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IRS Announces Five New Campaigns

Yesterday, the Large Business and International Division (“LB&I”) of the IRS announced five new compliance campaigns. This is in addition to the 40 previously announced campaigns discussed here.

The new campaigns are:

Individual Foreign Tax Credit Phase II

“Section 901 of the Internal Revenue Code alleviates double taxation through a dollar-for-dollar credit against U.S. tax on foreign-sourced income in the amount of foreign taxes paid on that income.

Individuals who meet certain requirements may qualify for the foreign tax credit. This campaign addresses taxpayers who have claimed the credit but do not meet the requirements. The IRS will address noncompliance through a variety of treatment streams, including examination.”

Offshore Service Providers

“The focus of this campaign is to address U.S. taxpayers who engaged Offshore Service Providers that facilitated the creation of foreign entities and tiered structures to conceal the beneficial ownership of foreign financial accounts and assets, generally, for the purpose of tax avoidance or evasion. The treatment stream for this campaign will be issue-based examinations.”

FATCA Filing Accuracy

“The Foreign Account Tax Compliance Act (FATCA) was enacted in 2010 as part of the HIRE Act. The overall purpose is to detect, deter and discourage offshore tax abuses through increased transparency, enhanced reporting and strong sanctions. Foreign Financial Institutions and certain Non-Financial Foreign Entities are generally required to report the foreign assets held by their U.S. account holders and substantial U.S. owners under the FATCA. This campaign addresses those entities that have FATCA reporting obligations but do not meet all their compliance responsibilities. The Service will address noncompliance through a variety of treatment streams, including termination of the FATCA status.”

1120-F Delinquent Returns Campaign

“The objective of the Delinquent Returns Campaign is to encourage foreign entities to timely file Form 1120-F returns and address the compliance risk for delinquent 1120-F returns. This is accomplished by field examinations of compliance risk delinquent returns and external education outreach programs. The campaign addresses delinquent-filed returns, Form 1120-F U.S. Income Tax Return of a Foreign Corporation.

Form 1120-F must be filed on a timely basis and in a true and accurate manner for a foreign corporation to claim deductions and credits against its effectively connected income. For these purposes, Form 1120-F is generally considered to be timely filed if it is filed no later than 18 months after the due date of the current year’s return. The filing deadline may be waived, in situations based on the facts and circumstances, where the foreign corporation establishes to the satisfaction of the commissioner that the foreign corporation acted reasonably and in good faith in failing to file Form 1120-F per Treas. Reg. Section 1.882-4(a)(3)(ii). LB&I Industry Guidance 04-0118-007 dated 2/1/2018 established procedures to ensure waiver requests are applied in a fair, consistent and timely manner under the regulations.”

Work Opportunity Tax Credit

“The IRS has agreed to accept the Work Opportunity Tax Credit (WOTC) year of credit eligibility issue into the Industry Issue Resolution (IIR) program (pursuant to Rev. Proc. 2016-19). This campaign addresses the consequences of WOTC certification delays and the burden of amended return filings. The campaign’s objective is to collaborate with industry stakeholders, Chief Counsel, and Treasury to develop an LB&I directive for taxpayers experiencing late certifications and to promote consistency in the examinations of WOTC claims.

Due to delays associated with the WOTC certification process, taxpayers are often faced with the burdensome requirement of amending multiple years of federal and state returns to claim the WOTC in the year qualified WOTC wages were paid. This requirement, coupled with any resulting examinations of this issue, is an inefficient use of both taxpayer and IRS resources. The IIR is intended to provide remedies to reduce taxpayer burden, promote consistency, and decrease examination time to most effectively use IRS resources.”

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As with the other campaigns, if you are a corporate taxpayer under LB&I’s jurisdiction and your return involves identified issues, it would be advisable to anticipate an audit and act accordingly.

 

 

IRS Announces Five New Campaigns

Yesterday, the Large Business and International Division (“LB&I”) of the IRS announced five new compliance campaigns.  This is on top of the 35  previously announced campaigns and discussed here.

