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IRS Acknowledges Limitations on Use of Outside Contractors in Audits

Several years ago, it came to light that the Internal Revenue Service (IRS) had hired a law firm to assist with transfer pricing matters in an ongoing audit of a large corporate taxpayer. Contemporaneous with that hiring, the IRS issued temporary regulations providing that third-party contractors “may receive books, papers, records, or other data summoned by the IRS and take testimony of a person who the IRS has summoned as a witness to provide testimony under oath” and “clarifying that contractors are permitted to participate fully in a summons interview.” We previously discussed this highly controversial position here.

Congress seemingly disapproved of the IRS practice of outsourcing legal and audit services to private law firms. In 2019, it enacted Internal Revenue Code (Code) Section 7602(f) as part of the Taxpayer First Act. That provision prohibits the IRS from hiring outside contractors for purposes other than providing “expert evaluation and assistance” and specifically prohibits non-IRS employees from questioning witnesses under oath. However, no definition was provided as to the meaning “expert evaluation and assistance.”

The IRS recently finalized regulations (applicable to summonses served on after August 6, 2020) providing taxpayer-favorable guidance on the meaning of “expert evaluation and assistance.” Under the final regulations, the IRS may not engage outside legal counsel unless the attorney is hired by the IRS for expertise in (A) foreign, state or local law, (B) non-tax substantive law that is relevant to an issue in the examination, or (C) knowledge, skills or abilities other than providing legal services as an attorney (such as a translator). In addition, the final regulations prohibit IRS contractors from asking a witness (or his or her representative) to clarify an objection or assertion of privilege, as well as from asking questions to witnesses generally, when the witness is under oath.

Practice Point: The final regulations provide helpful guidance to taxpayers regarding the role that outside contractors can play in IRS audits and provide a much-needed deterrent on the IRS’s outsourcing of audits to private law firms. However, taxpayer who believe that the IRS is using outside counsel may want to request in writing a list of all third parties that the IRS contacts during the course of the examination.




What are the Time Limits for Assessing Additional Federal Tax and Filing a Refund Claim?

The Internal Revenue Service (IRS) must follow the “statute of limitations” as stated in Internal Revenue Code (IRC) Section 6501 to “assess” additional federal tax. Likewise, taxpayers must seek a tax overpayment or refund within the statutory period stated in IRC Section 6511. In this article, we’ll answer some of the most common questions regarding when the IRS can assess additional federal tax and when taxpayers must file a refund claim.

WHEN DOES THE STATUTE OF LIMITATIONS FOR ASSESSING ADDITIONAL TAXES START?

Typically, the period during which the IRS can seek additional tax starts when the taxpayer files their tax return. A taxpayer “self-assesses” when the amount of tax is stated on the return, but tax assessment can also occur when the IRS creates a “substitute for return” under IRC Section 6020. (For example, when the taxpayer fails to timely file a return.) Assessment merely means that the IRS records the tax liability on its official ledger for each taxpayer. An assessment is significant because it is legally considered a debt of the taxpayer for which the IRS can commence collection activities, like placing a lien and levy on property.

Self-Assessment Example: The taxpayer reports on a timely filed return a tax liability of $10,000 and submits payment of $5,000. The $10,000 tax is automatically assessed and constitutes a tax debt of the taxpayer, despite only a partial payment. In this case, the IRS would seek to collect the balance due ($5,000) from the taxpayer under the collection rules.

WHAT IS A TAX ASSESSMENT?

The IRS assesses tax by recording the amount owed in its official records. The assessment establishes the fact and amount of the tax liability that’s due to the IRS and starts the period during which the IRS can collect the amounts due and owing. Generally, the IRS may not lien or levy a taxpayer’s property until after an assessment is made.

There are three primary types of assessments:

  1. A “summary assessment” occurs automatically when the taxpayer reports an amount of tax on a return.
  2. A “jeopardy assessment” occurs when the IRS determines that the taxpayer may abscond with property that the IRS may need to lien and/or levy to satisfy a tax deficiency.
  3. A “tax deficiency assessment” occurs after the IRS determines the amount owed by the taxpayer and follows its procedures to permit the taxpayer to challenge its determination (usually after an audit).

