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IRS Announces 13 Campaigns – New Focus

The Large Business and International division of the IRS has restructured its approach to examinations.  Yesterday, it released its list of 13 focus areas for issue- based examinations and concerns for compliance.   One of those areas involves the IRS Offshore Voluntary Disclosure Program.  Entitled, “OVDP Declines-Withdrawals Campaign,” this area of focus involves taxpayers who have applied for the offshore voluntary disclosure program through the pre-clearance process, but were either denied access to the program or withdrew from the program.

What happens next?  “The IRS will address continued noncompliance through a variety of treatment streams including examination.”  Examining those taxpayers who could not enter the program, because they are under civil audit, criminal investigation, or the IRS is otherwise aware of the account(s) at issue in the disclosure, is expected. Further, those who violated the law intentionally might expect a criminal tax investigation or possible referral for prosecution, depending on the circumstances and reasons for denial into the program.

We have seen an uptick in audits and FBAR inquiries associated with taxpayers who have not come forward, and certainly anyone who opts-out of the OVDP program is subject to an immediate audit of their tax returns and FBAR filings.  “Making this effort a ‘campaign’ certainly raises the awareness of the programs and need to quickly come into compliance and assures that resources are available to support the audits and other investigations,” says Jim Mastracchio, Co-Chair of Dentons National Tax Controversy Practice.

Fast Track Settlements for Collection Cases

Late last year the IRS issued guidance on Fast Track settlement procedures for collection cases.  The goal of the process is to provide resolution of disputed issues within 30-40 calendar days.  Generally, issues involving an offer-in-comprise or trust fund recovery penalties can be brought before an Appeals mediator.  The new program is called SB/SE Fast Track Mediation- Collection (FTMC) and should provide a meaningful avenue to resolve differences.  Ultimate settlement authority continues to reside with Collections and not with IRS Appeals.  See guidance at Rev. Proc 2016-57.

2017 US Tax Filing News

As we head into a new year, some tax reporting news to keep in mind.  The first day that you can file your 2016 US individual income tax return by paper or by electronic submission is January 23, 2017.  The regular filing season ends April 18, 2017, as April 15 falls on a Saturday and Monday, April 17 is Emancipation Day observed in Washington, DC.

While we expect tax law changes to be announced in 2017, here are some current standard dollar limits:   Start of the Top Tax Bracket for joint filers (39.6%)  –  $466,950 (2016); $470,700 (2017); Gift Tax Annual Exclusion  $14,000 (2016 and 2017); Personal Exemptions $4,050 (2016 and 2017).

And don’t forget, those with foreign accounts or signatory authority over non-US accounts must file the FBAR (FinCEN Form 114) on the due date of the US Income tax return.  If you seek an extension for your income tax return you can seek an extension to file the FBAR.  Other rules apply to U.S. persons residing outside of the United States.  We will keep you posted on these and other new tax developments as they arise in what will be a busy tax news year.




Israel Cleared to Implement FATCA and Report on U.S. Persons

A recent decision by the Israeli Supreme Court has cleared the way for FATCA implementation by lifting a temporary injunction on the disclosure of information to U.S. authorities under Israel’s intergovernmental agreement (IGA). In connection with the decision, the Israeli government has agreed to give individual taxpayers at least thirty days to object to the inclusion of their information in data transferred to U.S. authorities under the IGA.

The government also agreed to delay the implementation of the IGA to September 30, 2016. Israeli financial institutions now have until September 20, 2016, to provide the Israeli Tax Authority with the required data on U.S. taxpayers. This is a notable development in Israel where, reportedly, as much as five percent of the population – upwards of 300,000 people – holds U.S. citizenship.

The decision arose from Republicans Overseas-Israel, et al. v. Israel, et al, where the plaintiffs challenged the constitutionality of FATCA implementation under Israeli law, claiming that the IGA’s required reporting to U.S. authorities violated Israel’s sovereignty. Earlier in September, the Israeli Supreme Court issued a temporary injunction preventing the disclosure of financial information to U.S. authorities under the IGA. In its more recent decision, however, the Court rejected the challenge to Israeli sovereignty and analyzed the claim as an issue of privacy. The Court considered whether the privacy of U.S. taxpayers was being infringed and, if so, whether the harm was reasonable. It assumed that there was some infringement on privacy, but found that the privacy concerns were outweighed by the need for Israel to abide by its agreement to provide international financial cooperation, and that Plaintiffs failed to show that the State did not limit the impact on privacy as much as was possible.

For those U.S. persons with Israeli bank accounts who have yet to come into compliance with U.S. tax filings, there is little time remaining. The IRS has announced a series of voluntary disclosure programs and options, some of which can give rise to zero penalties. Should you have questions regarding this post or the IRS disclosure options, please contact Jim Mastracchio (james.mastracchio@dentons.com) or Jennifer Walrath (jennifer.walrath@dentons.com).