The new campaigns are:

Restoration of Sequestered AMT Credit Carryforward Practice

“LB&I is initiating a campaign for taxpayers improperly restoring the sequestered Alternative Minimum Tax (AMT) credit to the subsequent tax year. Refunds issued or applied to a subsequent year’s tax, pursuant to IRC Section 168(k)(4), are subject to sequestration and are a permanent loss of refundable credits. Taxpayers may not restore the sequestered amounts to their AMT credit carryforward. Soft letters will be mailed to taxpayers who are identified as making improper restorations of sequestered amounts. Taxpayers will be monitored for subsequent compliance. The goal of this campaign is to educate taxpayers on the proper treatment of sequestered AMT credits and request that taxpayers self-correct.”

S Corporation Distributions

“S Corporations and their shareholders are required to properly report the tax consequences of distributions. We have identified three issues that are part of this campaign. The first issue occurs when an S Corporation fails to report gain upon the distribution of appreciated property to a shareholder. The second issue occurs when an S Corporation fails to determine that a distribution, whether in cash or property, is properly taxable as a dividend. The third issue occurs when a shareholder fails to report non-dividend distributions in excess of their stock basis that are subject to taxation. The treatment streams for this campaign include issue-based examinations, tax form change suggestions, and stakeholder outreach.”

Virtual Currency

“U.S. persons are subject to tax on worldwide income from all sources including transactions involving virtual currency. IRS Notice 2014-21 states that virtual currency is property for federal tax purposes and provides information on the U.S. federal tax implications of convertible virtual currency transactions. The Virtual Currency Compliance campaign will address noncompliance related to the use of virtual currency through multiple treatment streams including outreach and examinations. The compliance activities will follow the general tax principles applicable to all transactions in property, as outlined in Notice 2014-21. The IRS will continue to consider and solicit taxpayer and practitioner feedback in education efforts, future guidance, and development of Practice Units. Taxpayers with unreported virtual currency transactions are urged to correct their returns as soon as practical. The IRS is not contemplating a voluntary disclosure program specifically to address tax non-compliance involving virtual currency.”

Repatriation via Foreign Triangular Reorganizations

“In December 2016, the IRS issued Notice 2016-73 (“the Notice”), which curtails the claimed “tax-free” repatriation of basis and untaxed CFC earnings following the use of certain foreign triangular reorganization transactions. The goal of the campaign is to identify and challenge these transactions by educating and assisting examination teams in audits of these repatriations.”

Section 965 Transition Tax

“Section 965 requires United States shareholders to pay a transition tax on the untaxed foreign earnings of certain specified foreign corporations as if those earnings had been repatriated to the United States. Taxpayers may elect to pay the transition tax in installments over an eight-year period. For some taxpayers, some or all of the tax will be due on their 2017 income tax return. The tax is payable as of the due date of the return (without extensions).”

As with the other campaigns, if you are a corporate taxpayer under LB&I’s jurisdiction and your return involves identified issues, it would be advisable to anticipate an audit and act accordingly.

 

 

The Ninth Circuit Holds Equitable Recoupment Not Time-Barred

In a taxpayer win, the Ninth Circuit recently reversed the Tax Court and held equitable recoupment was not time barred.  Revah v. Comm’r, No. 11-70211 (9th Cir. Sept. 17, 2014) (unpublished opinion).  Relying on longstanding precedent, the Ninth Circuit held the taxpayers were not statutory barred from applying for equitable recoupment because it’s permitted even with respect to an untimely refund claim.  Thus, even though the taxpayers failed to timely file their refund claims, “untimeliness is not a ground upon which the tax court may deny equitable recoupment.”  Id.

