Tax Compliance
IRS May Be Able to Improve Compliance for Nonresident Aliens and Updating Requirements Could Reduce Their Compliance Burden Gao ID: GAO-10-429 April 14, 2010Every year, the U.S. receives millions of legal visits by foreign individuals. Nonresident aliens--who are neither U.S. citizens nor residents--may be required to file a federal tax return if they earn U.S.- source income, and their noncompliance can contribute to the tax gap. As with U.S. citizens and residents, the Internal Revenue Service (IRS) is responsible for ensuring that nonresident aliens fulfill their tax obligations. GAO was asked to (1) identify what data are available on nonresident alien tax filing and compliance, (2) provide information on guidance IRS provides to nonresident aliens and third parties on tax requirements and any challenges associated with filing, and (3) assess actions IRS takes to enforce nonresident alien tax compliance. To meet its objectives, GAO examined IRS and other federal agency documentation, reviewed tax filing and other data, and interviewed IRS officials and other third parties.
For tax year 2007, nonresident alien individuals filed about 634,000 Forms 1040NR, the U.S. Nonresident Alien Income Tax Return. IRS has not developed estimates for the extent of nonresident alien tax noncompliance because it often lacks information to distinguish between nonresident aliens and other filers, and examinations can be costly and difficult since many nonresident aliens would depart the country before IRS could examine their returns. IRS's outreach and education efforts have focused on presenting information on nonresident tax issues to a variety of audiences and making information available on its Web site and in its publications. Nevertheless, some nonresidents, their employers, and paid preparers may not be aware of nonresident alien tax rules, according to representatives of groups that work with employers and nonresidents to assist them in fulfilling their tax obligations. Other filing challenges exist. For example, individuals filing Forms 1040NR cannot file electronically. Also, nonresidents in the U.S. for less than 90 days who earn over $3,000 in compensation for services paid for by a foreign employer will likely have to file Form 1040NR, even if they owe no tax. The $3,000 exemption threshold, enacted by Congress in 1936 to lessen the tax compliance burden on nonresident aliens and never adjusted for inflation or other purposes, likely results in a greater proportion of nonresident aliens having a filing requirement today than in 1936. IRS has expanded its nonresident alien enforcement efforts over the past decade. However, IRS does not have a program to automatically identify nonresident aliens who improperly file Form 1040 instead of Form 1040NR, which can result in lost tax revenue when these taxpayers take unallowed deductions. IRS may be able to use taxpayer information to identify this type of noncompliance systematically. Finally, some nonresidents must file a certificate of compliance, referred to as a sailing permit, before departing the U.S. to ensure that tax obligations have been satisfied. The requirement is difficult to enforce and few nonresidents fulfill it, potentially leading to broader noncompliance if individuals assume the lack of enforcement extends to other tax rules.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Michael Brostek Team: Government Accountability Office: Strategic Issues Phone: (202) 512-9039GAO-10-429, Tax Compliance: IRS May Be Able to Improve Compliance for Nonresident Aliens and Updating Requirements Could Reduce Their Compliance Burden
This is the accessible text file for GAO report number GAO-10-429
entitled 'Tax Compliance: IRS May Be Able to Improve Compliance for
Nonresident Aliens and Updating Requirements Could Reduce Their
Compliance Burden' which was released on May 14, 2010.
This text file was formatted by the U.S. Government Accountability
Office (GAO) to be accessible to users with visual impairments, as
part of a longer term project to improve GAO products' accessibility.
Every attempt has been made to maintain the structural and data
integrity of the original printed product. Accessibility features,
such as text descriptions of tables, consecutively numbered footnotes
placed at the end of the file, and the text of agency comment letters,
are provided but may not exactly duplicate the presentation or format
of the printed version. The portable document format (PDF) file is an
exact electronic replica of the printed version. We welcome your
feedback. Please E-mail your comments regarding the contents or
accessibility features of this document to Webmaster@gao.gov.
This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed
in its entirety without further permission from GAO. Because this work
may contain copyrighted images or other material, permission from the
copyright holder may be necessary if you wish to reproduce this
material separately.
Report to the Chairman, Subcommittee on Select Revenue Measures,
Committee on Ways and Means, House of Representatives:
United States Government Accountability Office:
GAO:
April 2010:
Tax Compliance:
IRS May Be Able to Improve Compliance for Nonresident Aliens and
Updating Requirements Could Reduce Their Compliance Burden:
GAO-10-429:
GAO Highlights:
Highlights of GAO-10-429, a report to the Chairman, Subcommittee on
Select Revenue Measures, Committee on Ways and Means, House of
Representatives.
Why GAO Did This Study:
Every year, the U.S. receives millions of legal visits by foreign
individuals. Nonresident aliens”who are neither U.S. citizens nor
residents”may be required to file a federal tax return if they earn
U.S.-source income, and their noncompliance can contribute to the tax
gap. As with U.S. citizens and residents, the Internal Revenue Service
(IRS) is responsible for ensuring that nonresident aliens fulfill
their tax obligations. GAO was asked to (1) identify what data are
available on nonresident alien tax filing and compliance, (2) provide
information on guidance IRS provides to nonresident aliens and third
parties on tax requirements and any challenges associated with filing,
and (3) assess actions IRS takes to enforce nonresident alien tax
compliance. To meet its objectives, GAO examined IRS and other federal
agency documentation, reviewed tax filing and other data, and
interviewed IRS officials and other third parties.
What GAO Found:
For tax year 2007, nonresident alien individuals filed about 634,000
Forms 1040NR, the U.S. Nonresident Alien Income Tax Return. IRS has
not developed estimates for the extent of nonresident alien tax
noncompliance because it often lacks information to distinguish
between nonresident aliens and other filers, and examinations can be
costly and difficult since many nonresident aliens would depart the
country before IRS could examine their returns.
IRS‘s outreach and education efforts have focused on presenting
information on nonresident tax issues to a variety of audiences and
making information available on its Web site and in its publications.
Nevertheless, some nonresidents, their employers, and paid preparers
may not be aware of nonresident alien tax rules, according to
representatives of groups that work with employers and nonresidents to
assist them in fulfilling their tax obligations. Other filing
challenges exist. For example, individuals filing Forms 1040NR cannot
file electronically. Also, nonresidents in the U.S. for less than 90
days who earn over $3,000 in compensation for services paid for by a
foreign employer will likely have to file Form 1040NR, even if they
owe no tax. The $3,000 exemption threshold, enacted by Congress in
1936 to lessen the tax compliance burden on nonresident aliens and
never adjusted for inflation or other purposes, likely results in a
greater proportion of nonresident aliens having a filing requirement
today than in 1936.
IRS has expanded its nonresident alien enforcement efforts over the
past decade. However, IRS does not have a program to automatically
identify nonresident aliens who improperly file Form 1040 instead of
Form 1040NR, which can result in lost tax revenue when these taxpayers
take unallowed deductions. IRS may be able to use taxpayer information
to identify this type of noncompliance systematically. Finally, some
nonresidents must file a certificate of compliance, referred to as a
sailing permit, before departing the U.S. to ensure that tax
obligations have been satisfied. The requirement is difficult to
enforce and few nonresidents fulfill it, potentially leading to
broader noncompliance if individuals assume the lack of enforcement
extends to other tax rules.
Table: Nonresident Alien Filing Statistics, Tax Years 2003 through
2007:
Form 1040NR filers: Number of filers (in thousands);
2003: 627;
2004: 638;
2005: 648;
2006: 636;
2007: 634.
Form 1040NR filers: Total income reported (dollars in billions);
2003: $7.8;
2004: $9.3;
2005: $11.2;
2006: $13.4;
2007: $12.8.
Form 1040NR filers: Total tax liability reported (dollars in billions);
2003: $1.5;
2004: $1.8;
2005: $2.1;
2006: $2.5;
2007: $2.5.
Source: IRS.
[End of table]
What GAO Recommends:
GAO suggests that Congress consider raising the exemption threshold
for income paid by a foreign employer and eliminating the certificate
of compliance, or sailing permit, requirement. GAO also recommends
that IRS determine if creating an automated program to identify
improper filing of Form 1040 by nonresident aliens would be a cost-
effective means of improving compliance. In commenting on a draft of
this report, IRS agreed with our recommendation.
View [hyperlink, http://www.gao.gov/products/GAO-10-429] or key
components. For more information, contact Michael Brostek at (202) 512-
9110 or brostekm@gao.gov.
