Nonresident Aliens’ Ability to Receive Credit for Certain Taxes Withheld at Source Continues to Be Jeopardized

Imagine how you would feel if you were expecting your tax refund to arrive imminently, and checked the mailbox or your bank account day after day, only to be disappointed. Finally, you receive the hoped-for letter from the IRS, which you open eagerly. Disappointed to find no refund check enclosed, you read a letter that in part says, “We’re holding the portion of your refund that relates to the withholding credit you claimed…while we review it. Our review can take up to 6 months from the date we received your return or the due date of the return, whichever is later.”

In dismay, you begin the long wait. Eventually, you receive the letter you have been looking for, again minus a refund check. This time, the accompanying letter in essence says that your refund is being withheld because the specified information provided on your return does not match the information provided to the IRS by your withholding agent. The letter goes on to explain that unless you made the error and can correct it on an amended return, you must contact the withholding agent and have them remedy it on their end.

It so happens that the error in question was made on an information report sent to the IRS by a third-party payroll processing company and it takes you a good deal of time and effort to figure out how to get in touch with the company, and then find someone to speak with about your issue. When you finally do so, you learn, to your frustration, that the company is not terribly interested in your situation, or in fixing the problem. The company gives you a number of explanations and excuses that, in the end, boil down to the message that they are simply not going to amend their information report.

In disbelief at the entire situation, you contact the IRS and ask what to do next. Again, you come up against a brick wall and no progress is made toward resolution of the issue. Eventually, you come to understand that all you can do is contact my office, the Taxpayer Advocate Service, for assistance, go to the IRS Office of Appeals to present your case, or take the matter to court. Some of these approaches will cost money for representation and all of them will involve continued delay and uncertainty regarding whether you will ever recover the money that you earned and that was withheld from your paycheck on behalf of the IRS.

Although this scenario sounds like an excerpt from a dystopian short story, it is precisely what thousands of nonresident aliens have been experiencing over the last few years. I have expressed deep concerns about this problem in several of my Annual Reports to Congress, but unfortunately it continues to exist. Although the number of taxpayers affected has been reduced because, as I suggested in my recommendations, the IRS has done a better job of limiting the population of tax credits being frozen, thousands of taxpayers per year are still subject to this fate.

In January 2015, the IRS began freezing credits claimed on Forms 1040NR, U.S. Nonresident Alien Income Tax Return, associated with Forms 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding. The IRS did so based on concerns regarding potential fraud. Nevertheless, the IRS took this drastic measure without any comprehensive statistical data establishing the existence and nature of widespread fraud or noncompliance with respect to these credit claims. My own researchers have analyzed two different sets of data, both of which indicate that taxpayers seeking Form 1042-S credits are actually more compliant with their tax obligations than the overall group of Form 1040 taxpayers.

Nevertheless, the freezes were implemented and the IRS’s Large Business & International operating division (LB&I) decided to develop its own semi-automated system for matching the Forms 1042-S issued by withholding agents against the data provided by taxpayers on their Forms 1040NR. LB&I did this even though the Wage & Investment division (W&I) had already developed an automated program that it uses to match Forms W-2, Wage and Tax Statement, and Forms 1099 against information provided on tax returns in the domestic context. Although the W&I system has its flaws, and could benefit from some fine tuning, LB&I spent millions of dollars starting from scratch in an attempt to create its own mechanism. Ultimately, that semi-automated matching tool failed to work effectively and chaos ensued. Over one hundred thousand taxpayers had their credits frozen and eventually LB&I had no choice but to discontinue use of the semi-automated matching tool. In June of 2016, the IRS made the decision to issue all refunds associated with the credits.

Much of the outcry has diminished because the IRS is now more selective regarding the Form 1042-S freezes it imposes. Nevertheless, the same underlying problems still remain. LB&I continues to operate without any automated matching capacity and to undertake manual reviews of Forms 1042-S against taxpayers’ Forms 1040NR. While this manual review is slowly taking place, impacted taxpayers must sit and wait for their refunds to arrive, hoping that withholding agents did not make any errors, which may or may not be correctible later.

TAS was invited to attend meetings of a cross-functional Form 1042-S verification team established to examine the program adopted by LB&I and to recommend procedural and systemic improvements. This team made some effective recommendations that helped resolve a number of real problems in this area. Further, participation in the team gave my office additional insight into the existing problems and a voice in the policy decisions being developed. Nevertheless, without any explanation to TAS, the Form 1042-S verification team simply stopped meeting several months ago. The team’s work did not seem to be finished—at least the existing problems have by no means been resolved—but, for some reason, this particular vehicle for progress is no longer operational.

Likewise, the IRS Commissioner established an Executive Steering Committee (ESC) to oversee implementation of the Foreign Account Tax Compliance Act (FATCA). Among other things, the FATCA ESC considered issues associated with the Form 1042-S matching program and received regular updates on related problems and potential resolutions. This committee, in which TAS participated, recently was disbanded even though some FATCA-related issues and risks are still unresolved. Instead, they will now be addressed only in the normal course of business by the new FATCA Governance Board comprised of LB&I and IT executives. However, the Governance Board will operate without the benefit of oversight from the top IRS executives and the National Taxpayer Advocate. While there may have been legitimate reasons to end the FATCA ESC, I am concerned about the lack of urgency to find a solution for the problems that plague the Form 1042-S matching program and the taxpayers who are victimized by its failure to function smoothly.

The shortcomings in the Form 1042-S matching program not only disproportionately disadvantage a highly compliant group of taxpayers, but waste scarce IRS resources. My office will continue to monitor issues in this area and advocate for affected taxpayers. You can read more about these issues in Most Serious Problem: The IRS’s Approach to Credit and Refund Claims of Nonresident Aliens Wastes Resources and Burdens Compliant Taxpayers in my 2017 Annual Report to Congress.