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Tax Court Affirms That Reportable Transaction Penalty Is Constitutional

by and | Feb 10, 2017 | , , ,

In Thompson v. Commissioner, 148 T.C. No. 3 148 (2017), the US Tax Court confirmed that the Internal Revenue Code (IRC) Section 6662A penalty for reportable transactions is constitutional and does not violate the Excessive Fines Clause of the Eighth Amendment.

IRC Section 6662A(a) imposes a penalty on any “reportable transaction understatement.” A “reportable transaction understatement” generally refers to the difference between the increase in the amount of federal income tax that is calculated from the proper treatment of an item that results from a reportable or listed transaction and the taxpayers actually treatment of that item.  IRC Section 6662A(b). If a taxpayer fails to adequately disclose a reportable transaction giving rise to an understatement under IRC section 6662A, the penalty is imposed at a rate of 30 percent, and there are no available defenses. IRC Section 6662A(c). However, if a taxpayer sufficiently discloses the details of the transaction, the penalty rate is 20 percent of the amount of the reportable transaction understatement. IRC Section 6662A(a). In this latter instance, a taxpayer may avoid the penalty if he shows reasonable cause and good faith, as well as that there is substantial authority for a position he claimed on the tax return, and the taxpayer reasonably believed that such treatment was more likely than not the proper treatment of the transaction in question. IRC Section 6664(d)(1) and (3).

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Revenue Procedure 2017-23: IRS Releases Guidance on Form 8975 and Country by Country Reporting

by | Feb 6, 2017 | , ,

As a follow-up to regulations issued last June, the Internal Revenue Service (IRS) has issued Revenue Procedure 2017-23, which sets forth the process for filing Form 8975, Country-by-Country (CbC) Report, and accompanying Schedules A, Tax Jurisdiction and Constituent Entity Information (collectively, Form 8975), by ultimate parent entities of US multinational enterprise (MNE) groups for reporting periods beginning on or after January 1, 2016, but before the applicability date of §1.6038-4 (early reporting periods).

The Treasury Department and the IRS published final regulations on June 30, 2016 –Treas. Reg. 1.6038-4– that require ultimate parent entities of US MNE groups to report CbC information about the group’s income, taxes paid and location of economic activity. The impacted taxpayers must report this information annually via Form 8975. The CbC reporting regulations apply to reporting periods of ultimate parent entities of US MNE groups that begin on or after the first day of the first taxable year of the ultimate parent entity that begins on or after June 30, 2016.

For annual accounting periods beginning on or after January 1, 2016, some jurisdictions have adopted CbC reporting that would require an entity in that jurisdiction to report CbC information if it is part of an MNE group in which the ultimate parent resides in a jurisdiction without CbC reporting requirements for the same annual accounting period. This can result in constituent entities of a US MNE group being subject to various local CbC filing requirements for early reporting periods unless the ultimate parent entity files a Form 8975 in the US, or reports CbC information through surrogate filing in another jurisdiction.

The preamble to the US CbC reporting regulations addressed this issue by indicating that the Treasury Department and the IRS would provide a procedure for ultimate parent entities of US MNE groups to file Form 8975 for early reporting periods; Revenue Procedure 2017-23 is the resulting procedure.

The Revenue Procedure provides that, beginning on September 1, 2017, taxpayers may file Form 8975 for an early reporting period with their income tax return or other return as provided in the Instructions to Form 8975 for the taxable year of the ultimate parent entity of the US MNE group with or within which the early reporting period ends. Taxpayers can amend an income tax return for a taxable year that includes an early reporting period without a Form 8975 attached if they follow the normal procedures for filing an amended return, and attach the Form 8975 to the amended return within twelve months of the close of the taxable year that includes the early reporting period. Filing an amended return for the sole purpose of attaching Form 8975 will have no effect on the statute of limitations. Ultimate parent entities are encouraged to file their returns and Forms 8975 electronically through the IRS Modernized e-File system in Extensible Markup Language (XML) format. The IRS plans to provide information on the Form 8975 to the software industry to [...]

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Run for Cover—IRS Unveils Initial “Campaigns” for LB&I Audits

by , , and | Feb 1, 2017 | , ,

They’re here!  On January 31, 2017, the Internal Revenue Service (IRS) Large Business & International (LB&I) division released its much-anticipated announcement related to the identification and selection of campaigns.  The initial list identifies 13 compliance issues that LB&I is focused on and lists the specific practice area involved and the lead executive for each campaign.  Prior coverage of audit campaigns can be found here.