[End of section]
Contents:
Letter:
Background:
Several Hundred Thousand Individuals File Form 1040NR and It Would Be
Difficult to Measure Nonresident Alien Tax Noncompliance:
IRS Has Recently Expanded Nonresident Outreach and Education Efforts,
but Nonresidents Still Face Challenges in Fulfilling Their Tax
Obligations:
IRS Has Increased Nonresident Alien Tax Enforcement but May Be Able to
Identify Additional Noncompliant Taxpayers:
Conclusions:
Matters for Congressional Consideration:
Recommendation for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Scope and Methodology:
Appendix II: Comments from the Internal Revenue Service:
Appendix III: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Examples of Nonresident Aliens Earning U.S.-Source Income:
Table 2: Nonresident Alien Filing Statistics, Tax Years 2003 through
2007:
Table 3: Comparison of Selected Filing Statistics from Forms 1040NR
and 1040, Tax Year 2007:
Table 4: Central Withholding Agreements, Fiscal Years 2007 through
2009:
Figure:
Figure 1: Number and Total Reported Tax Liability of 1040NR Filers by
Income Bracket, Tax Year 2007:
[End of section]
United States Government Accountability Office: Washington, DC 20548:
April 14, 2010:
The Honorable Richard E. Neal:
Chairman:
Subcommittee on Select Revenue Measures:
Committee on Ways and Means:
House of Representatives:
Dear Mr. Chairman:
Every year, the U.S. receives millions of legal visits by foreign
individuals, some of whom have U.S.-source income or are engaged in a
U.S. trade or business. Individuals who are neither U.S. citizens nor
residents are known as nonresident aliens for tax purposes and may be
required to file federal tax returns to report their U.S.-source
income.[Footnote 1] Nonresident aliens' failure to comply with their
tax requirements can contribute to the tax gap--the difference between
taxes paid on time and what should have been paid. The Internal
Revenue Service (IRS) last estimated a gross tax gap of $345 billion
for tax year 2001. IRS estimated that it would eventually collect,
through various enforcement efforts, about $55 billion of the gross
tax gap, leaving a net tax gap of $290 billion. As it is for U.S.
citizens and residents, IRS is responsible for helping nonresident
aliens to understand their tax obligations and ensuring compliance
with such obligations.
In response to your request, this report provides information on
nonresident alien tax obligations and compliance. Specifically, this
report (1) identifies what data are available on nonresident alien tax
filing and compliance, (2) provides information on guidance IRS
provides to nonresident aliens and associated third parties on tax and
filing requirements and any burdens and challenges associated with
filing, and (3) assesses actions IRS takes to enforce nonresident
alien tax compliance.
To provide data on nonresident alien tax filing and compliance, we
obtained and reviewed IRS data from nonresident alien income tax
returns (Form 1040NR) filed for tax years 2003 to 2007, the 5 most
recent years for which data were available. We compared the Form
1040NR data to published data on other individual taxpayers from IRS's
Statistics of Income program. We also interviewed IRS research and
compliance officials. To provide information on guidance IRS provides
to nonresident aliens and associated third parties on tax and filing
requirements and associated burdens and challenges, we reviewed IRS
tax forms, guidance, and outreach materials. We also interviewed IRS
officials responsible for conducting outreach efforts and
representatives from groups that work with employers and nonresidents
to assist them in fulfilling their tax obligations, such as paid tax
return preparers, accounting and law firms, and university business
officers. To assess actions that IRS takes to enforce nonresident
alien tax compliance, we used IRS's goal in its 2009-2013 strategic
plan of increasing resource allocation to priority areas as criteria.
We reviewed data from IRS's enforcement programs, reviewed related
documentation, and interviewed IRS enforcement officials to determine
whether resources were increased for nonresident alien compliance
efforts and what results IRS had achieved.
We conducted this performance audit from July 2009 through April 2010
in accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our
findings and conclusions based on our audit objectives. For more
information on our scope and methodology, see appendix I.
Background:
For federal tax purposes, non-U.S. citizens are categorized as either
resident or nonresident aliens and are subject to different tax and
filing requirements. Generally, a nonresident alien is an individual
who (1) does not possess a permanent resident card, known as a green
card, or (2) has not established a substantial presence in the U.S.,
which is generally determined by the number of days an individual
spends in the U.S. over a 3-year period, though other considerations
apply.[Footnote 2] Resident aliens are generally subject to the same
federal tax requirements as U.S. citizens, which include paying U.S.
taxes on worldwide income and filing an individual tax return (Form
1040). On the other hand, nonresident aliens generally pay U.S. taxes
only on income derived from U.S. sources and may be required to report
income on the nonresident alien individual tax return (Form 1040NR).
[Footnote 3] Nonresident aliens cannot take some credits and
deductions available to residents and citizens. However, nonresidents
may qualify for reduced tax rates or exemptions as a result of tax
treaties between the U.S. and their countries of residence.[Footnote 4]
Generally, the tax rate nonresident aliens are to pay varies by both
the types of income earned and the individuals' countries of
residence. Nonresident aliens earning income effectively connected to
a U.S. trade or business, such as employee wages, are generally taxed
at the same graduated rates as U.S. citizens and residents, though
some tax treaties offer certain exemptions on this type of income. The
U.S.'s tax treaty with China, for example, exempts from taxation
certain income earned from the performance of personal services if the
nonresident alien is in the country for no more than 183 days.
[Footnote 5] Income not effectively connected to U.S. trade or
business, such as certain types of investment income, is generally
taxed at 30 percent. However, nonresidents with income such as
interest payments on deposits with a U.S. bank, or who are covered by
a tax treaty may qualify for income exemptions or lower tax treaty
rates. For example, residents of Mexico earning dividends from U.S.
companies may qualify for a 10 percent or lower tax rate on this
income instead of the flat 30 percent rate.
Nonresidents with income effectively connected to a U.S. trade or
business are generally required to file Form 1040NR even if they owe
no taxes because of a tax treaty or deductions. Conversely,
nonresident aliens not engaged in a U.S. trade or business and whose
tax liability was satisfied by the withholding of tax at the source do
not have to file.[Footnote 6] A filing exemption also holds for
nonresidents meeting certain other criteria, such as the following.
* Nonresidents whose only U.S.-source income is wages in an amount
less than the personal exemption amount--$3,650 for tax year 2009--do
not have to file if they have no other need to file, such as to claim
tax treaty benefits or a refund.[Footnote 7]
* Income of $3,000 or less paid by foreign employers for personal
services performed in the U.S. is not considered to be from U.S.
sources for nonresidents in the country for 90 days or less.[Footnote
8] An individual with only this type of U.S.-source income would not
need to file a return. This $3,000 threshold has not changed since its
inception in 1936 and would equate to over $46,000 in 2009 dollars if
adjusted for inflation.
Table 1 lists examples of nonresident aliens earning U.S.-source
income and the potential tax treatment in each scenario.
Table 1: Examples of Nonresident Aliens Earning U.S.-Source Income:
Income effectively connected to a U.S. trade or business:
Nonresident alien: Foreign visitor on nonimmigrant work visa;
Example of income earned and potential tax treatment: An individual
earns wages while employed by a U.S. entity. The income is generally
taxed at the same graduated rates as for U.S. citizens and residents.
Nonresident alien: Foreign short-term business traveler to U.S.;
Example of income earned and potential tax treatment: Employee of a
foreign corporation travels to U.S. for a conference, meetings, or
other business matters and earns more than $3,000 in wage income
during work days spent in the U.S. The wages are taxed at graduated
rates unless exempted via tax treaty.
Nonresident alien: Foreign athlete or entertainer performing or
competing in U.S.;
Example of income earned and potential tax treatment: Foreign
athletes' and entertainers' income is taxable in the same manner as
income derived by other nonresident aliens: income for performances
within the U.S. is taxed at graduated rates on a net basis, and income
such as royalties is subject to a 30 percent withholding tax. Tax
treaties generally provide special exemptions for specific amounts of
income earned for these performances.
Nonresident alien: Foreign student in U.S. on scholarship;
Example of income earned and potential tax treatment: Students in
certain visa classes are nonresident aliens for at least the first 5
years spent in the U.S. Scholarship income may be excludable if the
student is a degree candidate and uses the funds to pay tuition or
other course-related expenses.
Nonresident alien: Employee of foreign government or international
organization;
Example of income earned and potential tax treatment: Generally
considered a nonresident regardless of the number of days spent in the
U.S. Salaries from foreign governments and certain international
organizations may be exempt from U.S. taxes.
