIs in jurisdictions with a Model 1 IGA, and only for Forms 8966 relating to calendar years 2017 through 2019.

TIGTA’s fourth recommendation is geared toward fixing this problem with common data fields, so that matching forms 8938 and 8966 is a reliable indicator of potential noncompliance and a productive use of the IRS’s time. Without mandatory fields for TINs and GIINs, FATCA enforcement is fundamentally flawed.

TIGTA urged the IRS to issue formal notices to Model 1 IGA partners informing them that TINs must be collected and reported for all U.S. account holders.

IRS management disagreed with the recommendation, replying to TIGTA that those IGA partners are already aware of the need for TINs, as the requirement is spelled out in the text of the agreement itself (Model 1 IGA, article 2).

This continues to be a problem. For the years 2016 to 2019 less than half (44 percent) of all Forms 8966 received by the IRS contained valid TINs. The remainder contained either invalid TINs or no TINs at all. There’s only so much a foreign bank can do when a U.S. account holder refuses to respond or offers a bogus TIN.

Recommendations 5 and 6

The final two TIGTA recommendations relate to internal procedures — specifically, the IRS decision in 2018 to ditch the FATCA roadmap in favor of the two LB&I compliance campaigns. TIGTA does not urge the IRS to reinstate the roadmap.

The fifth recommendation is that the IRS establish “goals, milestones, and timelines” for measuring the LB&I campaigns’ effectiveness. The sixth recommendation is that LB&I collaborate with the IRS’s Small Business/Self-Employed Division for examination and collection functions and establish information sharing programs between the two divisions that will enable SB/SE to fully use data extracted from Form 8933.

IRS management has responded that these changes have been implemented.

Smaller Haystacks, Please

The TIGTA report dwells on how FATCA is being administered. This is very useful. It was never intended, however, to serve as a policy manifesto on how the building blocks of FATCA should be reconfigured. But that constraint doesn’t prevent me from going there.

Imagine how much simpler FATCA enforcement would be if the statutory regime contained a same-country exemption. Simply put, no U.S. taxpayer would need to identify financial accounts held in FFIs located in their country of residence.

Say someone happens to work for a multinational tech company in Dublin. The person’s local checking account would be outside the scope of FATCA. If that same Irish resident maintained a financial account in Liechtenstein (or any place other than Ireland), it would be game on for FATCA.

Looking back at the UBS offshore scandal (which functioned as the impetus for FATCA’s creation), how many names from Birkenfeld’s client log were U.S. citizens who chose to stay put in Geneva or Zürich long enough to acquire Swiss residence? None of them, as far as we know. There were tax dodgers among his clients, to be sure, but they were all living in places like California, Florida, or New York City.

The individuals who dabble in the offshore sector typically can’t be bothered with traveling to the host venue. If they do, they certainly wouldn’t think of living there for a minimum of 183 days in a calendar year. Even something as blissful as skiing in Zermatt gets old after a few weeks.

We hear a lot about rich Americans who conceal their wealth in the Cayman Islands or some other Caribbean tax haven. But would any of them want to live there long enough to establish residence?

Beyond the palm trees and beaches, most of these places are dumps. Why do you think guests are admonished against leaving the resort? The quality of public services can be atrocious; heaven forbid you slip on the poolside and require treatment from a local hospital.

Let’s remember these people are Americans, after all. They’ll want to return to their state-side lifestyles and the SUV parked in their driveway. There are social connections that require hands-on maintenance. Many of these folks have country club memberships to use. They probably have kids in private schools, who require some degree of parental attention, plus a mutt they abandoned in a kennel. Not to mention a U.S.-based business to run.

The point is that the U.S. expat community is not representative of Birkenfeld’s clients. Yet the former group will no doubt have a foreign bank account, perhaps more than one. They’re sure to be sucked up by FATCA’s breadth. This is a rather long-winded way of saying that FATCA’s scope is overinclusive, and it has been from day one. But it doesn’t need to be.

A same-country exemption would do more than provide relief for the expat community. In light of everything discussed in the TIGTA report, it would also improve the IRS’s ability to identify and respond to actual tax evaders.

To repurpose Rettig’s recent comment, if you’re a dutiful IRS official committed to catching offshore tax evaders, you’re essentially looking for needles in haystacks. It would surely be helpful if you were dealing with smaller haystacks.