International Tax Enforcement in the United States

• Author: David Kerzner, David W. Chodikoff
• Pages: 135-180

135

chapter five

INTERNATIONAL TAX ENFORCEMENT IN

THE UNITED STATES

A INTRODUCTION

International tax enforcement may comprise an examination or investiga-

tion process, an enforcement or collections process, and, where warranted,

a criminal prosecution process. This chapter will be of particular interest

to professionals who work in wealth management, accounting, and law and

who have clients with of‌fshore or delinquent compliance issues concerning

the tax or foreign-reporting laws of the United States. It explains the do-

mestic administrative measures relied upon by the United States to obtain

foreign-based taxpayer information for the purpose of conducting a civil

audit or examination, or a criminal investigation. Without the ability to ver-

ify the foreign earned income of its citizens and residents, the United States

would not be able to ef‌fectively or fairly administer its tax system, which is

based on the taxation of worldwide income.1 Hence, the focus of this chap-

ter is on understanding the framework of legal powers granted to the f‌is-

cal authorities in the United States to obtain taxpayer information for the

administration and enforcement of their respective tax laws and to combat

non-compliance related to of‌fshore accounts, where this information is not

currently in the government’s possession, or is otherwise unobtainable from

an unwilling taxpayer or record holder. As the Supreme Court of the United

States observed in United StatesvArthur Young & Co,

1 See United States, Congress, Joint Committee on Taxation, Tax Compliance and Enforcement

Issues with respect to Of‌fshore Accounts and Entities (Washington, DC: Joint Committee on

Taxation, 2009) at 44 [JCT, Enforcement Issues].

136 •InternatIonal tax evasIon In the Global InformatIon aGe

Our complex and comprehensive system of federal taxation, relying as it

does upon self-assessment and reporting, demands that all taxpayers be

forthright in the disclosure of relevant information to the taxing authorities.

Without such disclosure, and the concomitant power of the Government to

compel disclosure, our national tax burden would not be fairly and equit-

ably distributed. In order to encourage ef‌fective tax investigations, Con-

gress has endowed the IRS withexpansive information-gathering authority;

§7602 is the centerpiece of that congressional design.2

An understanding of these administrative measures is critical to grasping

where tax information exchange agreements (TIEAs) and exchange of in-

formation (EOI) under double tax conventions (DTCs) f‌it into the infor-

mation-gathering process and to evaluating their functionality in f‌ighting

tax evasion against alternative tools. This chapter is also important to the

research in this book because it examines some of the legal, political, eco-

nomic, and social problems connected to the EOI process. Moreover, it illus-

trates the range of domestic powers that the IRS can use against a taxpayer or

third-party holder of information to inf‌lict potential civil and criminal sanc-

tions for failing to comply with its summons power, thereby creating serious

consequences for uncooperative parties. As Professor Gianni admonishes,

“since def‌iciencies asserted by the IRS are presumptively correct when liti-

gated, taxpayers usually lose more than they gain by dragging their feet when

asked for information.”3

This chapter begins by reviewing the privacy rights and safeguards of tax-

payers in the United States, including the vital interplay between these domes-

tic rules and the obligations of governments to exchange information under

TIEAs and DTCs. An understanding of these rights is important because, as

discussed below, taxpayer privacy is a cornerstone both to administering the

tax system domestically and to enabling ef‌fective EOI with treaty partners.

This chapter also examines, perhaps for the f‌irst time in this research f‌ield,

the use of criminal prosecution by the United States as a new means of bol-

stering EOI. Additionally, it examines the legal regime surrounding the use of

the summons powers, including the John Doe “super” summons power, to ob-

tain foreign-based information. The use of these two administrative measures

either as an alternative to treaty-based EOI mechanisms or in conjunction

with them serves to (1) illustrate how these measures dif‌fer from TIEAs and

2 465 US 805 at 815–16 (1984), cited in Monica Gianni, “IRS Investigative Authority” in Boris

Bittker & Lawrence Lokken, Federal Taxation of Income, Estates, and Gifts (Thomson Reuters/

WG&L) (Checkpoint) at 112.2.1 [Revised].

3 Gianni, above note 2.

International Tax Enforcement in the United States •137

(2) reveal underlying political and legal problems with EOI mechanisms. To

help illustrate the use of some of the tools being used to obtain foreign docu-

mentation, this chapter draws on the experience of the United States in ob-

taining foreign account information from UBS both under the United States’

tax treaty with Switzerland and through such unilateral measures as the John

Doe summons and the recent and new formalization of the threat of criminal

prosecution. The UBS case study highlights the legal, political, and economic

challenges that exist in the EOI f‌ield. And these challenges pose the broader

policy questions of whether EOI works without incentives (be they sanctions

or rewards) and whether one “policy size” (e.g., automatic exchange of infor-

mation) will be ef‌fective in the war on tax evasion for all players.

B PRIVACY RIGHTS AND SAFEGUARDS OF TAXPAYERS

The question of whether or not information regarding taxpayers in America

should be private is as old as the income tax itself.4 Present rules on tax privacy

provide that tax returns and tax return information are to be treated as con-

f‌idential and prohibit the release, subject to limited exceptions, of taxpayer

information by the federal government without the consent of the taxpayer.5

Taxpayer information that is to be treated as conf‌idential is broadly de-

f‌ined to include the following: a tax or information return, a taxpayer’s iden-

tity, the nature, source, or amount of a taxpayer’s income, payments, receipts,

deductions, exemptions, credits, assets, liabilities, net worth, tax liability, tax

withheld, def‌iciencies, overassessments, and tax payments, and any other

data received or collected by the Secretary of the Treasury (Secretary) with

4 See Joshua Blank, “In Defense of Individual Tax Privacy” (2012) 61 Emory Law Journal 265 at

267, quoting Boris I Bittker, “Federal Income Tax Returns—Conf‌identiality vs. Public Disclo-

sure” (1981) 20 Washburn Law Journal 479 at 480–81: when the income tax was f‌irst intro-

duced in 1862 to pay for the American Civil War, the statute required the names of taxpayers

and their liabilities to be open to public access. In this article, Professor Blank examines the

relationship between individual tax privacy and individual tax compliance, arguing that tax

privacy allows the government to inf‌luence individuals’ perceptions of its tax enforcement

strengths without exposing its weaknesses, which would become apparent without appropri-

ate measures of conf‌identiality.

5 Internal Revenue Code, USC 26 (1986) of 1986, as amended, and the Treasury Regulations

issued thereunder at §6103(a) [Code]. Section 6103, relating to tax return privacy, was rewrit-

ten by Congress in 1976 in part to address privacy concerns following the Watergate scandal:

see M Saltzman & L Book, IRS Practice and Procedure (Thomson Reuters/WG&L, 2012 ed)

(Checkpoint) ch 2B and 4C. Although the Privacy Act of 1974, 5 USC ch 5 §552a, provides cer-

tain safeguards against the invasion of personal privacy, Code, ibid, §6103 expressly regulates

the disclosure of tax return information (Saltzman & Book, ibid, ch 2B). Exceptions to the

general rule of IRS non-disclosure may be made for a variety of reasons involving tax admin-

istration and law enforcement: see Code, ibid, §§6103(c)–(o); Blank, above note 4 at 279.