Income not effectively connected to a U.S. trade or business:
Nonresident alien: Foreign investor in U.S. companies;
Example of income earned and potential tax treatment: An individual
realizes a capital gain from trading stocks or securities through a
U.S. broker. The income is generally tax exempt. Dividend income that
is not effectively connected to a U.S. trade or business is taxed at a
flat 30 percent or lower treaty rate.
Nonresident alien: Foreign investor with U.S. bank deposits;
Example of income earned and potential tax treatment: An individual
receives interest from bank deposits with a U.S. financial
institution. The interest income is from U.S. sources but is generally
tax exempt.
Source: GAO analysis.
Note: Examples have been simplified for the purposes of illustration;
exceptions may apply.
[End of table]
As with U.S. citizens and residents, nonresidents must have a taxpayer
identification number in order to file a tax return. Foreign
individuals authorized to work in the U.S., such as individuals
traveling on a nonimmigrant temporary worker visa, must apply for a
Social Security number (SSN). Individuals who do not qualify for a SSN
but have a valid filing requirement under the Internal Revenue Code
may apply to IRS for an individual tax identification number (ITIN).
For example, certain short-term foreign business visitors earning
wages from foreign employers while in the U.S. and foreign investors
would generally apply for an ITIN.
Tax law also requires that both resident and nonresident aliens obtain
a certificate of compliance, known as a sailing permit, to ensure that
their outstanding U.S. tax obligations have been satisfied prior to
departing the country.[Footnote 9] First enacted in 1921, the
requirement stipulates that most aliens permitted to work in the U.S.
must visit an IRS office 2 weeks to 30 days prior to departing the
country, provide documentation to support any claims of taxable income
and prior tax payments made, and complete either a Form 1040-C (U.S.
Departing Alien Income Tax Return) or Form 2063 (U.S. Departing Alien
Income Tax Statement). An alien is to file Form 1040-C to report all
income received or expected to be received during the tax year and
generally is to pay any outstanding U.S. tax liability at the time the
form is filed. Form 2063 is to be filed when the departing alien has
no taxable income for the tax year or when tax collection will not be
hindered by the alien's departure from the country. Certain frequent
travelers between the U.S. and Mexico or Canada, alien students and
exchange visitors, and visitors for business admitted on a class B-1
or B-1/B-2 visa with no taxable income and in the country for no more
than 90 days are generally exempted from the sailing permit
requirement.
Finally, entities making income payments to nonresidents are required
to withhold taxes at either graduated or fixed rates, depending on the
type of income earned, except when the payee can verify the
individuals are entitled to an exemption. For example, a nonresident
alien earning wages from a U.S. employer would generally be subject to
graduated withholding in a manner similar to that of U.S. citizens and
residents. On the other hand, a financial institution disbursing U.S.-
source investment income to a foreign-based individual would generally
withhold at a fixed 30 percent rate, unless the entity could verify
that the nonresident was entitled to a reduced treaty rate. In both of
these examples, the employer and financial institution are required to
report income payments and withholding to IRS on information returns,
such as Form W-2 (Wage and Tax Statement) or Form 1042-S (Foreign
Person's U.S.-source Income Subject to Withholding). In certain
circumstances with nonresident alien athletes and entertainers, IRS
enters into arrangements that set withholding rates for income earned
from specific events, often at less than the 30 percent otherwise
required. These arrangements, called Central Withholding Agreements,
specify the amount and timing of U.S. tax payments and take into
account expenses associated with the income earnings.
Several Hundred Thousand Individuals File Form 1040NR and It Would Be
Difficult to Measure Nonresident Alien Tax Noncompliance:
According to IRS data, nonresident alien individuals filed about
634,000 Forms 1040NR for tax year 2007, a small number compared to the
143 million Forms 1040 other individual taxpayers filed for that year.
[Footnote 10] These nonresident filers reported $12.8 billion in
income, resulting in a $2.5 billion tax liability.[Footnote 11] The
number of Form 1040NR filers varied little from 2003 to 2007, the
latest years for which data were available. However, total income and
total tax liability reported increased during this period, as shown in
table 2. Total income and tax liability reported on Form 1040NR
increased by 64 percent and 71 percent, respectively, compared to
increases in reported income (40 percent) and tax liability (48
percent) reported on Form 1040 from tax year 2003 to tax year 2007.
[Footnote 12] The $5 billion increase in total income reported on
Forms 1040NR for this period is largely due to increases among higher
earners, since the total income that nonresidents with $100,000 or
more in income reported on Form 1040NR increased from $3.8 billion to
$8.1 billion (111 percent).
Table 2: Nonresident Alien Filing Statistics, Tax Years 2003 through
2007:
Form 1040NR filers: Number of filers (in thousands);
2003: 627;
2004: 638;
2005: 648;
2006: 636;
2007: 634.
Form 1040NR filers: Total income reported (dollars in billions);
2003: $7.8;
2004: $9.3;
2005: $11.2;
2006: $13.4;
2007: $12.8.
Form 1040NR filers: Total tax liability reported (dollars in billions);
2003: $1.5;
2004: $1.8;
2005: $2.1;
2006: $2.5;
2007: $2.5.
Source: IRS.
[End of table]
Form 1040NR filing data do not represent the full population of
nonresident alien taxpayers, however. Certain foreign investors
earning U.S.-source investment income with sufficient taxes withheld
at the source, for example, are not required to file Form 1040NR.
Also, nonresidents married to U.S. citizens or residents can choose to
be treated as residents and jointly file Form 1040 with their spouses.
[Footnote 13] Other nonresident aliens may incorrectly file Form 1040,
meaning their tax return information is not reflected in the Form
1040NR data.
IRS data also allow for comparison of nonresident alien filing
characteristics to those of U.S. citizen and resident filers, as shown
in table 3.
Table 3: Comparison of Selected Filing Statistics from Forms 1040NR
and 1040, Tax Year 2007:
Filing statistic: Forms with no tax liability;
Percentage of filed forms: Form 1040NR: 53;
Percentage of filed forms: Form 1040[A]: 25.
Filing statistic: Forms reporting tax balance due;
Percentage of filed forms: Form 1040NR: 8;
Percentage of filed forms: Form 1040[A]: 20.
Filing statistic: Forms reporting a refund due;
Percentage of filed forms: Form 1040NR: 67;
Percentage of filed forms: Form 1040[A]: 77.
Filing statistic: Forms prepared by a paid preparer;
Percentage of filed forms: Form 1040NR: 64;
Percentage of filed forms: Form 1040[A]: 56.
Source: GAO analysis of IRS data.
[A] Figures for Form 1040 are estimates.
[End of table]
As shown in table 3, 53 percent of Form 1040NR filers reported no tax
liability for tax year 2007, in contrast to an estimated 25 percent of
Form 1040 filers. Some nonresidents qualify for tax treaty income
exemptions which may contribute to the higher proportion of Form
1040NR filers with no tax liability.[Footnote 14] Requiring a
nonresident with no tax liability to file a U.S. return creates some
burden on the taxpayer, yet there are reasons why it may be
beneficial. For example, for individuals filing exclusively to claim a
treaty exemption, IRS may use that information to review and
potentially dispute claims. Additionally, some nonresidents may not
know if they have a tax liability until they go through the process of
preparing a tax return.[Footnote 15]
Also as shown in table 3, a smaller percentage of Forms 1040NR than
Forms 1040 reported a tax balance or refund due for tax year 2007.
These differences could be due to various factors, such as some
nonresidents having no tax liability as a result of tax treaties.
Also, a greater proportion of Forms 1040NR than Forms 1040 were
prepared by a paid tax return preparer, a disparity which may be due
to several factors, such as the complexity of nonresident tax law and
that some employers with employees traveling internationally may hire
tax professionals to assist in preparing employees' returns.
Figure 1 below shows that a small proportion of filers accounted for
the majority of reported tax liability. For example, about 20,000
filers (3 percent of all Form 1040NR filers) reported over $100,000 in
total income, yet this population contributed 76 percent ($1.9 billion
of $2.5 billion) of reported tax liability reported for tax year 2007.
Conversely, 72 percent of nonresidents reported $10,000 or less in
income, with these returns accounting for 1 percent of all reported
tax liability ($29 million out of $2.5 billion). One reason why most
nonresidents reported low income amounts might be that some are in the
country for only part of the tax year.
Figure 1: Number and Total Reported Tax Liability of 1040NR Filers by
Income Bracket, Tax Year 2007:
[Refer to PDF for image: 2 vertical bar graphs]
Total income: Less than $0;
Number of filers in thousands: 30;
Reported tax liability, in billions: $0.
