Expat Tax Info from Barron HarperAmericans Approach Tax Paying Deadline
By Barron Harper
Pursues American Expatriate Couple for Social Security Taxes
Status: After well-nigh two years of contesting an erroneous IRS audit, an American expatriate couple continues in spite of challenging circumstances and mounting assessments to convince the Service to cancel their examination.
I. A Tax Compliant Expatriate Couple.
A married couple – let’s call them James and Isabel Platt - have resided in Spain since 1997. Together they run a business building single family homes in the Costa del Sol. As U.S. citizens, they file an annual tax return on which they report their earnings from their self-employment business on Schedule C of Form 1040. Since they pay Social Security taxes to Spain, they have never filed a corresponding Schedule SE the purpose of which is to calculate a Schedule C filer’s liability for U.S. Self-Employment (Social Security/Medicare) taxes.
II. IRS Audits the Couple’s 2006 Tax Return for Social Security Taxes.
On April 13, 2009, the Internal Revenue Service (IRS) in Philadelphia audited their 2006 tax return. In the audit, the Service alleged that the couple owed $5,379 in Self-Employment Taxes on $38,068 of net profit from their home building business ($38,068 x .9235 x .153 = $5,379). In addition to these taxes, IRS fined them $538 in late filing penalty, $952 in interest charges and a 20% accuracy penalty of $1,076 ($5,379 x 20%), bringing their total assessed liability to $7,945 ($5,379 + 538 + 952 + 1,076). As they had never been audited for U.S. Self-Employment taxes in the past, Isabel was bewildered. She exclaimed: ‘Why are they doing this?!’
According to the postmark date, the Platt’s had not actually filed their 2006 tax return late. But the Service’s refusal to acknowledge foreign postal dates must have triggered the rather stiff late filing penalty. Besides the apparent injustice of the $2,566 in penalties and interest being assessed, an unbiased observer might ask why Social Security, which is after all a retirement pension fund, is subjected to such heavy-handed fines? Moreover, why does the Service inflict a 20% accuracy-related penalty for what can only be described in a worse-case scenario as an unintentional misdemeanor?
III. IRS Clarifies Its Case Against the Couple?
In response to filing an appeal at the end of April, the IRS wrote on 21 September 2009: ‘According to our records you were penalized for not reporting all of your income. As a result, the Under-Reporting Department assessed you based on the income reported.’ This response was unclear and unsatisfactory. By charging the couple with under-reporting, IRS had created the impression that the Platt’s were charged with tax evasion. Sometime later, we would learn that IRS’s definition of under-reporting was the couple’s failure to report their Schedule C earnings on Schedule SE.
IV. Certificate of Coverage.
As the 21 September from IRS had yet to arrive, we took the advice of an IRS agent in a phone call. He advised that we write a letter stating that the Platt’s, being long-time residents of Spain, pay Social Security taxes to the Spanish tax authority. The agent felt sure that such a letter of explanation which is supported by the Bilateral Agreement between Spain and the United States would close the audit. Accordingly a letter dated 10 August 2009 was prepared and sent to IRS in Philadelphia.
Responding to this letter, IRS wrote on 25 September: ‘Please send in documentation … showing you paid Social Security Taxes on your earnings of $38,068. Once we receive this information we will make the necessary adjustments to your tax account.’ This letter appeared fortuitous.
Yet no one was sure what sort of documentation the IRS required. After some research on the U.S. Social Security Administration website, it appeared that a Certificate of Coverage might satisfy the Service. Accordingly the client was advised. Subsequently the Platt;s, after undergoing some difficulties with the Spanish tax authority as to what a Certificate of Coverage in Spain might represent, they were able to acquire Certificados de Situacion de cotizacion from the ‘Tesoreria General de la Seguridad Social’ affirming that they do indeed pay Social Security taxes to Spain.
The couple, anxious lest they erred in acquiring the appropriate Certificate of Coverage and might therefore find themselves subjected to further IRS penalties, copied these certificates to me on 20 November 2009.
On 4 December 2009, these certificates were attached to a letter of explanation sent to Philadelphia IRS. The letter delineated conversations with IRS agents, pointed out that the couple pay Social Security taxes to the Spanish authority, reminded the Service of the existence of a bilateral treaty that grants Spain the right to tax residents on Social Security, suggested that the IRS could be failing to bridge cultural interpretations, and asked that the 2006 audit be set aside.
On 28 December, the couple received a more ominous notice from IRS: ‘Urgent!! We intend to levy on certain assets. Please respond NOW.’ Naturally when the couple received this notice, they would write me on 12 January 2010 at the end of the Christmas holidays: ‘It seems that (their notice) doesn’t relate at all to the letter you sent them. We just don’t know what to do.’ I replied: ‘(Their notice) relates to the same 2006 self-employment tax issue. It is as if IRS is mindlessly ignoring our correspondence. Someone pushed in a code number and now the collection process is on autopilot.’
In a phone call, Agent Ramer, Badge #0739802 of IRS, explained that IRS had not yet processed our 4 December letter. She did assure me that our appeal had been assigned to an agent and therefore we would receive a response within 30-45 days. IRS never did respond.
V. Appealing to Taxpayer Advocate.
On 10 April 2010, I was writing the client: ‘Seems like IRS is really dragging its feet.’ Meanwhile the worsening tenor of assessment notices continued. On 3 May 2010, the client was again threatened with an IRS levy. ‘To prevent collection action, please pay the current balance now.’ The balance was $8,768.
