IRS Targeting Post-Voluntary Disclosure Compliance With New Campaign

Recently, the IRS announced that it was targeting individual taxpayers who previously participating in its Offshore Voluntary Disclosure Program (“OVDP”) to check and see if they were still in compliance with their foreign income and asset reporting obligations.

U.S. persons generally owe taxes on their worldwide income and pursuant to the Foreign Account Tax Compliance Act (“FATCA”) must disclose their assets held abroad every year. Failure to either pay the appropriate amount of taxes or disclose foreign assets may subject a taxpayer to penalties and in particularly egregious cases, criminal charges.

Several years ago, the IRS started OVDP in an effort to promote compliance among U.S. taxpayers with foreign assets and income. The program was designed to allow those who faced potential criminal liability to come forward and pay all taxes due and reduced penalties in exchange for an agreement by the IRS not to pursue criminal charges.

The program was a resounding success, with tens of thousands of taxpayers participating. After more than a decade, the IRS closed the program late last year.

Now, the IRS has announced a campaign aimed at addressing “noncompliance related to form Offshore Voluntary Disclosure Program (“OVDP”) taxpayers’ failure to remain compliant with their foreign income and asset reporting requirements.” The IRS claims that it will address such noncompliance “through soft letters and examinations.” This means that the IRS will be devoting its resources to finding taxpayers who have fallen out of compliance and to use its audit-based tools in order to bring them into compliance.

For such taxpayers, however, there is a risk that once an examination begins, criminal charges could follow. The OVDP program was for those taxpayers whose failure to file the proper asset disclosures or file tax returns and pay taxes owed may have been willful.1 If a taxpayer came forward before, acknowledged their duties to pay taxes, and reported their foreign-held assets and then stopped doing so, it may suggest that the post-disclosure noncompliance was the result of some sort of willful intent to evade taxes or reporting obligations. This is particularly so since the taxpayer, by the mere act of making the disclosure, would have been aware of his or her obligation to report foreign assets and income.

Taxpayers finding themselves in this situation are not without ways to protect themselves. Though OVDP is closed, the IRS maintains procedures for taxpayers to come forward and make voluntary disclosures to avoid criminal penalties. While it does not have the same reduced penalties as OVDP, it may offer protection from future criminal charges. Given the IRS’s renewed focus on OVDP participants recent non-compliance, it is something taxpayers should seriously consider.

Denver-Based Court of Appeals Issues Two Important Cannabis Rulings

In the last few week, the Denver-based United States Court of Appeals has issued two decisions important to Colorado’s burgeoning cannabis industry.
Both cases relate to the applicability of section 280E of the Internal Revenue Code. Section 280E denies a taxpayer all deductions and credits for any amount paid or incurred by a business that traffics in controlled substances, as defined under federal law. This provision has been a thorn in the side of cannabis companies operating lawfully under state law, significantly increasing their cost of doing business, as they generally must report more income and pay more tax than they otherwise should under general tax principles.

In both cases, the Court evidences a hostility to arguments centered around the criminal element of 280E. In determining that section 280E applies, the IRS is essentially determining as a matter of fact that a taxpayer is (in the eyes of federal law) engaging in an illegal business. The Court has not been sympathetic to the underlying concern that the federal government could use the IRS’s auditing and summons authority as a back-door to building a criminal case against cannabis companies. In both cases, the criminal element has not swayed the court. Each case is described in more detail below.

Feinberg v. Commissioner:

In Feinberg, the Tenth Circuit affirmed the Tax Court’s determination that the taxpayer was not entitled to deductions and credits for its medical marijuana dispensary pursuant to section 280E.
Much of the opinion focuses on the Tax Court’s insertion of a substantiation issue not raised by the IRS in its notice of deficiency, but ultimately the Court affirmed the Tax Court on the basis that the taxpayers had not introduced any evidence to show that the IRS erred in determining they were in the medical marijuana business. As such, the opinion does not address the scope of the section 280E bar, but it does reaffirm two important points. First, it held that the taxpayer, not the IRS, bears the burden on section 280E. Also, it rejects an argument many cannabis companies appear to be making in 280E cases — that requiring them to prove that 280E does not apply violates the Fifth Amendment privilege against self-incrimination. Most cases in the 280E space involve corporations, which have otherwise have no fifth amendment rights. Here, the taxpayers were faced with the Hobsonian choice of either providing evidence that they are not engaged in the trafficking of a controlled substance or forgoing the tax deductions available by the grace of Congress. This did not sway the court and it refused to see that placing the taxpayer in such a position constituted a violation of their fifth amendment privileges.