Total income: $0;
Number of filers in thousands: 87;
Reported tax liability, in billions: $0.
Total income: $1 to $10,000;
Number of filers in thousands: 336;
Reported tax liability, in billions: $0.03.
Total income: $10,001 to $25,000;
Number of filers in thousands: 90;
Reported tax liability, in billions: $0.12.
Total income: $25,001 to $100,000;
Number of filers in thousands: 71;
Reported tax liability, in billions: $0.44.
Total income: Over $100,000;
Number of filers in thousands: 20;
Reported tax liability, in billions: $1.91.
Source: GAO analysis of IRS data.
Note: Form 1040NR filers could have reported less than $0 dollars in
total income if they had losses, such as capital or business losses,
that exceeded their income.
[End of figure]
IRS Lacks Comprehensive Data on Nonresident Alien Tax Compliance and
Obtaining Data Would Be Challenging:
IRS has not developed estimates for three types of nonresident alien
tax noncompliance: (1) failing to file a tax return, known as
nonfiling, (2) underreporting income on filed returns, and (3) filing
Form 1040 instead of Form 1040NR.[Footnote 16] IRS has developed an
estimate of overall individual taxpayer nonfiling by comparing general
population information from the U.S. Census Bureau's Current
Population Survey to individual income tax filing data, and matching
data taxpayers report on tax returns to that which third parties
report on information returns, such as wage and tax statements from
employers.[Footnote 17] However, according to IRS research officials,
it is not possible for IRS to parse out the nonresident portion of its
nonfiling estimate because the agency lacks the information necessary
to distinguish between nonresident alien and other nonfilers. Also,
census data exclude many short-term nonresident visitors.
IRS has excluded Form 1040NR returns from its studies of individual
taxpayer underreporting, which it uses to estimate the tax
gap.[Footnote 18] Those studies rely partially on face-to-face
examinations with individual taxpayers. Sampling Form 1040NR filers in
these studies would have been costly and difficult since many
nonresident aliens would have departed the country by the time IRS
examined the returns, according to IRS research officials. Given
limited agency resources, IRS has focused its compliance measurement
efforts on types of taxpayers that may represent greater compliance
risks. Total lost tax revenues associated with nonresident
noncompliance, for example, may be modest when compared with
underreporting for other areas, such as individual income tax,
employment taxes, or entities such as S corporations.[Footnote 19]
Additionally, IRS has not estimated the extent to which nonresidents
improperly file Form 1040 instead of Form 1040NR.[Footnote 20] This is
partly because sampling and examining Form 1040 filers to identify
nonresidents would be time-consuming and costly, given the large
number of Form 1040 filers and the likelihood that nonresidents will
have already departed the country.
Generating a rough estimate of the number of nonresident aliens who
may have a filing requirement using data from other federal agencies
would be challenging. The Department of Homeland Security (DHS)
reported admitting 9.7 million visitors for purposes other than
pleasure to the U.S. in 2007, while the Department of State reported
issuing 6.4 million nonimmigrant visas in the same year. Yet neither
figure serves as a reliable proxy for the number of nonresident aliens
entering the country for employment or business purposes, much less
incurring a filing obligation. DHS's data reflect the number of
entries into the U.S. rather than the number of individuals, thus
overcounting individuals making multiple trips to the U.S. State data
reflect the number of visas issued, but some were issued for strictly
leisure purposes, some visa recipients never enter the U.S., and
others may enter the U.S. and stay for a period of time sufficient to
establish tax residency. Even with an estimate of the number of
nonresident aliens entering the U.S. each year, it would be difficult
to further determine the number incurring a tax liability. Some
individuals may not earn sufficient income to prompt a filing
requirement and others may be noncompliant with the filing requirement
but not owe U.S. taxes because of tax treaty benefits.
IRS Has Recently Expanded Nonresident Outreach and Education Efforts,
but Nonresidents Still Face Challenges in Fulfilling Their Tax
Obligations:
IRS's outreach efforts have focused on presenting information on
nonresident tax issues to a variety of audiences. In 2009, IRS began
conducting seminars and workshops for tax practitioners on nonresident
alien tax issues and Form 1040NR at its Nationwide Tax Forums. IRS
also conducted two phone forums in 2008 on federal tax withholding,
for nonresident alien athletes and entertainers, and Central
Withholding Agreements.[Footnote 21]
IRS has also presented annually to groups such as the American Payroll
Association and National Association of College and University
Business Officers and has presented periodically to the American Bar
Association, Tax Executives Institute, and local attorney and
certified public accountant groups. Regarding nonresident aliens,
these presentations covered a wide array of topics, including tax
residency rules, income sourcing rules, tax treaty issues,
descriptions of which forms to file, and guidance on withholding on
payments to foreign individuals. Additionally, IRS employees at
foreign posts are available to provide guidance to nonresidents,
although these posts generally are staffed by few employees, making
outreach difficult.
IRS has held preliminary discussions with the Department of State and
the U.S. Citizenship and Immigration Service about having links to
information on IRS's Web site on nonresident alien tax requirements
included on sections of those agencies' Web sites that cover visa
applications and requirements. IRS and the Department of State have
discussed incorporating tax information within visa application
materials. However, according to an IRS official involved with this
effort, State was not inclined to produce this material because of the
cost involved and because the agency did not want to be perceived as
providing guidance on tax matters.
According to IRS compliance officials, IRS does not engage in outreach
to tax software providers on nonresident alien tax issues, primarily
because Form 1040NR currently cannot be filed electronically, as
discussed later. Software providers could conceivably insert a
question in their Form 1040 preparation programs inquiring if the user
is a citizen, resident, or nonresident alien.
According to IRS officials, IRS is assessing the feasibility and cost-
effectiveness of setting up a toll-free number that individuals can
call from outside of the U.S. to receive tax assistance. Currently IRS
tax assistance toll-free numbers cannot be called from outside of the
U.S. IRS also produces various publications containing information
relevant to nonresident aliens and includes information on nonresident
alien tax issues on its Web site.[Footnote 22]
Nonresident Aliens Face Challenges in Fulfilling Their Tax Obligations:
According to representatives from groups that work with employers and
nonresidents to assist them in fulfilling their tax obligations,
nonresident aliens face challenges in fulfilling their tax filing
obligations. For example and despite IRS's outreach and education
efforts, some nonresidents and their employers may not be aware of the
nonresident alien tax rules. Although nonresidents earning wages from
U.S. employers would likely know that they had taxes withheld from
their wages, they may not know they also have to file a tax return or
which return to file. Likewise, foreign individuals in the U.S. for
short-term business trips may be unaware that they have a filing
requirement given that comparable requirements may not exist in their
countries of residence. For example, in Canada, nonresidents generally
do not have to file a tax return if they owe no Canadian tax. Also,
some paid tax return preparers may not be familiar with nonresident
alien tax rules. Representatives from groups we spoke with thought
that unlicensed preparers in particular might not be familiar with the
nonresident alien tax rules.
Likewise, aspects of nonresident alien taxation, such as tax residency
rules, determining whether income is effectively connected to a U.S.
trade or business or is U.S.-or foreign-source, and applying tax
treaty provisions, can be difficult for nonresidents to understand.
For example, it can be challenging to answer the basic question of
whether or not a foreign person is a nonresident or resident alien.
Beyond the green card and substantial presence tests, noncitizen
taxpayers or their practitioners need to consider various scenarios in
making residency determinations. For example, individuals who would
otherwise be treated as residents can file as nonresidents if they
have a closer connection to a foreign country.[Footnote 23] It is also
possible to be both a nonresident alien and resident alien in the same
tax year and different rules apply for the part of the year an
individual is a nonresident alien and the part of the year the
individual is a resident alien. Although no single rule may be
difficult to apply, that numerous rules need to be considered can make
the residency determination a difficult and time consuming one,
according to representatives from groups that work with employers and
nonresidents to assist them in fulfilling their tax obligations.
The inability for nonresidents to file Form 1040NR electronically is
another challenge the groups we interviewed mentioned. Currently, IRS
does not allow for electronic filing of Form 1040NR because it
contains fields that cannot easily be transcribed into an electronic
format. IRS redesigned Form 1040NR for tax year 2009, in part to
address this problem. However, it does not plan to accommodate
electronic filing of the form until at least 2014.[Footnote 24]
Another set of challenges that groups we interviewed identified
concerned obtaining ITINs, as discussed below.