Taxpayers Putting Pressure On Courts to Establish The IRS’s Burden Of Proof In Offshore Disclosure Cases

Recently, the U.S. Fifth Circuit Court of Appeals, in Bernard Gubser v. IRS, et al., was asked to overturn a recent U.S. District Court’s decision. The case involved the appropriate burden of proof the Internal Revenue Service (IRS) must meet when the IRS asserts a willful failure to file penalty for the Report of Foreign Bank and Financial Accounts (FBAR). At issue is whether the IRS must meet a clear and convincing evidence standard to establish willfulness or whether the appropriate measure is the lower preponderance of the evidence level of proof.

The District Court’s dismissed the initial suit for lack of standing. A group of taxpayers filed an amici curiae brief with the Fifth Circuit urging the Court to reverse the District Court’s decision due to the perceived harm that the uncertainty of the burden of proof could cause taxpayers who made an error in failing to file the FBAR, but who believe their oversight was not willful. This comes at a time when an unprecedented number of District Court cases will be filed for FBAR violations due to the inability of many taxpayers to achieve relief through the IRS Appeals process.

The Tax Court Rejects the IRS’s Section 6901 Analysis

On May 29, 2014, the Tax Court, in a division opinion, decided another transferee liability case in favor of the taxpayers.  See Swords Trust v. Commissioner, 142 T.C. No. 19 (2014). In Swords, the taxpayers (which were four separate trusts) together owned all the outstanding shares of stock in a C corporation, Davreyn.  Davreyn was a personal holding company that owned a substantial amount of stock in Reynolds Metal (which produced the popular aluminum foil brand, Reynolds Wrap).  Prior to the transaction at issue, Reynolds Metal merged with Alcoa, Inc., another aluminum company, and Davreyn’s existing Reynolds Metal stock was converted into shares of Alcoa stock.

Sometime in 2000, the taxpayers’ accountant learned about an opportunity for shareholders of a personal holding company to sell their appreciated stock to a financial buyer in a tax-efficient manner.  The taxpayers eventually agreed to enter into such proposed stock sale and on February 15, 2001, the taxpayers executed a stock purchase agreement wherein the taxpayers sold all of their stock in Davreyn to Alrey Trust (an entity that was affiliated with the investment banking firm, Integrated Capital Associates or ICA).  Unbeknownst to the taxpayers, Alrey Trust immediately liquidated Davreyn and then sold the Alcoa stock.  On its tax return, Alrey Trust reported a substantial gain on the subsequent sale of the Alcoa stock and offset such gain with an artificial loss that was generated from a Son-of-Boss transaction.

After assessing substantial tax liabilities against Alrey Trust and Davreyn—both to no avail—the IRS proceeded to attempt to collect Davreyn’s unpaid tax liability from the taxpayers, as transferees of Davreyn’s assets.  The IRS argued that a two-step analysis applies in determining whether the taxpayers, as transferees, are liable under Section 6901 for Devreyn’s unpaid taxes:  (1) analyze whether the subject transactions are recast under Federal law, which in Swords was primarily the Federal substance over form doctrine, and then (2) apply State law to the transactions as recast under Federal law.  Of course, to anyone familiar with transferee liability cases, this argument should not come as a surprise—it has functioned as the constant mantra of the IRS in several prior transferee liability cases.  Even though the First, Second and Fourth Circuit Courts had all recently rejected this argument, the IRS found itself once again in front of the Tax Court reiterating its Section 6901 argument.  See Diebold Found., Inc. v. Commissioner, 736 F.3d 172, 184-185 (2d Cir. 2013); Sawyer Trust of May 1992 v. Commissioner, 712 F.3d 597, 604-605 (1st Cir. 2013); Starnes v. Commissioner, 680 F.3d 417, 428-429 (4th Cir. 2012).  This time though, the Tax Court explicitly rejected the IRS’s proposed two-step analysis.  As the Fourth Circuit held in Starnes, the question of whether a transfer occurred for purposes of Section 6901 is separate from the question of whether the transfer was fraudulent for state law purposes.  See Starnes, 680 F.3d at 428-429.  Accordingly, the Tax Court found that Section 6901 requires that the court apply state (rather than Federal) law to determine whether a transaction is recast under a substance over form (or similar) doctrine.

The IRS argued alternatively that the applicable state law, Virginia, has a substance over form doctrine that applies to recast the series of transaction as one transfer between each of the taxpayers and Davreyn.  Again, the Tax Court disagreed, finding that the IRS “has left us unpersuaded that the Supreme Court of Virginia would apply a substance over form analysis to the present setting.”  Swords, 142 T.C. *15.  The IRS had not identified an adequate Virginia case wherein the court applied a substance over form or similar doctrine.  Moreover, even if such an analysis would apply in Virginia, the Tax Court was unpersuaded that the taxpayers or their representatives had the requisite actual or constructive knowledge of Alrey Trust’s plans to sell the Alcoa stock and to illegitimately avoid any resulting tax liability.  The Tax Court concluded that the transaction was in form and substance a sale of stock and that the transaction should not be recast as a sale of assets followed by a liquidating distribution.  After analyzing the transaction in light of Virginia’s actual fraud statute, constructive fraud statue and trust fund doctrine, the Tax Court found that the IRS failed to establish an independent basis under Virginia state law for holding the taxpayers liable for Davreyn’s unpaid tax.  Accordingly, Section 6901 did not apply to this case.