The Service’s recommendation to the taxpayer is to always pay an assessment. Even if the taxpayer eventually wins the argument, paying off the taxes and other IRS fines will stop interest and notices from accruing. However, owing to the difficulty of resolving this audit, taxpayers are bound to feel mistrustful of paying an unjust assessment to an unreliable tax authority.
Frustrated by the Service’s unresponsiveness to our appeals in letters and phone calls, we contacted the Taxpayer Advocate Service. Nancy Chichilitti, Case Advocate, replied by ‘snail’ mail in a letter dated 20 May. She asked that the taxpayers fax to her their 2006 Form 1040 and related schedules. On 11 June by fax, I sent their tax return and a letter which states in part: ‘In 17 years of preparing tax returns for American expatriates, I never had an expatriated American client residing and earning in a European country being required to pay Social Security taxes to both their foreign country of residence and IRS.’
On 17 June, Advocate Chichilitti asked for a signed copy of page 2 of 2006 Form 1040. We could now take comfort that the IRS collection process was on a temporary holding pattern. However, as the summer season faded into autumn without our receiving any further word from Advocate Chichilitti and she had proved unreachable by phone, I spoke with another Advocate: Agent Neal, Badge #1000341613.
Agent Neal told me that the case had been closed on 23 September. Advocate Chichilitti had sent a letter on 23 August in which she asked to see an English translation of the taxpayers’ Spanish tax return in order to verify payment of Social Security taxes to Spain. The Platt’s never received this letter. Ms Chichilitti, not hearing back from the Platt’s, simply shelved the case. Nevertheless, a Spanish tax return is no proof of Social Security tax payments; rather it is for the filing and assessment of income taxes only.
Explaining to Agent Neal 19 October 2010 that the taxpayer had not received any letter from her Advocate colleague and possibly mentioning that a Spanish tax return is no proof that Social Security taxes have been paid to Spain, I asked that the case be reopened. Agent Neal promised to do so. In the meantime at her suggestion, I left my name and phone number so that an IRS representative in the international tax department could contact me. Later, however, the case was not reopened. Nor did the representative contact me.
VI. The Bilateral Agreement.
About this time, I wrote the couple: ‘These Advocates are turning out to be useless. I am going to phone regular IRS tonight. In that phone call, an agent told me that resolving the dispute is simply a matter of pulling up the Totalization (Bilateral) Agreement between Spain and the United States. The agent took down my appeal on the clients’ behalf, gave me a reference number, and promised that someone who was expert in the field of Social Security in the IRS legal department should be calling or emailing me. No such person ever did contact me.
On 15 November 2010, IRS announced their intention to levy the taxpayers’ assets for $9,245. The Platt’s – utterly frustrated by now but feeling compelled to do something - contacted the Federal Benefits Unit (FBU) in Madrid. The result merely reconfirmed the requirement of a Certificate of Coverage. Based on FBU advice, the couple, in a replay from 2009, obtained another set of Certificates dissimilar to those obtained the year before. On 10 December 2010, this set of Certificates was sent to IRS with a cover letter.
As one should allow six to eight weeks for correspondence with IRS to enter their system, I phoned on 28 January. After apprising Agent Latasso, Badge #100130669, of the tedious circumstances of the audit, she informed me that my 10 December letter had been placed in the hands of the International Section on 12 January. She advised me to wait to phone again as their processing was very slow.
VII. The Audit Cancelled – Almost.
On 12 February 2011, I spoke with Agent Gayle Clough, Badge #1000147298, of the International Division. Like many agents, she was courteous, business-like and capable. During quite a lengthy chat, she located the Certificates of Coverage and presented them to a tax lawyer there. He approved them as legitimate. So Agent Clough proceeded to cancel the assessment. But at the last moment, she reversed her decision. As the assessment had originated from the Under-reporting Department, her hands were tied. She said.
Agent Clough explained that by under-reporting, the taxpayers had failed to report their Self-Employment earnings on Schedule SE. So anyone who is self-employed in a foreign country that imposes Social Security taxes must also report his liability for self-employment taxes on the SE schedule. This requirement can only mean that the Totalization (or Bilateral) Agreement between Spain and the United States is mute!
In his 2010 book – The Tax Reform Alternative (www.offshorepress.com) – the author has written: ‘The Internal Revenue Code contains more than 3.4 million words; printed 60 lines to the page, it would fill more than 7,500 letter size pages. To conserve space, the tax code uses extensive cross-referencing to other parts of the tax code as a substitute for explaining the cross reference in any semblance of English. This forces readers to look up numerous other parts of the tax code in order to understand the scope of any section with cross references. In spite of this mountain of verbiage, every citizen is presumed to be familiar with the entire US Tax Code. … Ignorance of the law is not an excuse for the imposition of numerous burdensome civil penalties.’
Given that IRS endorses such a draconian theory of jurisprudence in imposing harsh penalties on anyone they deem as having failed to comply with an incomprehensible system of rules and regulations, the Service can apparently victimize anyone at any time with impunity. Further, if James and Isabel Platt can be arbitrarily taxed by a taxing authority whose tortuous conduct effectively denies them a defensive platform, they might be tempted to pay the IRS for the sake of their own sanity. If they cannot win the argument, they can at least stop the dunning notices.