* ITIN applicants need to submit large amounts of documentation to
IRS, some of which must be certified by going to a U.S. embassy, which
can be time-consuming.
* Some applicants need to prove that they cannot obtain a SSN before
they can be assigned an ITIN and some nonresidents apply for a SSN
just to get the rejection letter so they can then apply for an ITIN.
* Some nonresidents unable to obtain an ITIN prior to departing the
country may end up not filing a return, even if owed a refund. Whether
or not they persist in the process to obtain an ITIN may depend on
whether or not the individuals anticipate subsequent U.S. taxable
activities.
Finally, some groups noted it is a burden for nonresidents paid by
foreign employers who take short business trips to the U.S. to file
the required Form 1040NR.[Footnote 25] As previously discussed,
personal service income of $3,000 or less paid to a nonresident by a
foreign employer is not considered to be from U.S. sources for
individuals in the U.S. 90 days or less who have no other compensation
for services within the U.S. Congress established this threshold in
1936 to permit foreign residents to visit the U.S. for business
purposes without being subject to taxes on the compensation they earn
while in the U.S. In discussing this exemption, the Senate noted that
the lack of a threshold had created ill will disproportionate to the
small amount of revenue raised by taxing foreign residents making
short business trips to the U.S.[Footnote 26]
Because the $3,000 threshold has not increased since 1936, it is
likely that a greater proportion of nonresident aliens have a filing
requirement today than when the threshold was established. For
example, in 1936, $3,000 was 559 percent of the U.S. per capita
personal income amount of $537. In 2008, $3,000 represented 8 percent
of the U.S. per capita personal income amount of $39,751. Likewise, a
nonresident would need to earn an annual salary of $12,133 to exceed
the $3,000 threshold during a 90-day period, assuming the individual
had no other U.S.-source income.[Footnote 27] A salary of $12,133 in
1936 is equivalent to $187,938 in 2008 dollars. A nonresident earning
$187,938 in 2008 would need to be in the U.S. for only 5 days for
business purposes to trigger a filing requirement, if the individual
earned no other U.S.-source income.[Footnote 28] This increased reach
of the filing requirement is underscored by the advance of economic
globalization and increase in business travel since the threshold was
established.
Some groups we spoke with suggested raising the $3,000 threshold to
reduce the burden of filing tax returns on nonresidents who make short
business trips to the U.S. and are paid by foreign employers. In
evaluating whether to increase the threshold, either by the level of
inflation since 1936 or another amount, various issues warrant
consideration. For example, although the current filing requirement
may be applicable to a broader population of nonresident aliens than
in 1936, many nonresidents who are required to file may ultimately owe
reduced or no taxes because of the tax treaties the U.S. has adopted.
According to DHS data, at least 78 percent of admissions to the U.S.
in fiscal year 2007 were of individuals residing in countries with
which the U.S. has tax treaties. Also, raising the exemption amount
could negatively affect U.S. residents if they do not receive
reciprocal exemptions on income otherwise subject to tax in countries
with which the U.S. has tax treaties.
Raising the threshold amount could result in lost tax revenue. For
example, IRS calculated that Form 1040NR filers who had income from
personal services in an amount of $40,000 or less reported $222.1
million in tax liability for tax year 2007. This amount represented
about 9 percent of the total tax liability reported on Form 1040NR for
that year. If the threshold had been set at $40,000 for tax year 2007,
which is slightly less than the value of $3,000 in 1936 dollars
inflated to 2007 dollars, the $222.1 million could have been exempt
and not paid. However, it is not likely that all of that amount would
have been exempt because some of the nonresidents with personal
services income of $40,000 or less could have been paid by a U.S.
employer or could have been in the U.S. for more than 90 days, and
therefore would not have been entitled to the exemption. Also, some of
that tax amount may be attributed to other types of income.
Although increasing the exemption threshold would likely result in
reduced tax revenue, it would also likely result in reduced burden and
cost savings for some nonresidents and IRS. Some taxpayers would no
longer bear the burden or cost of obtaining an ITIN and filing a
return. IRS would likely realize cost savings from having to process
fewer ITIN applications and Forms 1040NR.
IRS Has Increased Nonresident Alien Tax Enforcement but May Be Able to
Identify Additional Noncompliant Taxpayers:
IRS has expanded its enforcement efforts over the past decade. In
2001, IRS had two examiners who covered nonresident alien compliance
issues. Currently, IRS's Large and Mid-sized Business division's
International Compliance Strategy and Policy group (LMSB
International) has 261 examiners dedicated to international compliance
issues, including nonresident alien tax compliance.[Footnote 29] LMSB
International plans to hire an additional 202 examiners during fiscal
year 2010.
LMSB International has generally conducted face-to-face examinations
of nonresident aliens through special projects that focus on
particular types of taxpayers. For example, LMSB International has
examined individuals employed by foreign embassies or consulates and
international organizations in the U.S. Although U.S.-source income
paid to nonresident employees of foreign governments and international
organizations may be exempt from federal income tax, the exemption
depends on the tax treaty or consular convention between the U.S. and
the relevant foreign governments or other U.S. tax laws. Also,
employees of foreign governments and international organizations are
generally considered nonresidents regardless of how long they are in
the U.S. LMSB International found that some individuals were claiming
income exemptions to which they were not entitled or filed Form 1040
instead of Form 1040NR.[Footnote 30] For this project, IRS first
contacted potentially noncompliant individuals and allowed them to
voluntarily correct any noncompliance. IRS assessed $32.0 million in
taxes for 4,540 taxpayers who voluntarily settled with IRS from fiscal
year 2007 through the end of January 2010, for an average of $7,049
per settlement. IRS then examined 3,720 taxpayers who did not
voluntarily settle with IRS, assessing $21.8 million in taxes, for an
average of $5,851 per examination. LMSB International is continuing
these examinations.
Building face-to-face examination cases for nonresidents is resource
intensive. For example, preparing for and conducting the examinations
of employees of foreign embassies and consulates and international
organizations took up nearly all of LMSB International's resources
that were dedicated to nonresident alien enforcement. LMSB
International used State Department visa information to identify the
nonresidents it contacted and examined. However, it is difficult and
time consuming for IRS to use visa information to identify
corresponding tax returns because visas do not include SSNs or ITINs,
which are the unique identifiers included on tax returns that IRS uses
to build examination cases.
LMSB International is planning on using examiners it expects to hire
in fiscal year 2010 to conduct additional enforcement actions against
nonresidents that would be less time consuming and complex than face-
to-face examinations. For example, IRS may examine potentially
noncompliant nonresidents through correspondence, according to an LMSB
International official. Likewise, through its Automated Underreporter
program (AUR), IRS has begun to match information taxpayers report on
Forms 1040NR to information third parties report to IRS to identify
nonresident alien taxpayers who may have underreported their income.
IRS previously concluded, through a test, that matching income items
from Form 1040NR, such as wages, was not a prudent use of resources.
IRS found that many of the tax returns it studied claimed tax treaty
benefits, which can be time consuming to verify and can require
expertise to evaluate that IRS AUR staff generally did not possess.
However, given that LMSB International is planning to hire additional
staff, it may be able to examine nonresident alien taxpayers whom it
identifies as potentially noncompliant through AUR, according to the
official.
IRS has a broad program to identify taxpayers who failed to file a
required tax return, including those who should have filed Form
1040NR. The program only identifies whether individuals may have
failed to file a tax return and cannot easily identify which form they
should have filed (i.e., Form 1040 versus Form 1040NR). IRS may be
able to identify during an examination that a nonfiler should have
filed Form 1040NR.
IRS May Be Able to Systematically Identify Nonresidents Who Improperly
File Form 1040:
IRS does not have a program to automatically identify taxpayers who
may have improperly filed Form 1040 instead of Form 1040NR. According
to an LMSB International official familiar with examinations of
nonresidents, IRS has found that some nonresidents improperly file
Form 1040 instead of Form 1040NR. The official told us that
nonresidents filing the wrong tax return presents a greater compliance
risk than nonresidents failing to file a tax return altogether because
withholding is required for most nonresidents earning U.S.-source
income regardless of whether they file a tax return. Also, other
nonresidents who do not file and for whom taxes are not withheld, such
as those working for foreign employers, may not have tax liabilities
because of tax treaty benefits. On the other hand, nonresidents who
file Form 1040 instead of Form 1040NR may claim credits or take
deductions to which they are not entitled, which may lead to reduced
tax revenue.