STATUTORY NOTICE OF DEFICIENCY (THE 90-DAY LETTER)

If the IRS audits a return and determines that the taxpayer owes additional tax, it generally cannot assess the tax before sending the taxpayer a statutory notice of deficiency, or the so-called “90 day letter.” The letter must be sent by certified or registered mail to the last known address of the taxpayer (which is usually the address listed on the last return filed with the IRS). If the taxpayer does not file a timely petition with the US Tax Court in response to the 90-day letter, the IRS may then assess [...]

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Supreme Court Opens Door to APA Challenge of Overreaching IRS Information Reporting Regime

In CIC Services, LLC v. Internal Revenue Service, a unanimous US Supreme Court allowed CIC, a tax advisor, to proceed with a pre-enforcement challenge to the Internal Revenue Service’s (IRS) “reportable transaction” regime. CIC alleged that the IRS violated the Administrative Procedure Act (APA) when it issued Notice 2016-66 (Notice), deeming certain micro-captive insurance transactions as “reportable transactions” and sought an order enjoining enforcement of the Notice. The IRS sought to avoid judicial review by hiding behind the Anti-Injunction Act’s (AIA) bar on suits brought “for the purpose of restraining the assessment or collection of any tax.” Disagreeing with the trial and appellate courts, the Supreme Court allowed CIC’s suit to proceed, finding that CIC was challenging a regulatory mandate separate from any tax. As the Court explained, “The tax appears on the scene – as criminal penalties do too – only to sanction that mandate’s violation.” By choosing to address their concerns about micro-captive transactions by imposing a non-tax reporting obligation, Congress and the IRS “took suits to enjoin their regulatory response outside the Anti-Injunction Act’s domain.”

On remand, the Court’s decision leaves open questions that the lower courts must now address while also providing meaningful clues about how the Court may approach future disputes over IRS enforcement strategies. Such questions include: (1) does the reportable transaction regime as the IRS currently administers it violate the APA (See: Mann Construction, Inc. v. United States, No. 1:20-cv-11307 (E.D. Mich. May 13, 2021) (holding that IRS Notice requiring disclosure of listed transactions was not subject to APA’s notice-and-comment requirement); (2) would the AIA bar a suit to enjoin enforcement of a reporting obligation brought by a taxpayer, as opposed to an advisor; (3) how onerous must the challenged requirement be; (4) how disconnected from the tax penalty must the challenged requirement be and (5) is the existence of criminal penalties sufficient and/or necessary to exempt a challenge from the AIA?

Practice Point: APA challenges in tax cases have steadily increased since the Supreme Court’s rejection of tax exceptionalism 10 years ago in Mayo Foundation for Medical Education & Research v. United States, 562 U.S. 44 (2011). As tax law continues to get more complicated and the IRS issues additional guidance, we can expect this trend to continue. Understanding how to use the APA to challenge the overreaching of the IRS is an important tool for taxpayers and tax advisors alike. In the absence of a clear congressional mandate, any new enforcement policy issued by the IRS may be fair game for an APA challenge. The Supreme Court has opened the door to judicial review of unsanctioned IRS programs that place unfair burdens on taxpayers. And, this issue extends beyond the reportable transaction regime, including to the information reporting proposals recently announced by the Biden Administration.




Biden Spending Proposal Calls for 10% IRS Budget Increase

The Biden Administration has requested a $1.2 billion increase in funding for the Internal Revenue Service (IRS) as part of its proposal for Fiscal Year 2022 (FY 2022) discretionary funding released in a letter from Office of Management and Budget Acting Director Shalanda Young on April 9, 2021. The additional funding would bring the IRS FY 2022 budget to $13.2 billion, which represents a 10.4% increase over the 2021 enacted budget.

The additional funding would be used to increase IRS enforcement, especially for oversight of high-income individuals and corporate tax returns to ensure compliance with existing tax laws. The discretionary request also seeks an additional $417 million to fund a multiyear tax enforcement initiative aimed at increasing tax compliance and revenues. In total, the discretionary request would increase resources for tax enforcement by nearly $1 billion. Other funds appropriated to the IRS would be used for development and improvement of online tools and better telephone and in-person customer service for taxpayers.