IRS Granted Considerable Latitude to Delay Payment of Tax Refunds

A recent Fifth Circuit opinion, El Paso CGP Co., L.L.C. v. United States, illustrates that the IRS’s authority under the Code’s mitigation rules is, at least in the Fifth and Third Circuits, construed broadly.  Acknowledging the general rule that a closing agreement with the IRS prevents the IRS from reopening a year included in that agreement, the Fifth Circuit’s opinion—overall, favorable to the IRS—turns upon the exceptions to this general rule found in the Code’s mitigation rules, which allow the IRS to reopen a closed tax year through an assessment within one year of a closing agreement.  However, the Fifth Circuit offered a taxpayer-friendly interpretation of the variance doctrine, which generally provides that in a refund suit, a taxpayer may not raise a ground for recovery which was not previously set forth in the taxpayer’s administrative refund claim.

As is the case in many tax cases, this dispute involved a much earlier tax year—here, 1986.  On a company’s 1986 tax return, the company claimed various tax credits, which exceeded the allowable amount for that year.  As a result, the company carried some of those credits forward to 1987 through 1990.  After an IRS audit of the 1986 tax return, the IRS disallowed some of the credits and increased the company’s liabilities for 1986 – 1990, which the company later paid.

Several years later, the IRS and the company executed a Form 870-AD (“Offer to Waive Restrictions on Assessment and Collection of Tax Deficiency and to Accept Overassessment”), in which the company agreed to the assessment and collection of a tax deficiency for 1986 but reserved the right to file a claim for refund.  The company later exercised this right and filed an approximately $18 million refund claim, primarily attributable to replacing the disallowed tax credits with other tax credits which the company originally had carried forward to later years.  This action, however created tax deficiencies for 1987 through 1990.

In July 2005, the IRS and the company agreed on the amounts of liability owed or refund due for each of the 1986 through 1990 taxable years and entered a “Closing Agreement”.  Pursuant to the Closing Agreement the company was owed a refund for 1986 and had deficiencies for 1987 – 1990.

In September 2005, the IRS made only a partial payment of the agreed-upon refund due for 1986.  The IRS asserted that the remaining portion would be used to satisfy the deficiencies for 1987 – 1990.  In August 2006, the company sought from the IRS a refund the remaining amount for 1986, asserting that the IRS had failed to assess deficiencies within the applicable one-year statute of limitations.  The company further asserted that the IRS was precluded from collecting deficiencies from 1987 – 1990 because the IRS failed to follow the mitigation rules.  The IRS denied the refund claim, and the company filed a refund suit in district court.

The district court granted summary judgment to the Government.  First, the district court held that it lacked jurisdiction because the refund suit was not based on a valid administrative refund claim.  The district court reasoned that the administrative refund claim was disposed of by the Closing Agreement.   As another basis for holding that it lacked jurisdiction, the district court concluded that the refund suit violated the variance doctrine because the grounds for recovery in the refund suit varied from the grounds in the original administrative refund claim.  The company appealed.

Stating that courts “have not always been so dogmatic in applying” the variance doctrine, the Fifth Circuit disagreed with the district court and concluded that it had jurisdiction over the refund suit.  The Fifth Circuit noted that there is an exception from the variance doctrine where, as in this case, the Government’s “unilateral action creates the substantial variance.”  The court further stated that the Government “cannot use the variance doctrine to straightjacket the taxpayer when the Government unexpectedly changes its litigation strategy.”

It was not all bad news for the Government though.  Although the court concluded that the IRS had failed to assess tax within the applicable period of limitations, the court concluded the IRS had complied with the mitigation rules (i.e., which allowed the IRS to reopen the closed tax years).

The court rejected a contention from the company that each tax year must be treated separately and followed an approach taken by the Third Circuit.  Pursuant to that approach, the court reasoned that the separate-tax-year concept should not apply where the parties reach an agreement, such as the Closing Agreement, that permits the IRS to pay out or recover a sum attributable to multiple years.  Accordingly, the court held that when a taxpayer enters into a closing agreement with the IRS, the IRS can comply with the mitigation rules by “assessing and collecting” any net deficiency from the years covered by the Closing Agreement (or, alternatively, by  “refunding or crediting” a net overpayment).

This approach essentially allows the IRS to take a piecemeal approach to resolving a taxpayer’s liability after entering a Closing Agreement and affords the IRS another “bite at the apple,” even after statutes of limitations for assessment are arguably closed—which could substantially delay closure of a tax dispute and payment of a refund.