IRS may be able to systematically identify nonresidents who improperly
file Form 1040 instead of 1040NR. As previously discussed,
nonresidents must obtain an ITIN to file a tax return if they do not
meet the requirements to obtain a SSN. IRS can identify Forms 1040
filed using ITINs. IRS can also identify Forms 1040 filed jointly by
married individuals that included both an ITIN and a SSN, as
nonresidents married to U.S. citizens or residents can choose to be
treated as residents and file Form 1040 jointly with their spouses.
IRS may also be able to use information from ITIN applications (Form W-
7) to further refine the identification of taxpayers who may have
filed the wrong tax return because ITIN applicants indicate if they
are resident or nonresident aliens, or a spouse or dependent of
either, on that form.
LMSB International officials told us that IRS may be able to
effectively use such a filtering process in its enforcement efforts.
As previously discussed, LMSB International is planning on initiating
additional enforcement actions against nonresidents that would be less
time consuming and complex than the face-to-face examinations it has
traditionally conducted. The officials told us that if IRS were able
to identify nonresidents who may have improperly filed Form 1040
instead of Form 1040NR, IRS could examine some of those individuals
through correspondence, for example those who took large deductions
that would not be allowed when filing Form 1040NR. Likewise, IRS could
review Forms 1040 filed jointly by a married couple where one filer
used an ITIN to ensure that the return included the couple's worldwide
income, and not just their U.S.-source income, as is required by U.S.
tax law. The officials told us that it would be worthwhile to test the
identification process to determine the size of the potential
examination inventory and the cost-effectiveness of working on these
examination cases.
IRS Has Expanded Enforcement for Reporting and Withholding on Payments
to Foreign Individuals:
In 2008, LMSB designated reporting and withholding on U.S. income paid
to foreign individuals as a high-priority issue.[Footnote 31] U.S.
persons or entities who make payments of certain types of U.S.-source
income to nonresidents generally must withhold tax at a rate of 30
percent on such payments, unless there are applicable tax treaty
provisions allowing for a reduced rate. Such payments are generally
subject to reporting on Form 1042 (Annual Withholding Tax Return for
U.S. Source Income of Foreign Persons) and Form 1042-S (Foreign
Person's U.S. Source Income Subject to Withholding). The person or
entity making these payments--generally referred to as a U.S.
withholding agent--is responsible for the withholding and reporting.
IRS's focus for this issue is on the compliance of U.S. withholding
agents with regard to these reporting and withholding responsibilities.
The impetus behind designating U.S.-source income reporting and
withholding as a priority issue was two-fold, according to an LMSB
International official. First, in September 2008, the Permanent
Subcommittee on Investigations of the Senate Committee on Homeland
Security and Government Affairs issued a report on actions foreign
individuals take to avoid payment of taxes on U.S. stock
dividends.[Footnote 32] The report brought attention to the problem of
withholding agents not reporting and withholding proper amounts of
tax. Second, IRS historically had not taken actions to enforce
compliance with the requirements for reporting and withholding on
payments to nonresidents.
The U.S.-source income reporting and withholding initiative is made up
of three components, according to LMSB International officials.
* First, IRS is attempting to address intermediary (e.g., hedge funds'
and other financial institutions') marketing of aggressive tax
positions, such as through instruments like total return swaps, which
may allow taxpayers to avoid taxation on income that would otherwise
be taxed at 30 percent.[Footnote 33]
* Second, IRS has begun to match filed Forms 1042-S to Forms 1040 or
1040NR to determine if taxpayers are underreporting income.
* Third, IRS has initiated a number of compliance projects. LMSB
International has started a marketing campaign within IRS to increase
focus on withholding agent compliance by, for example, encouraging
examiners to look for taxpayers with foreign addresses when reviewing
businesses' payroll information. LMSB International has also begun
testing whether it can identify entities that filed Forms 5471
(Information Return of U.S. Persons With Respect To Certain Foreign
Corporations) or 5472 (Information Return of a 25 Percent Foreign-
Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S.
Trade or Business) but failed to report payments to nonresidents on
Form 1042-S. IRS found for a test group of 10 corporations, 9 failed
to report some payments. However, it was unclear if these payments
were exempt because of tax treaties and as such appropriate to exclude
from reporting. IRS is continuing this test.
IRS uses Central Withholding Agreements to minimize tax compliance
risk for athletes and entertainers, who often are high earners
relative to other nonresident aliens. As shown in table 4, the number
of agreements and amounts withheld has increased over the past 3
fiscal years, although the average amounts withheld have fluctuated.
Table 4: Central Withholding Agreements, Fiscal Years 2007 through
2009:
Number of agreements:
2007: 507;
2008: 655;
2009: 944.
Total withholding deposits (dollars in millions):
2007: $53.7;
2008: $59.2;
2009: $70.9.
Average withholding deposit per agreement:
2007: $106,009;
2008: $90,363;
2009: $75,066.
Source: IRS.
[End of table]
Few Nonresidents Obtain Sailing Permits and IRS Does Not Enforce the
Sailing Permit Requirement:
The number of sailing permits filed annually has decreased
substantially over past decades. As we reported in 1988, the number of
Form 1040-C sailing permits filed dropped from about 176,000 in
calendar year 1960 to 1,245 in fiscal year 1986.[Footnote 34]
According to an LMSB International official, about 1,000 Forms 1040-C
were filed for tax year 2006. Likewise, neither IRS nor the U.S.
Customs and Immigration Service have enforced the sailing permit
requirement for departing aliens for decades, according to LMSB
International officials. These officials told us that IRS cannot
realistically enforce the sailing permit requirement given the volume
of foreign individuals who depart the U.S. daily. Enforcing the
requirement would be particularly burdensome, as IRS would have to
check all aliens for sailing permits even though the requirement is
only applicable to some. For example, only a portion of foreign
individuals enter the U.S. for business purposes. According to DHS
data, about 74 percent of visitor admissions were for pleasure rather
than for business or other purposes in fiscal year 2007.
That few individuals file sailing permits and IRS does not enforce the
filing requirement may not represent a significant compliance risk.
Tax withholding is generally required on payments of U.S.-source
income to nonresident aliens.[Footnote 35] Such withholding reduces
the chance that nonresidents will depart the country without paying
taxes owed. Furthermore, although foreign employers may not withhold
U.S. taxes on U.S-source income payments made to nonresidents, those
individuals may not have substantial tax liabilities because of tax
treaties. As previously discussed, at least 78 percent of admissions
to the U.S. in fiscal year 2007 were of individuals residing in
countries with which the U.S. had a tax treaty.
On the other hand, there may be a downside to having a requirement
that is not enforced. Nonresidents who recognize that IRS does not
enforce the sailing permit requirement may assume that IRS will not
enforce other requirements, which could lead to broader noncompliance.
Representatives from groups that work with employers and nonresidents
to assist them in fulfilling their tax obligations told us that they
were aware that IRS has not enforced the sailing permit requirement in
decades. Also, according to an LMSB International official, the
existence of a requirement could even negatively affect overall tax
compliance in that some foreign individuals who file the Form 1040-C
version of the sailing permit may not realize that they have to file a
tax return after the year's end and pay any additional tax that was
not paid in conjunction with filing Form 1040-C. Finally, although few
aliens file sailing permits, IRS incurs at least some cost to process
filed permits and maintain guidance concerning the requirement.
Conclusions:
Much has changed since Congress developed the tax rules for
nonresident aliens. The world economy is increasingly interconnected
and the number of aliens entering the U.S. for business purposes has
increased accordingly. Congress passed legislation in 1936 to lessen
the tax compliance burden for nonresidents paid by foreign employers
in the U.S. for short periods of time. However, inflation has eroded
the effect of the dollar threshold Congress established and
nonresidents increasingly may have to file tax returns if they are in
the U.S. for business for only a few days.
Another requirement that has been effectively eroded by the increase
in travel to the U.S and other tax laws is the requirement that aliens
obtain certificates of compliance, otherwise known as sailing permits.
For nonresidents working for U.S. employers, withholding has
supplanted sailing permits as the primary way to minimize compliance
risk. Nonresidents working for foreign employers may not have
substantial tax liabilities because of tax treaty benefits. Further,
few nonresidents obtain sailing permits. IRS does not enforce the
requirement, and it likely could not effectively enforce the
requirement given the volume of foreign individuals departing the
country daily. A lack of enforcement may also lead taxpayers to
conclude that IRS does not enforce other filing requirements. Taken
together, these conditions call into question whether the sailing
permit requirement is still necessary to ensure compliance.