Apart from IRS spending, the discretionary spending proposal includes $191 million for the US Department of the Treasury’s Financial Crimes Enforcement Network to create a database that tracks the ownership and control of certain companies and organizations.

The discretionary spending proposal is intended as a starting point for congressional appropriators and will be followed by the president’s full budget proposal—including tax changes and pay-fors—later in the spring.

Practice Point: We believe that the US Congress is likely to appropriate additional funds for tax enforcement in the FY 2022 budget. Taxpayers should begin preparing for additional IRS audits and scrutiny of return positions. Such preparation may include examining prior tax return positions and ensuring they have audit-ready files.




Finding John Doe: IRS Steps up Enforcement Efforts to Take the Anonymity Out of Virtual Currency

The Internal Revenue Service (IRS) is stepping up its virtual currency enforcement, and taxpayers who have engaged in a cryptocurrency transaction should immediately assess any potential tax implications as the IRS has recently issued two John Doe summonses to popular exchanges. These are the first it has issued in about three years, sending a very clear signal that the IRS is ready to tackle what it believes to be a continuing noncompliance. A US Federal District Court in Massachusetts upheld the summons issued to Circle Internet Financial Inc., including the popular cryptocurrency exchange Poloniex, while a US Federal Court for the Northern District of California required the government to submit a response explaining its need for the information requested in its summons to Kraken. (See: In re Tax Liability of John Does, No. 21-cv-2201, ECF No. 8 (N.D. Cal. Mar. 31, 2021)).

Filed on April 14, 2021, the government’s response provided numerous examples of how the data received in the Coinbase summons required additional requests in order for the exchange to locate actual taxpayers. The response argued that the need for multiple follow-ups defeated the purpose of the summons. It also described how information in Kraken’s possession, such as accountholder telephone numbers and email addresses, will facilitate the IRS’s ability to utilize relevant cryptocurrency platform data in its possession that was received from other sources relating to foreign-based cryptocurrency exchanges. Noting the potential for abuse by an accountholder, the response provided an example of an individual falsifying their identity as the basis for its need for complete account history in order to catch these issues. In addition, the response stated, “[m]atching the IP addresses for Kraken users to IP addresses and other data points in the IRS’s information will allow the IRS to link substantive account information from multiple sources for a single individual taxpayer and make a more accurate initial determination of whether that individual is in compliance with the internal revenue laws.”

It remains to be seen how the court will react to the government’s response. What is clear, though, from the response and the accompanying affidavit is that the IRS has made significant progress in its analysis of this data and its ability to follow leads. As a result, now is the time for individuals involved in these transactions to consult a tax professional to determine if they have any tax liability or potential exposure, including criminal exposure. After the Coinbase summons, the IRS issued 10,000 letters to taxpayers regarding virtual currency transactions. In the wake of these summonses, and potentially others, it is only a matter of time before the IRS reaches out to thousands of other taxpayers.

It is also clear that the enforcement arm of the IRS is working very closely with its counterparts around the world. The need for email addresses and phone numbers mentioned above to use foreign data certainly drives this point home. Even more so, as a precursor of things to [...]

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Weekly IRS Roundup March 22 – March 26, 2021

Presented below is our summary of significant Internal Revenue Serve (IRS) guidance and relevant tax matters for the week of March 22, 2021 ­­– March 26, 2021. Additionally, for continuing updates on the tax impact of COVID-19, please visit our resource page here.

March 22, 2021: The IRS issued Notice 2021-22, providing guidance on various interest rates relevant to employee benefit plans.

March 22, 2021: The IRS issued a news release announcing that the next batch of Economic Impact Payments under the American Rescue Plan Act of 2021 (ARPA) would be issued to taxpayers this week.

March 24, 2021: The IRS issued a news release confirming, as previously announced, the disbursement of approximately 37 million Economic Impact Payments, bringing the total amount of disbursements under ARPA to approximately 127 million payments worth approximately $325 billion.

March 25, 2021: The IRS released Revenue Procedure 2021-19, providing guidance on median gross income figures, used by certain issuers of mortgage bonds and mortgage credit certificates.