The initial list, along with descriptions of each campaign, is as follows:

Domestic Campaigns

  • Section 48C Energy Credits

This campaign is designed to ensure that only taxpayers whose advanced energy projects were approved by the Department of Energy, and who have been allocated a credit by the IRS, are claiming the credit.  Apparently, there has been confusion regarding which taxpayers are entitled to claim the credits.

  • Micro-Captive Insurance

This campaign addresses certain transactions described in Notice 2016-66 in which a taxpayer reduces aggregate taxable income using contracts treated as insurance contracts and a related company that the parties treat as a captive insurance company.  We previously blogged about Notice 2016-66 here. Captive insurance, along with basketing and inbound distribution, were three subject-matter specific campaigns announced during LB&I’s initial rollout last summer, as we discussed in our prior post on the subject.

  • Deferred Variable Annuity Reserves & Life Insurance Reserves

This campaign seeks to address uncertainties on issues important to the life insurance industry, including amounts to be taken into account in determining tax reserves for both deferred variable annuities with guaranteed minimum benefits, and life insurance contracts.

  • Distributors (MVPD’s) and TV Broadcasts

This campaign is targeted at multichannel video programming distributors and television broadcasters that may claim that groups of channels or programs are a qualified film for purposes of the Internal Revenue Code (Code) Section 199 deduction.  The description indicates that LB&I has developed a strategy to identify taxpayers impacted by the issue and that it intends to develop training, including the development of a publicly published practice unit, published guidance, and issue based exams, to aid revenue agents.  It appears that this campaign stems from various private guidance issued in 2010, 2014 and 2016 on these issues.

  • Related Party Transactions

This campaign is focused on transactions among commonly controlled entities that the IRS believes might provide a taxpayer a means to transfer fund from the corporation to related pass-through entities or shareholders.  The campaign is aimed at the mid-market segment.

  • Basket Transactions

This campaign focuses on certain financial transactions described in Notices 2015-73 and 74, which relate to so-called basket transactions.  Basketing was a topic named during LB&I’s initial campaign announcement last summer, along with captive insurance and inbound distribution.

  • Land Developers – Completed Contract Method

This campaign addresses the Service’s concern that large land developers that construct residential communities may improperly be using the completed contract method.  This campaign appears to be a [...]

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National Taxpayer Advocate 2016 Report – Penalties

by | Jan 26, 2017 | , , , ,

Every year, the Taxpayer Advocate Service’s (TAS) Annual Report to Congress provides a unique perspective regarding the workings of the Internal Revenue Service (IRS) and how the IRS relates to the vast majority of taxpayers. That insight is particularly valuable when the IRS chooses to assert penalties—one of the most policy-driven decisions that the IRS can make. In its 2016 report, the TAS makes a number of important observations and recommendations related to three of the most commonly asserted types of penalties—accuracy-related penalties, failure-to-file and failure-to-pay penalties, and the Trust Fund Recovery Penalty.

Accuracy-Related Penalties

The TAS identified 122 cases litigated between June 1, 2015, and May 31, 2016 (the reporting period), involving accuracy-related penalties.  Of those cases, the IRS prevailed in full in 86 cases (70 percent), taxpayers prevailed in full in 20 cases (16 percent), and 16 cases were split decisions (13 percent) (percentages were rounded down in the original report). Unusual this year were the number of split decisions and the number of taxpayer wins in pro se cases. Many cases involving the negligence penalty turned upon the taxpayer’s failure to maintain adequate books and records related to the adjustments at issue.

In 2013, the TAS issued a study noting that the IRS’s imposition of accuracy-related penalties, subsequently abated after an assessment and a successful taxpayer appeal (among other fact patterns), could lead to a perception of unfairness among taxpayers regarding the IRS’s manner of assertion of these penalties. The TAS cited this study in its 2016 report, and noted again that this conduct could be detrimental to voluntary taxpayer compliance and could undermine the purpose of accuracy-related penalties.

In fact, a main priority of the Annual Report overall is to improve voluntary compliance, a fundamental element of our tax system. The TAS notes that “unnecessary coercion” by the IRS—whether through unsustained penalties or otherwise—could have the effect of reducing voluntary compliance.

Failure-to-File / Failure-to-Pay Penalties

The TAS identified 45 total decisions involving failure-to-file and failure-to-pay penalties in the reporting period.  Of these, 28 cases involved taxpayers representing themselves. The majority of cases involved full or partial taxpayer losses.

The TAS noted, consistent with our experience, that the IRS frequently relies upon selection of failure-to-file and failure-to-pay cases through its Reasonable Cause Assistant software, which makes the initial decision to impose the relevant penalties in most cases without significant human involvement.  Personal review of the penalty decision does not generally occur until after the taxpayer files an administrative appeal.  The TAS advocated for heightened personal review of these penalties and heightened consideration of relevant facts and circumstances potentially supporting abatement.