Despite an increased focus on nonresident alien tax enforcement, IRS
may be missing an opportunity to identify more potentially
noncompliant taxpayers because it does not systematically identify
nonresidents filing the incorrect type of tax return. If IRS were able
to identify taxpayers who should have filed Form 1040NR instead of
Form 1040 by using information reported on tax returns or ITIN
applications, it may be able to cost-effectively address this form of
noncompliance for some taxpayers. Without further study, IRS cannot
know if this type of enforcement action would be cost-effective.
Matters for Congressional Consideration:
Given the increasing extent of business travel to the U.S. and the
eroding effect of inflation, Congress should consider raising the
amount of U.S. income paid by a foreign employer that is exempt from
tax for nonresidents who meet the other conditions of the exemption.
Also, given the difficulty of enforcing the requirement for aliens to
obtain certificates of compliance--sailing permits--before departing
the country and the existence of withholding requirements and tax
treaties, Congress should consider eliminating the sailing permit
requirement.
Recommendation for Executive Action:
We recommend that the Commissioner of Internal Revenue determine if
creating an automated program to identify nonresident aliens who may
have improperly filed Form 1040 instead of Form 1040NR by using ITIN
information would be a cost-effective means to improve compliance.
Agency Comments and Our Evaluation:
In a March 31, 2010, letter responding to a draft of this report,
IRS's Deputy Commissioner for Services and Enforcement stated that IRS
agreed to study the feasibility of an automated system to identify
nonresident aliens who improperly file Form 1040 instead of Form
1040NR, including whether information from ITIN applications can be
effectively analyzed with such an automated system. The letter also
stated that IRS would continue to look for ways to improve nonresident
alien tax compliance through enforcement and outreach. For the full
text of IRS's comments, see appendix II.
As we agreed with your office, unless you publicly announce the
contents of this report earlier, we plan no further distribution of it
until 30 days from the date of this report. At that time, we will send
copies of the report to the Commissioner of Internal Revenue and other
interested parties. This report will also be available at no charge on
GAO's Web site at [hyperlink, http://www.gao.gov]. If you or your
staff have any questions about this report, please contact me at (202)
512-9110 or brostekm@gao.gov. Contact points for our Offices of
Congressional Relations and Public Affairs may be found on the last
page of this report. Key contributors to this report are listed in
appendix III.
Sincerely yours,
Signed by:
Michael Brostek:
Director, Tax Issues Strategic Issues Team:
[End of section]
Appendix I: Scope and Methodology:
To provide data on nonresident alien tax filing, we obtained and
reviewed statistics from the Internal Revenue Service's (IRS)
compliance data warehouse (CDW) on Form 1040NR, the U.S. Nonresident
Alien Income Tax Return, for tax year 2003 to tax year 2007, the last
5 years for which complete filing data were available. To provide
context on these statistics, we reviewed published data on other
individual taxpayers from IRS's Statistics of Income program, which
draws from a widely used database composed of a sample of unexamined
income tax returns. We determined that the estimates provided had
sampling errors of less than 1 percent. We then assessed these two
data sources for reliability purposes. To do this, we interviewed IRS
research officials, conducted logic testing, and compared certain CDW
data elements received by IRS to publicly available data on Form
1040NR filings. On the basis of our assessment, we determined that
both sources used were sufficiently reliable for the purposes of our
review. To identify the availability of compliance data, we reviewed
IRS documentation on the National Research Program and interviewed IRS
research and compliance officials. We also examined documentation on
tax treaties, visa issuance data from the Department of State, and the
number of annual admissions of foreign visitors from the Department of
Homeland Security (DHS), in order to provide context as to the
potential number of nonresident aliens with a filing requirement or
incurring a tax liability each year.
To provide information on guidance IRS provides to nonresident aliens
and associated third parties on tax and filing requirements and any
burdens and challenges associated with filing, we reviewed IRS tax
forms, guidance, and outreach materials. We also interviewed IRS
officials responsible for conducting outreach efforts and groups that
work with employers and nonresidents to assist them in fulfilling
their tax obligations. More specifically, we conducted group
interviews with members of the American Institute of Certified Public
Accountants, the National Association of Enrolled Agents, and the
National Association of College and University Business Officers, and
spoke with staff from accounting and law firms that have nonresident
aliens or their employers as clients.
To assess actions that IRS takes to enforce nonresident alien tax
compliance, we used IRS's goal in its 2009-2013 strategic plan of
increasing resource allocation to priority areas as criteria. We
reviewed data from IRS's enforcement programs and interviewed IRS
enforcement officials to determine whether resources were increased
for nonresident alien compliance efforts and what results IRS had
achieved. Specifically, we reviewed IRS data on examinations and
Central Withholding Agreements and various IRS tax forms, and
interviewed IRS officials to discuss potential opportunities to expand
enforcement efforts. We then assessed these IRS sources for
reliability by reviewing IRS documentation and interviewing agency
officials and determined that these sources were sufficiently reliable
for the purposes of our review.
We conducted this performance audit from July 2009 through April 2010
in accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our
findings and conclusions based on our audit objectives.
[End of section]
Appendix II: Comments from the Internal Revenue Service:
Department Of The Treasury:
Internal Revenue Service:
Deputy Commissioner:
Washington, D.C. 20224:
March 31, 2010:
Mr. Michael Brostek:
Director, Tax Issues:
Strategic Issues Team:
U.S. Government Accountability Office:
441 G Street, N.W.
Washington, DC 20548:
Dear Mr. Brostek:
Thank you for providing your draft report, Tax Compliance: IRS May Be
Able to Improve Compliance for Nonresident Aliens and Updating
Requirements Could Reduce Their Compliance Burden (GA0-10-429), for
our review and comments. We appreciate the time the GAO team spent
reviewing the tax obligations of nonresident aliens and the IRS's
efforts to enforce those obligations.
Ensuring U.S tax compliance of nonresident aliens in today's economy
is challenging, particularly given the increasing mobility of
individuals. The tax laws and treaties applicable to foreign persons
are complex and not always current. IRS's systems and processes that
may work very well for U.S. citizens and permanent residents are often
less effective in enforcing the tax rules governing nonresident aliens.
We agree with the report that the IRS should tackle these challenges,
both through enforcement and through outreach, and we will continue to
look for improvements on both fronts. Further, we agree to study the
feasibility of an automated system to identify nonresident aliens who
improperly file Form 1040 instead of Form 1040NR. We will study
whether information made available to us on filed returns or on
Individual Taxpayer Identification Number (ITIN) applications can be
effectively analyzed with such an automated system.
Attached is a response to the report's recommendation. We look forward
to receiving your final report. In the meantime, if you have any
questions, please contact Michael Danilack, Deputy Commissioner
(International), Large and Mid-Size Business Division, at (202) 435-
5000.
Sincerely,
Signed by:
Steven T. Miller:
Enclosure:
[End of letter]
Attachment:
Recommendation:
GAO recommends that the IRS determine if creating an automated program
to identify improper filing of Form 1040 by nonresident aliens would
be a cost-effective means of improving compliance.
Comments:
We will study the feasibility of establishing an automated program to
identify improper filing of Form 1040 by nonresident aliens to
determine whether it would be a cost-effective means to improve
nonresident alien compliance. Further, we will determine whether such
an automated system can be effectively used to analyze information
made available to us on filed returns or on Individual Taxpayer
Identification Number (ITIN) applications.
[End of section]
Appendix III: GAO Contact and Staff Acknowledgments:
GAO Contact:
Michael Brostek, (202) 512-9110 or brostekm@gao.gov:
Acknowledgments:
In addition to the contact named above, Joanna Stamatiades, Assistant
Director; Jeff Arkin; Amy Bowser; Karen O'Conor; Amy Radovich; Cynthia
Saunders; and John Zombro made key contributions to this report.
[End of section]
Footnotes:
[1] Nonresidents with U.S.-source income may also owe state income
taxes; however, we focus only on federal taxes in this report.
[2] Generally, aliens are resident aliens if they are present in the
U.S. on 183 days or more in a calendar year. Individuals are also
considered to have met the substantial presence test if they are
present in the U.S. on at least 31 days during the current year and
183 days during the 3-year period that includes the current year and
the 2 years immediately before that. When calculating the 183 day
figure, individuals are to count all the days they were present in the
current year, one-third of the days they were present in the
immediately preceding year before the current year, and one-sixth of
the days they were present in the second preceding year before the
current year. I.R.C. § 7701(b)(3).