March 25, 2021: The IRS issued a news release summarizing the proceedings from “The Challenge,” a meeting (held virtually this year) of the Joint Chiefs of Global Tax Enforcement (J5) regarding international coordination on tax crimes.

March 25, 2021: The IRS issued a news release noting the one-year anniversary of the Coronavirus Aid, Relief and Economic Security (CARES) Act and pledging the Criminal Investigation Division’s continued commitment to investigating COVID-19 fraud.

March 26, 2021: The IRS released Revenue Procedure 2021-17, providing guidance on average residence purchase prices, used by certain issuers of mortgage bonds and mortgage credit certificates.

March 26, 2021: The IRS released Revenue Procedure 2021-18, providing state and local governments in which an empowerment zone is located with an automatic procedure for extending the empowerment zone designation under section 1391(a).

March 26, 2021: The IRS issued Announcement 2021-5, announcing that the United States and Japan have entered into an arrangement regarding the implementation of the arbitration process provided for in the 2003 US-Japan tax treaty.

March 26, 2021: The IRS issued Announcement 2021-7, notifying taxpayers that amounts paid for personal protective equipment for the primary purpose of preventing the spread of COVID-19 are treated as deductible medical expenses under section 213.

March 26, 2021: The IRS released its weekly list of written determinations (e.g., Private Letter Rulings, Technical Advice Memorandums and Chief Counsel Advice).

Special thanks to Le Chen in our Washington, DC, office for this week’s roundup.




IRS Issues Practice Unit on Section 965 Transition Tax

One of the most pressing audit issues for large taxpayers today centers on the Internal Revenue Code (Code) Section 965 transition tax. The Internal Revenue Service (IRS) has designated Code Section 965 as a campaign issue and is actively auditing taxpayers’ transition tax calculations and positions, along with other tax reform items. The stakes are high, particularly given the potential to pay this tax over a period of eight years.

On March 23, 2021, the IRS released a Practice Unit that provides an overview of the Code Section 965 transition tax with references to relevant resources. Unfortunately, unlike some other Practice Units, guidance is not provided as to the type of information revenue agents should be requesting from taxpayers.

Practice Point: Practice Units are presentation-type materials compiled by the IRS as a means for collaborating and sharing knowledge among IRS employees. They provide helpful guidance to revenue agents in the form of an overview of the law in a specific area, examination tips and guidance and references to relevant resources. Although the Code Section 965 transition tax Practice Unit does not provide insights into the types of questions and information that revenue agents may seek on audit, it is still useful for taxpayers to review to understand the IRS’s perspective in this area.




2020’s Key Tax Controversy Developments

In the face of the pandemic and all the challenges that came with 2020, tax controversy marched on. In this article, we explore several important cases, including one of the most closely watched Supreme Court cases, CIC Services LLC v. Internal Revenue Service, which raises important questions regarding the scope of the Anti-Injunction Act and impacts the ability of taxpayers to engage in preenforcement challenges to regulations.

We also look into the latest updates in the transfer pricing area, changes to the Compliance Assurance Process, what to expect during the audit of a campaign issue and more.

Read the full article.




Skip Jail and Clean Up Your Tax Problems

If you have knowingly failed to report income or claimed deductions you know you are not entitled to, or just decided not to file your tax returns and pay the tax owed, you may be liable for civil penalties and even jail time for criminal tax evasion. Taxpayers with civil and criminal tax exposure may want to fix their past mistakes but are afraid of what will happen if they “come clean.” So, the majority of offenders keep offending year after year. But did you know there is an Internal Revenue Service (IRS) program that can help taxpayers get out of that “evasion” cycle, and clean up past tax issues, usually without criminal liability?

The IRS has a longstanding program through which taxpayers can make voluntary disclosures of tax underreporting and tax criminal evasion. Such disclosures may help taxpayers limit their criminal exposure, although disclosure does not automatically guarantee immunity from criminal prosecution.

