On May 21, 2018, the IRS announced six new campaigns by the Large Business and International Division as part of its move toward issue-based examinations. Of the six campaigns, four affect nonresident individuals to improve compliance in reporting effectively connected income, tax credits and deductible expenses and withholding tax. One campaign targets U.S. residents owning or having transactions in foreign trusts. The campaigns were strategically planned based on IRS data and employee feedback.
In conjunction, the IRS is reviewing Tax Cuts and Jobs Act (P.L. 115-97) provisions to determine whether they influence any existing campaigns and will identify any affected campaigns after it completes its review.
One of the four campaigns affecting nonresident filers is intended to increase compliance in nonresident alien (NRA) individual tax treaty exemption claims in relation to both Effectively Connected Income (ECI) and Fixed, Determinable, Annual or Periodical (FDAP) income. ECI is all income from sources within the U.S. connected with the conduct of that trade or business. FDAP income is all other income, except: 1) gains derived from the sale of real or personal property; and 2) items of income excluded from gross income, without regard to the U.S. or foreign status of the owner of the income, such as tax-exempt municipal bond interest and qualified scholarship income. NRA individuals are required to report both types of income on Form 1040NR except where the NRA is not engaged in a U.S. trade or business and FDAP income tax liability is fully withheld at source. From the announcement, “Some NRA taxpayers may either misunderstand or misinterpret applicable treaty articles, provide incorrect or incomplete forms to the withholding agents or rely on incorrect information returns provided by U.S. payors to improperly claim treaty benefits and exempt U.S. source income from taxation. This campaign will address noncompliance through a variety of treatment streams including outreach/education and traditional examinations.”
Another campaign seeks to improve compliance in the proper deduction of expenses for NRA individuals. There are requirements and limits for deducting various expenses. “NRA taxpayers may either misunderstand or misinterpret the rules for allowable deductions under the previous and new Internal Revenue Code provisions, do not meet all the qualifications for claiming the deduction and/or do not maintain proper records to substantiate the expenses claimed. This campaign will address noncompliance through a variety of treatment streams including outreach/education and traditional examinations.”
A third campaign addresses NRA individuals’ tax credit claims. Here, the IRS is seeking to reduce tax credit claims from ineligible individuals. According to the announcement, “NRAs who either have no qualifying earned income, do not provide substantiation/proper documentation, or do not have qualifying dependents may erroneously claim certain dependent related tax credits. In addition, some NRA taxpayers may also claim education credits (which are only available to U.S. persons) by improperly filing Form 1040 tax returns.”
The final campaign affecting nonresidents targets the payors and seeks increased compliance with reporting and withholding obligations under forms 1042 and 1042-S from those payors. “Taxpayers who make payments of certain U.S.-source income to foreign persons must comply with the related withholding, deposit, and reporting requirements. This campaign addresses Withholding Agents who make such payments but do not meet all their compliance duties.”
The foreign trust campaign seeks to improve the timely reporting of taxpayers’ ownership of, and transactions with, foreign trusts through forms 3520 and 3520-A.
For more information or to evaluate the implications of this announcement for you, contact Toni, Paul or your trusted BKD advisor.