High Desert Relief, Inc. v. United States:

In High Desert Relief, the Tenth Circuit affirmed district courts’ denials of the taxpayer’s motions to quash summons issued to third-party banks. High Desert Relief (“HDR”) is a cannabis company that had refused to comply with IRS’s Information Document Requests (“IDRs”) unless the IRS assured HDR that it would not use that information in a subsequent criminal investigation. The IRS refused and it issued summons to third-party banks. In several district courts, HDR sought to quash the summons, which the courts rejected.

On appeal, HDR put forth two arguments: First, it argued that the district court erred when it determines that the IRS satisfied its burden under the Powell factors and that the IRS’s investigation did not proceed in good faith. Second, it argued that the district courts erred in not applying a “dead letter rule” to the IRS’s motion to enforce. Each will be described in more detail below.

As to the first, under United States v. Powell, 379 U.S. 48, 57 (1964), the IRS demonstrates it issued a summons in good faith when it meets four factors: (1) the investigation will be conducted pursuant to a legitimate purpose”; (2) “the inquiry may be relevant to the purpose”; (3) “the information sought is not already within the Commissioner’s possession”; and (4) “the administrative steps required by the [Internal Revenue] Code have been followed. Once the IRS satisfies this “slight” burden, the taxpayer must demonstrate that enforcement would constitute an abuse of the court’s process.

The IRS must also demonstrate that it has not referred the matter to the Department of Justice for criminal prosecution. Here, the IRS satisfied this burden by putting forth an affidavit from an IRS agent that stated no referral had been made. It did not matter that the IRS indicated that it was investigating whether section 280E applied. As to the second factor, HDR argued that the investigation did not have a legitimate purpose because it is essentially a disguised criminal investigation. In examining 280E, the IRS would be determining that HDR would be engaging in criminal activity, which is outside of the bounds of its statutory authority. The Court rejected this argument for lack of evidence. The Court continued to find that the remaining factors were satisfied.

As to the second, HDR argued that the IRS cannot deny it deductions pursuant to 280E because “the underlying public policy that § 280E purports to vindicate as to marijuana trafficking–that is, the policy regarding marijuana trafficking embodied in the [Controlled Substances Act]–is a ‘dead letter.’” There is a limited exception to the general deductibility of ordinary and necessary business expenses if it would be otherwise against public policy, which HDR characterizes as the very purpose that 280E serves. The Court easily rejected this argument because this exception only applies when Congress has not directly spoken on an issue. Since Congress specifically denied the deductions in 280E, this argument has no applicability here.

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.

 

 

IRS to end Offshore Voluntary Disclosure Program in September

The IRS has announced that it will begin winding down its Offshore Voluntary Disclosure Program (OVDP) on September 28, 2018. Under the OVDP, a taxpayer with undisclosed foreign assets or income could come forward to pay tax, interest and reduced penalties in exchange for immunity from criminal prosecution. The IRS will continue its separate Streamlined OVDP, which is only available to certain taxpayers unaware of their international reporting obligations.

The IRS made the announcement now in order to give taxpayers who may still want to come forward time to do so. “Taxpayers have had several years to come into compliance with U.S. tax laws under this program,” said Acting IRS Commissioner David Kautter in a statement. “All along, we have been clear that we would close the program at the appropriate time, and we have reached that point. Those who still wish to come forward have time to do so.”

The program has been very successful, collecting more than US$11 billion in tax, interest and penalties from more than 50,000 taxpayers. With advances in international reporting and information-sharing regimes, the IRS has also aggressive pursued taxpayers who have tried to hide assets abroad. Since 2009, it has indicted 1,545 taxpayers for criminal violations related to international activities with 671 indicted specifically on international criminal tax violations.

Even with the OVDP ending, the IRS will not stop vigorously pursuing international tax evaders. Any US taxpayer who may have unreported assets or income abroad should come forward now and take advantage of the OVDP while it is still available. Otherwise, come September, such taxpayers could face huge penalties and potentially even prison.

About Denton’s Tax Controversy

Dentons’ Tax Controversy team has successfully represented over 100 clients in various OVPD and streamlined OVPD proceedings, addressing a wide variety of tax compliance issues from taxpayers all across the globe. In addition, Dentons is one of few firms that has experience litigating Report of Foreign Bank and Financial Accounts (FBAR) penalties under the Bank Secrecy Act, which are almost always at issue in OVDP proceedings.

If you would like to discuss the above further, please contact any of the members of the Dentons Tax Controversy team.