The latest iteration of the voluntary disclosure program is known as the Voluntary Disclosure Practice (VDP). (Here is a link to the IRS’s VDP program description.) Under the terms of the program, a taxpayer must submit Part I of Form 14457, Voluntary Disclosure Practice Preclearance Request and Application, which contains basic identifying and procedural information necessary to determine if the taxpayer is eligible to participate in the VDP program. The IRS uses this information to verify that the taxpayer is not already under criminal investigation, which is a bar to entering into the VDP program. Once the taxpayer has been “precleared,” the taxpayer must submit Part II of Form 14457, which seeks detailed information regarding the nature of the tax reporting failures and the associated unpaid tax liabilities. If the taxpayer is approved to participate in the VDP program, the taxpayer’s case is transferred to the appropriate IRS civil division for examination. Ultimately, the taxpayer must cooperate with the IRS to determine its correct tax liability and must make good faith arrangements to pay all unpaid liabilities, including interest and penalties. Typically, this will include the filing of corrected tax returns for six years; the payment of the correct tax and interest for those returns; and the payment of enhanced penalties for one tax year.

The current version of Form 14457 was released in April 2020. On July 14, 2020, Carolyn A. Schenck, the National Fraud Counsel for the IRS Fraud Enforcement Program, stated that the IRS is planning to issue additional instructions for Form 14457 to provide further guidance on the mechanics of the VDP. Conforming additions will be made to the Internal Revenue Manual.

Practice Point: The risk of criminal prosecution for tax offenses is increasing due to significant improvements in IRS enforcement strategies. IRS commissioner Charles Rettig was formerly in private practice defending taxpayers and has implemented significant changes in IRS programs and leadership. There is an unprecedented degree of coordination among the enforcement divisions and emphasis on preventing tax fraud, with Eric Hylton, previous deputy [...]

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Section 965 Statutes of Limitations for Partnerships

On May 26, 2020, the Internal Revenue Service (IRS) issued PMTA 2020-08 to provide guidance on the period of limitations for Internal Revenue Code (IRC) section 965, transition tax-related adjustments of partnerships. Typically, pursuant to IRC section 6501, the IRS has three years to assess a tax liability for a tax year. However, IRC section 6501(e)(1)(C) states that if the taxpayer omits from gross income an amount properly includible in income under IRC section 951(a), the tax may be assessed at any time within six years after the return was filed. Moreover, this special six-year limitation on assessment applies to the entire tax liability reportable on that return. Because special assessment and adjustment rules apply to partnerships, the IRS issued guidance on how the rules are applicable to certain partnerships and partners with section 965-related items.

For a deferred foreign income corporation’s (DFIC) last taxable year beginning before January 1, 2018, IRC section 965 imposes a one-time tax on a US shareholder’s pro rata share of the DFIC’s earnings and profits (E&P) otherwise deferred from US taxation. The IRS describes three steps for the calculation under IRC section 965: (1) IRC section 965(a) deems the DFIC to repatriate its untaxed E&P through a subpart F inclusion in the US shareholder’s gross income equal to the greater of its E&P as of two measurement dates in 2017; (2) IRC section 965(b) reduces the IRC section 965(a) inclusion by the E&P deficits of the US shareholder’s other foreign corporations; and (3) IRC section 965(c) provides for a deduction (based on the aggregate IRC section 965(a) inclusion amount and on cash positions) that has the effect of reducing the effective rate of US tax on the US shareholder’s IRC section 965(a) inclusion.

With respect to partnerships, in the guidance the IRS indicated that it can make three broad categories of adjustments that affect the computation of IRC section 965 amounts. Revisions could be made to the tax attributes and financial data underlying the computation of the IRC section 965(a) inclusion, the IRC section 965(c) deduction and foreign tax amounts. Such adjustments could affect the IRC section 965(a) inclusion amount and IRC section 965(c) deduction amount reportable by the partnership and affect the IRC section 965(a) inclusion and the IRC section 965(c) deduction reported by the partners. Accordingly, the IRS outlined how to apply the assessment and adjustment period rules apply when there are partners with IRC section 965-related items arising from partnerships subject to different procedures and audit regimes.

Under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), the IRS indicated it can make adjustments at any time provided the period for assessing tax attributable to the adjustments is open. The IRC section 965(a) inclusion amount and the IRC section 965(c) deduction amount reported by the partnership may be adjusted for the required reporting year if either: (1) the partner’s IRC section 6501 period of limitations on assessing tax attributable to adjustments to partnership items has not [...]

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