The Internal Revenue Service needs to beef up tax compliance efforts for nonresident aliens who earn money in the U.S., according to a new government report.

For tax year 2007, nonresident alien individuals filed about 634,000 Forms 1040NR, the U.S. Nonresident Alien Income Tax Return, according to a report from the Government Accountability Office. However, the IRS has not developed estimates for the extent of nonresident alien tax noncompliance because it often lacks enough information to distinguish between nonresident aliens and other filers. Examinations can be costly and difficult as many nonresident aliens depart the country before the IRS is able to examine their returns.

To date, the 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 the nonresident alien tax rules, according to representatives of groups that work with employers and nonresidents to help them fulfill their tax obligations.

Other filing challenges also exist. For example, individuals filing Forms 1040NR cannot file electronically. In addition, nonresidents who are in the U.S. for less than 90 days and who earn over $3,000 in compensation for services paid by a foreign employer will likely have to file Form 1040NR, even if they owe no tax. The $3,000 exemption threshhold, 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.

To be sure, the IRS has expanded its nonresident alien enforcement efforts over the past decade. However, the IRS does not have a program to automatically identify nonresident aliens who improperly file a Form 1040 instead of Form 1040NR, which can result in lost tax revenue when these taxpayers take disallowed deductions.

The IRS may be able to use taxpayer information to identify this type of noncompliance systematically. 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 sailing permit law dates back to 1921, requiring aliens who work in the U.S. to visit an IRS office before they depart the country to fill out forms and pay any taxes owed. But this 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.

Given the increasing extent of business travel to the U.S. and the eroding effects of inflation, the GAO noted that Congress may wish to 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. In addition, 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 may wish to consider eliminating the sailing permit requirement.

The GAO said the Commissioner of Internal Revenue should determine if creating an automated program to identify nonresident aliens who may have improperly filed Form 1040 instead of Form 1040NR by using Individual Taxpayer Identification Number information would be a cost-effective means to improve compliance.

The IRS generally agreed with the report’s recommendations and said it would look for improvements through both enforcement and outreach. “We agree to study the feasibility of an automated system to identify nonresident aliens who improperly file Form 1040 instead of Form 1040NR,” wrote IRS deputy commissioner for services and enforcement Steven T. Miller. “We will study whether information made available to us on filed returns or on ITIN applications can be effectively analyzed with such an automated system.”

The report was requested by Congressman Richard Neal, D-Mass., chairman of the House Subcommittee on Select Revenue Measures, who expressed misgivings about the IRS's outdated requirements. “Our tax laws should not be a deterrent to foreign business visitors to the U.S.," he said in a statement. "My state of Massachusetts hosts a number of international forums for athletes, business executives, and other professionals and we don’t want to welcome them by slipping a Form 1040 in their suitcase.”

His colleague, Rep. Shelley Berkeley, D-Nev., saw the report in terms of the effects on the Las Vegas economy of foreign visitors. “When high-level executives come from overseas to conduct business in Las Vegas, it is important we make it as easy and convenient as possible for them to comply with U.S. tax laws," she said. "This report highlights steps we can take to further improve the Las Vegas experience and prevent our visitors from overseas from thinking twice about spending their time and money here as a result of an outdated law. By assisting their compliance with our tax laws, the U.S. taxpayer will receive in full the dollars that our tax laws require overseas executives to pay.”

“Of course, we need to collect duly owed taxes from all who live and work in the U.S.," Neal added. "But the half-hearted collection from those who briefly visit the U.S. on business, many of whom are completely unaware of these laws, does not lead to overall compliance and confidence in the system.”

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