Equitable recoupment is a judicial doctrine that applies where one transaction or event is subject to two taxes based on inconsistent theories.  The equitable recoupment doctrine “allows a litigant to avoid the bar of an expired statutory limitation period” and “prevents an inequitable windfall to a taxpayer or to the Government that would otherwise result from the inconsistent tax treatment of a single transaction, item, or event affecting the same taxpayer or a sufficiently related taxpayer.”  Menard, Inc. v. Comm’r, 130 T.C. 54, 62 (2008).  To establish equitable recoupment a taxpayer must prove: (1) the overpayment or deficiency for which recoupment is sought by way of offset is barred by an expired period of limitation, (2) the time-barred overpayment or deficiency arose out of the same transaction, item, or taxable event as the overpayment or deficiency before the Court, (3) the transaction, item, or taxable event has been inconsistently subjected to two taxes, and (4) if the transaction, item, or taxable event involves two or more taxpayers, there is sufficient identity of interest between the taxpayers subject to the two taxes that the taxpayers should be treated as one.  Id. at 62-63.  In practice, taxpayers often have difficulty mounting arguments of equitable recoupment against the IRS, although the Government typically has more success in this area.

The IRS audited and made adjustments to the Revahs’ 1999 and 2000 tax returns related to inventory and bad debt, and resulting in a decrease in the net operated losses the taxpayers reported on their 1997 and 1998 returns.  The taxpayers accepted the adjustments assuming that, as the examiner acknowledged, they would be able to reduce income in 2001 through amended returns.  After the exam and in 2005, the taxpayers filed amended returns in accordance with the examiner’s adjustments, but the refund claims were denied as untimely.  The taxpayers petitioned the Tax Court for relief asserting the equitable recoupment doctrine.  The Tax Court (Judge Cohen) found the taxpayers’ inability to use the NOLs to reduce tax liabilities was not the result of the inequitable application of inconsistent theories of taxation contemplated by the equitable recoupment doctrine, and thereby denied the petition.  The Ninth Circuit reversed and remanded in favor of the doctrine’s application, illustrating that there is hope for future taxpayers seeking to offset current IRS liabilities with past credits under the doctrine.

Can the IRS Circumvent U.S. Law by Issuing a Treaty Request?

Shortcuts to identifying the “soft spots” of a tax return have long tempted the IRS. Those shortcuts are generally quite controversial and have included the aggressive use of penalties to force a reasonable cause defense and the resulting disclosure of privileged materials and, as another example, transparency programs such as Schedule UTP that arguably strain the credibility of the IRS’s policy of restraint with regard to tax accrual workpapers. More recently, with the increasing prevalence of complex, cross-border transactions having multi-jurisdictional tax consequences, there is often a paper trail of tax analysis strewn around the world that is providing the IRS with a new temptation. Would the IRS be tempted to quietly make a treaty request in an attempt to circumvent U.S. privilege protections and obtain the materials without the fuss of a privilege fight? Unfortunately, the IRS and foreign taxing authorities have succumbed to this temptation, and it is something that practitioners should be aware of. The propriety of any such request must be carefully scrutinized and the appropriate interventions should be considered.

Indeed, the IRS has used treaty requests in lieu of following the administrative summons process (as well as its own internal directives) in order to bypass procedural safeguards for the taxpayer to attempt to obtain privileged and protected documents that would otherwise be unavailable to the IRS under U.S. law. This premature and improper use of treaty requests violates two core principles contained in most bilateral tax treaties, and in articles 18-26 of the Convention on Mutual Administrative Assistance in Tax Matters and article 26 of the OECD Model Tax Convention and its Commentary.

