In recent years, the IRS has drastically increased the amount of audits for US tax filers living overseas, with an emphasis on refund filings from US citizens earning income in Israel. The IRS has a “shoot first” or “guilty until proven innocent” mentality, and will often send compliant tax filers a letter with an enormous sum of money as tax due. DO NOT BE AFRAID! These letters are the start of a process, not the end. XPAT provides full services to support our clients to achieve optimal results in audits. We work at all levels of bureaucracy, which includes the filing of petitions in United States tax court, or submitting an Offer in Compromise where appropriate. The IRS has the responsibility to ensure accurate and honest tax reporting by taxpayers, and the tax auditor’s job is to verify that the tax return is accurate.
The initial audit letter includes two important sections:
- Tax Adjustments. Form 4569 adjusts the various items on the tax return. The report will typically reverse any credits while leaving tax liabilities in place. Added to this will be an automatic 20% penalty plus interest. This typically results in a substantial tax bill. Remember, this is only an initial report and the adjustments, tax liabilities, penalties and interest can be reversed if the taxpayer complies with the Information Document Request to the satisfaction of the auditor. This approach can be summarized as “prove it or lose it”.
- Information Document Request. This form details the documents that the auditor demands in order to substantiate the credits that were initially reversed (as detailed above). Requested documents often include:.
Issues of particular scrutiny include:
- Citizenship: The IRS will scrutinize the date of citizenship of children claimed as tax dependents. If the child acquired citizenship after the tax year in question, then the IRS policy at this time is to disallow the child dependent.
- Earned income and foreign taxes paid: The “additional child tax credit” requires that the taxpayer report earned income to qualify for the refundable credit. The auditor will demand documentation to support the Line 7 entry of Form 1040. This can include annual wage summary from home country, pay slips, bank statements showing salary deposits and statements from the employer or employment contracts.
- Support of dependent children: The auditor will use documents such as the birth certificates, school records, utility bills and government ID cards to determine residence and support of the child dependents.