IRS Issues Final Regulations on BBA Partnership Audit Regime

The IRS has issued final regulations regarding the new centralized partnership audit regime, referred to as the BBA regime. The regulations are effective as of yesterday, January 2, 2018.. We have blogged about the new rules here and here.

These regulations implement the rules for electing out of the new audit rules. Here, we address how the regulations were updated from the proposed regulations issued over the summer.  While it acknowledged that “the new rules are a significant change in the way partnerships have been traditionally audited,” the IRS rejected most of the suggestions made during the notice and comment period. It noted its inexperience in the operation of these new rules as the reason behind its rejecting most of the suggestions, but consistently left the door open for further rulemaking.  Unfortunately, this does not provide certainty for taxpayers and means in the near future taxpayers must carefully review the rules to ensure they are compliant.

This is especially true for taxpayers who may wish elect out of the BBA regime. A taxpayer wishing to elect out of the BBA regime may do so if 1) it has 100 or fewer partners, and 2) all partners are eligible partners.

The 100-or-fewer partner rule

Under section 6221, a partnership is eligible to elect out of the BBA rules if it has 100 or fewer partners. Under now-final Treas. Reg. 301.6221(b)-1(b)(1)(i), a partnership has 100 or fewer partners if it is required to furnish 100 or fewer statements under section 6031(b), which generally requires a partnership to furnish a statement to each person that is a partner in the partnership during the partnership’s taxable year. This is a key issue because a partnership that fails to elect out of the regime or a partnership that attempts to elect out of it but cannot will find itself unexpectedly bound by these new rules.

Notice Requirement

Several commentators had suggested that the IRS exclude pass-through entities or disregarded entities in determining whether a partnership meets the 100-partnership threshold. The IRS rejected those suggestions, noting that under section 6031, notice must be provided to each partner, regardless of whether the partner is a disregarded entity or a pass-through.

The IRS also rejected suggestions that it establish a pre-filing procedure to address qualification issues. It did, however, leave open the door to further regulations on this issue, noting that it “may reconsider whether a pre-filing procedure would be helpful after gaining experience with the election out procedures.” It also left open the door for further regulations on the issue of how a partnership may elect out of the regime if it is found to be a constructive partnership or a de facto partnership. Under the regulations, if such a partnership exists and it does not file an election on a timely filed return for that taxable year, it will be bound by the new BBA rules.

Eligible Partner Requirement

Treasury Regulation 301.6221(b)-1(b)(3) describes the types of partners that are “eligible partners” for the 100-or-fewer rule. Partnerships, trusts, disregarded entities, nominees or other similar persons that hold an interest on behalf of another person, and estates other than the estate of a deceased partner are not considered eligible partners under the rules.

Commentators had requested that the IRS expand the definition of eligible partners to include partnerships, disregarded entities, trusts, individual retirement accounts, nominees , qualified pension plans, profit sharing plans , and stock bonus plans. The IRS rejected these suggestions and did not expand the definition of eligible partners because in its view “the interests of efficient tax administration outweigh” any additional administrative burdens created by a narrower definition. It appears the IRS was concerned about allowing more partnerships to elect out of the new regime, because it would require deficiency proceedings for each of the partners in such partnerships and result in substantially more audits.

Making the election

The IRS also addressed comments it had received regarding the timing for making the election and how it may be revoked. It left unchanged, for example, a partnership would be required to obtain the consent of the IRS to revoke an election out. It also did not address whether the election may be timely made on amended returns, stating that other areas of the code address this issue.

Observations

In addressing these comments, the IRS has sent a strong signal that it favors the new BBA regime and may take an aggressive stance against those partnerships that attempt to elect out of it. It also broadcasts to the tax community that it cannot at this stage address all the issues that may arise under the new regime through regulations because it lacks experience with how these rules will work in the real world. This leave taxpayers in a bind because the IRS is uncertain how these rules will work in practice but is likely to favor one particular outcome.

It is important that partnerships plan carefully and particularly if you are thinking of opting out of the BBA regime to ensure you are ready if the IRS decides to challenge that decision.

If you have any questions about this post or how you can prepare for these rule changes, please contact Jeff Erney at (202) 496-7511 or jeffry.erney@dentons.com

Update on Tax Reform

The more-or-less final version of the tax reform bill is here and Congress is expected to vote on it this week.

Dentons has done an extensive write-up of the provisions of the bill, which can be found here.

 

 

Tax Reform is Here

Dentons is covering all of the latest news on the various tax reform plans that the United States Congress is currently considering.

The latest about the Senate’s plan can be found here.

Check back for more updates.