First, the issuance of a treaty request to circumvent domestic law is improper and objectionable because the requested nation is not obligated to employ procedures or obtain information that is at variance with or not obtainable under the laws of either country. This means that, for example, where the U.S. issues a treaty request, the same procedural safeguards that exist in the U.S. would also effectively be available with respect to the request. Additionally, the privileges and protections that exist in the requested country also apply. Under U.S. law, the IRS has broad authority to issue a summons for the production of documents or testimony relevant to the purpose of ascertaining the correctness of a return or determining the liability of any person or any internal revenue tax. But the IRS is subject to specific limitations. Significantly, pursuant to United States v. Powell, 379 U.S. 48 (1964), a summons is not enforceable unless it is (1) issued for a legitimate purpose; (2) the material sought is relevant to that purpose; (3) the information sought is not already within the possession of the IRS; and (4) the administrative steps required by the Internal Revenue Code have been followed. Further, the IRS is limited to materials in the possession, custody, and control of the summonsed party and is not entitled to documents that are privileged or protected under U.S. law, including the attorney-client privilege, attorney work product protection, and the privilege against self-incrimination. A requested nation will not employ measures to circumvent these U.S. laws. As noted in the OECD Commentary, one nation cannot take advantage of its treaty partner’s information system merely because it is wider than its own. Thus, a treaty request at variance with the U.S. law, including those discussed above, should be denied.

Second, the issuance of a treaty request before exhausting domestic measures is a clear violation of the international authorities and is grounds for rejection of a request. Under U.S. law, a summons is not self-enforcing. Instead, if the summonsed party fails to comply with the summons, the U.S. government must bring an enforcement action in the appropriate federal district court. And, both the taxpayer and the recipient of a summons have the right to protest the enforcement of a summons by filing a petition to quash in federal district court. The administrative summons procedures thereby provide the prerequisite mechanisms for a court to review the legitimacy of the summons and/or whether the claims of privilege are well-founded. The IRS cannot circumvent a taxpayer’s privileges or right to have a court review these claims by simply pursuing the documents through a treaty request because a request made prior to exhausting the domestic administrative summons procedures should be denied.

The premature and improper issuance of a treaty request merely shifts the burden of potentially protracted and costly disputes to a foreign nation, attempting to force the foreign nation to interpret and decide U.S. law. In addition to the potentially resulting prejudice against the rights of the taxpayer, this shifting aspect is itself clearly an inappropriate imposition on a treaty partner. See article 26 of the OECD Model Tax Convention and its Commentary. Treaty partners are usually quite receptive to these arguments by the objecting taxpayer in intervention proceedings.

IRS Announces Third Special Offshore Voluntary Disclosure Initiative

The Internal Revenue Service (IRS) announced on January 9, 2012 that it has reopened its voluntary disclosure initiative for the third time, in response to the US government’s continuously widening investigation of foreign banks relating to unreported offshore accounts of US persons. This third special disclosure initiative follows the IRS’s 2009 and 2011 Offshore Voluntary Disclosure Programs (OVDPs) and is available to those taxpayers who did not file in time for the 2009 or 2011 OVDPs. As in the past the OVDPs are designed to bring offshore money back into the US tax system and help individuals with undisclosed income from hidden offshore financial accounts get current with their taxes. This program allows individuals with previously unreported foreign financial accounts to significantly reduce their exposure to substantial civil tax penalties and, in many cases, to eliminate the possibility of criminal prosecution. Foreign accounts include assets held in offshore trusts, foundations, corporations and other entities.

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“Strategies for Managing Parallel Proceedings with Fifth Amendment Implications,” Inside the Minds: Strategies for Criminal Tax Cases

The DOJ Tax Division has long recognized the efficacy of parallel criminal and civil proceedings and actively pursues them in its current endeavor at increased enforcement. Parallel proceedings often present complicated issues that create additional challenges for taxpayers and their attorneys. When a parallel proceeding is pending, the invocation of the Fifth Amendment by either the taxpayer, a tax advisor, or other non-party witness can create adverse implications in a subsequent proceeding.  Taxpayers and their attorneys must carefully navigate the risk of an adverse inference against the taxpayer under the circumstances of the particular case.  The well-informed attorney can prepare to face all of these issues and effectively navigate the specific facts of his or her case.  The following discussion will explain and analyze: the effect of a party’s invocation in independent proceedings, the effect of a party’s invocation in parallel proceedings, the implications of a non-party’s invocation, and whether an invoker can waive the privilege and later testify.

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