[3] Foreign individuals can have a U.S. tax liability without entering
the U.S., for example if they have certain types of U.S.-source
investment income.
[4] The U.S. had 59 income tax treaties as of 2009. Under these
bilateral agreements, residents of treaty countries are generally
exempted from taxation or taxed at reduced rates on certain types of
income they receive from U.S. sources, such as income from personal
services, capital gains, royalties, and pensions or annuities.
[5] Personal services can be those services performed independently by
professional persons, such as doctors and lawyers, or dependently by
employees for an employer.
[6] Treas. Reg. § 1-6012-1(b)(2). Examples of income from U.S. sources
but not effectively connected to U.S. trade or business include some
interest earnings, dividends, rents, premiums, and annuities.
[7] IRS Notice 2005-77 (2005-46 IRB, Nov. 14, 2005).
[8] I.R.C. § 861(a)(3). The same exception applies when determining
whether a nonresident alien is engaged in a trade or business within
the United States. I.R.C. § 864(b)(1).
[9] I.R.C. § 6851(d); Treas. Reg. § 1.6851-2.
[10] Although Form 1040NR is filed by both individual taxpayers and on
the behalf of nonresident alien estates or trusts, Form 1040NR data in
this report only include figures for individual nonresident alien
taxpayers.
[11] The $12.8 billion in income excludes about $1.9 billion in income
fully exempt from taxation due to tax treaties. Also excluded are tax-
exempt interest; qualified dividends; and nontaxable individual
retirement account distributions, pensions, and annuities on
effectively connected income. Total income includes $1.0 billion in
negative income so that positive income reported in 2007 was $13.9
billion (totals do not equal due to rounding).
[12] Total Forms 1040 filed increased 10 percent during the period.
[13] Nonresidents married to other nonresidents generally cannot
jointly file a tax return.
[14] IRS data show that about 60,000 Form 1040NR filers (9 percent of
all Forms 1040NR filed) reported treaty exempt effectively connected
income and no tax liability for tax year 2007, with little variation
over the preceding 4 years.
[15] In 2007, 187,000 Form 1040NR filers reported no tax liability and
filed a return to obtain a tax refund from IRS.
[16] Another type of individual income tax noncompliance is
underpayment of one's reported tax liability.
[17] IRS's most recent estimate of the nonfiling tax gap for
individual taxpayers was $25 billion for tax year 2001.
[18] IRS completed a study, through its National Research Program
(NRP), for tax year 2001 using a sample of about 46,000 Form 1040
returns. IRS has begun to study individual taxpayer reporting
compliance on an ongoing basis and expects to have an updated
compliance estimate by 2013.
[19] S corporations are corporations that elect to pass corporate
income, losses, deductions, and credits through to their shareholders,
who are to report these items on their personal tax returns.
[20] Nonresident aliens who file Form 1040 instead of Form 1040NR may
take deductions and claim credits to which they are not entitled.
However, by filing Form 1040 instead of Form 1040NR, these individuals
may forgo tax treaty benefits they are entitled to claim.
[21] IRS holds phone forums for tax practitioners, attorneys, payroll
professionals, and industry partners with the goal of facilitating the
filing of accurate tax returns.
[22] These publications include Publication 513, Tax Information for
Visitors to the United States; Publication 515, Withholding of Tax on
Nonresident Aliens and Foreign Entities; Publication 519, U.S. Tax
Guide for Aliens; Publication 901, U.S. Tax Treaties; and Publication
1915, Understanding Your IRS Individual Taxpayer Identification Number.
[23] Nonresident aliens in the U.S. for less than 183 days during the
year are considered to have a closer connection to a foreign country
if they maintain a tax home in that country during the tax year and
have maintained more significant contacts with the foreign country
than with the U.S. A tax home is the general area of an individual's
main place of business or employment, regardless of the location of
the individual's family home.
[24] However, since ITIN applications cannot be filed electronically,
nonresidents filing Form 1040NR in conjunction with an ITIN
application would not be able to file Form 1040NR electronically for
that year.
[25] A foreign employer is defined as a nonresident individual,
foreign partnership, or foreign corporation or an office or place of
business maintained in a foreign country or U.S. possession by a U.S.
corporation, a U.S. partnership, or an individual who is a U.S.
citizen or resident. Foreign governments are not considered to be
foreign employers.
[26] S. Rep. No. 74-2156, at 22 (1936).
[27] This calculation assumes that the individual works 5 days a week
every week of the year.
[28] In this scenario, the individual's U.S.-source income would
exceed both the $3,000 threshold for income paid by a foreign employer
and the personal exemption equivalent threshold of $3,500 for 2008.
[29] Areas for which the LMSB International group is responsible
include nonresident aliens, U.S. citizens and residents living abroad,
and entities that are required to report income and withhold taxes on
payments to foreign individuals.
[30] IRS found that some U.S. citizens and residents employed by
foreign governments were also improperly claiming income exemptions.
[31] Reporting and withholding on fixed, determinable, annual,
periodical (FDAP) U.S.-source income was designated as a LMSB Tier
One, or top, issue. FDAP income is any income other than gains from
the sale of personal or real property or items of income excluded from
gross income, such as tax-exempt municipal bond interest. LMSB adopted
its issue tiering strategy in 2006 to ensure that high-risk compliance
issues are properly addressed and treated consistently across the
division. According to LMSB, using issue tiers provides a consistent
framework for identifying, prioritizing, and addressing significant
compliance risks in a nationally coordinated manner.
[32] Permanent Subcommittee on Investigations, Committee on Homeland
Security and Governmental Affairs, United States Senate, Dividend Tax
Abuse: How Offshore Entities Dodge Taxes on U.S. Stock Dividends
(Washington, D.C., September 2008).
[33] An example of a total return swap is an arrangement where one
party agrees to pay an amount equal to any appreciation in the price
of a stock plus the amount of any stock dividends paid during the term
of the swap, while the other party agrees to pay any depreciation in
the stock price plus certain fees, which usually include an interest
component. The end result is that the swap provides the first party
with virtually all of the economic benefits and burdens of holding
stock without taking physical possession of the shares.
[34] GAO, Tax Administration: Opportunities Exist for Improving IRS'
Administration of Alien Taxpayer Programs, [hyperlink,
http://www.gao.gov/products/GAO/GGD-88-54] (Washington, D.C.: Apr. 11,
1988).
[35] I.R.C. § 1441.
[End of section]
GAO's Mission:
The Government Accountability Office, the audit, evaluation and
investigative arm of Congress, exists to support Congress in meeting
its constitutional responsibilities and to help improve the performance
and accountability of the federal government for the American people.
GAO examines the use of public funds; evaluates federal programs and
policies; and provides analyses, recommendations, and other assistance
to help Congress make informed oversight, policy, and funding
decisions. GAO's commitment to good government is reflected in its core
values of accountability, integrity, and reliability.
Obtaining Copies of GAO Reports and Testimony:
The fastest and easiest way to obtain copies of GAO documents at no
cost is through GAO's Web site [hyperlink, http://www.gao.gov]. Each
weekday, GAO posts newly released reports, testimony, and
correspondence on its Web site. To have GAO e-mail you a list of newly
posted products every afternoon, go to [hyperlink, http://www.gao.gov]
and select "E-mail Updates."
Order by Phone:
The price of each GAO publication reflects GAO‘s actual cost of
production and distribution and depends on the number of pages in the
publication and whether the publication is printed in color or black and
white. Pricing and ordering information is posted on GAO‘s Web site,
[hyperlink, http://www.gao.gov/ordering.htm].
Place orders by calling (202) 512-6000, toll free (866) 801-7077, or
TDD (202) 512-2537.
Orders may be paid for using American Express, Discover Card,
MasterCard, Visa, check, or money order. Call for additional
information.
To Report Fraud, Waste, and Abuse in Federal Programs:
Contact:
Web site: [hyperlink, http://www.gao.gov/fraudnet/fraudnet.htm]:
E-mail: fraudnet@gao.gov:
Automated answering system: (800) 424-5454 or (202) 512-7470:
Congressional Relations:
Ralph Dawn, Managing Director, dawnr@gao.gov:
(202) 512-4400:
U.S. Government Accountability Office:
441 G Street NW, Room 7125:
Washington, D.C. 20548:
Public Affairs:
Chuck Young, Managing Director, youngc1@gao.gov:
(202) 512-4800:
U.S. Government Accountability Office:
441 G Street NW, Room 7149:
Washington, D.C. 20548:
