On October 20, 2023, the Internal Revenue Service (IRS) announced new initiatives “to ensure large corporations pay taxes owed.” These initiatives leverage the substantial additional congressional funding that was given to the IRS thanks to the Inflation Reduction Act of 2022 (IRA). (We previously reported on how IRS enforcement is impacted by IRA funding here.) The announcement explains:
The IRS is working to ensure large corporate and high-income individual filers pay the taxes they owe. Prior to the Inflation Reduction Act, more than a decade of budget cuts prevented the IRS from keeping pace with the increasingly complicated set of tools that the wealthiest taxpayers use to hide their income and evade paying their share. The IRS is now taking swift and aggressive action to close this gap.
The announcement also outlines three new initiatives aimed at collecting tax revenue from large corporations:
1. The large foreign-owned corporations transfer pricing initiative. The IRS will focus its attention on US subsidiaries of foreign companies that distribute goods in the United States. Based on data likely received through the now retired Inbound Distributor Campaign, the IRS believes that some of these foreign companies “report losses or exceedingly low margins year after year through the improper use of transfer pricing to avoid reporting an appropriate amount of U.S. profits.” To jump start its initiative, the IRS will be notifying 150 subsidiaries of large foreign corporations “to reiterate their U.S. tax obligations and incentivize self-correction.” These “soft letters” can be a prelude to an audit.
2. The IRS will expand its Large Corporate Compliance (LCC) program. We previously reported on the LCC program, which focuses on noncompliance by using data analytics to identify large corporate taxpayers for audit. With an increased number of staff as a result of IRA funding, the IRS will commence examination of an additional 60 corporations that were selected using a combination of artificial intelligence and subject matter expertise. Key selection metrics will include factors from the various active compliance campaigns.
3. Cracking down on the abuse of former Internal Revenue Code (IRC) Section 199 domestic production activity deduction. The IRS has been battling taxpayers’ IRC Section 199 deductions since its promulgation. We have reported extensively on this topic over the years. The battle between the IRS and taxpayers has heated up in the wake of the repeal of IRC Section 199, which precipitated taxpayers filing billions of dollars of refund claims. The recent $1.8 billion taxpayer loss in Bats Global Market Holdings, Inc., No. 22-9002 (10th Cir. July 12, 2023), aff’g 158 T.C. No. 5 (2022), has clearly emboldened the IRS to intensify its existing Section 199 audit campaign to address noncompliance and review high-risk claims.
In the announcement, the IRS also reported that it has been pursuing high income, high-wealth individuals who have either not filed their taxes or failed to pay recognized tax debt. The IRS is focused on taxpayers with more than $1 million in income and more than $250,000 of tax owed.
Practice Point: We expect a substantial increase in IRS examinations of large corporations, large partnerships and high-net-worth individuals in the coming years as it expands its staff and enhances its audit tools with IRA funds. Front and center will be the increased use of civil (and criminal) tax penalties to enforce compliance, including IRC Section 482 penalties. Based on recent experience, we also expect the IRS to ramp up the use of the economic substance doctrine codified by IRC Section 7701(o) for transactions it believes are particularly abusive. What can you do now to prepare? Start by reviewing your returns for tax years open under the statute of limitations on assessment. Make sure you have all the documents you will need to substantiate the positions reported and retain materials that have been prepared in anticipation of an IRS audit. You will also want to ensure that you have any tax opinions in final form ready to be used to abate asserted penalties.