Trust Fund Recovery Penalties

The TAS noted that several Trust Fund Recovery Penalty cases this year had successfully challenged whether the penalty was properly noticed and assessed. United States v. Appelbaum, 117 A.F.T.R.2d 2016-633 (W.D.N.C.); Romano-Murphy v. United States, 816 F.3d 707 (11th Cir. 2016).

The TAS further discussed a number of unsuccessful taxpayer challenges to assessment of the Trust Fund Recovery Penalty on grounds of [...]

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What to Expect During a Change of Administration

by , , and | Jan 25, 2017 | , , ,

With the inauguration of President Trump, and the accompanying change of administration, the American people have been promised great change in all areas of the federal government. One question we at McDermott have been frequently asked since the election is: what should a taxpayer expect from the Internal Revenue Service (IRS) and the Department of Justice (DOJ) Tax Division while the transitions in the executive branch are taking place? Major tax policy changes are being discussed, but what about the immediate practical effects of a turnover in high-level personnel within these agencies, particularly if a taxpayer is under audit or investigation?

During a change in administration, taxpayers may be affected by any of the following:

  • If under audit, the exam team may ask for longer statute extensions than would otherwise apply, to account for possible delays in internal managerial-level approvals.
  • If a taxpayer is negotiating a settlement, and that settlement requires approval by the IRS National Office or the Assistant Attorney General for Tax, settlement approvals may be delayed due to personnel changes.
  • This applies to civil settlements reached with IRS Appeals, in Tax Court litigation, or in federal district court litigation. Delays are also possible for criminal agreements, including plea agreements, deferred prosecution agreements and non-prosecution agreements.
  • Ongoing litigation (particularly appellate litigation) may be stayed or delayed, to the extent a case involves a policy position that the administration may want to change.
  • The regulatory freeze enacted by the Trump administration also affects procedural regulations, including proposed regulations related to the new partnership audit rules.

Initial comments from prospective Secretary of Treasury Steven Mnuchin indicate that he believes IRS staffing should be increased, which would be a welcome change.  Any significant changes like this are likely to be long-term, however, so we are unlikely to see their effect for some time.



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Circuit Courts Agree Timely Filing Requirement for a Tax Court Petition is Jurisdictional

by and | Jan 23, 2017 | , , , ,

Arguably the most important aspect of litigating a case in the Tax Court or in a refund forum is the timely filing of the petition or complaint.  Absent timely filing, the court may not have jurisdiction and the case could be dismissed without the court ever reaching the substantive issues.  On January 13, 2017, the Seventh Circuit joined several other circuit courts in confirming that the time for filing a petition in Tax Court is jurisdictional, not a claims processing rule.

In Tilden v. Commissioner, No. 15-3838 (available here), the taxpayer’s petition was mailed on the last day of the 90-day filing deadline.  It was not stamped and bore no postmark; instead, a USPS print-at-home postage label was attached by legal staff, and it was delivered to the post office the same day.  The Internal Revenue Service (IRS) argued this was insufficient for timelymailing under the “mailbox rule” of Internal Revenue Code (Code) Section 7502.  The Tax Court disagreed with both parties about what section of the regulations applied, and used the date the envelope was entered into the postal service’s tracking system as the date of postmark and filing—which was two days late.  Thus, the Tax Court dismissed the petition for lack of jurisdiction (available here).

On appeal, the Seventh Circuit raised sua sponte the issue of whether the filing deadline for a Tax Court petition is jurisdictional or a claims processing rule.  The proper characterization of the filing deadline is extremely important.  If the deadline is considered jurisdictional, then late filing automatically precludes the taxpayer from seeking relief in the Tax Court.  But, the taxpayer may still pay the tax due, file a claim for refund with the IRS, and file a complaint in a refund forum (if the IRS denies or fails to timely act on the claim).  On the other hand, if the deadline is a claims processing rule, the taxpayer’s options may be limited.  Although the taxpayer that files a late petition might be able to demonstrate that the Tax Court should hear its case, if the court were to determine that the petition was untimely, it arguably would be required under the Code to enter a decision on the merits for the IRS, rather than a dismissal for lack of jurisdiction.  That result eliminates the alternative refund forum.

In Tilden, the Seventh Circuit considered the Supreme Court’s current approach in non-tax cases for determining whether deadlines are jurisdictional or claims processing rules, but decided that the language of the relevant statute and the body of Tax Court and circuit court precedent compelled a finding that the 90-day deadline is jurisdictional.  Finding it “imprudent to reject that body of precedent” under principles of stare decisis, the Seventh Circuit followed the Tax Court and other circuit court precedent.  The Seventh Circuit further disagreed with the Tax Court’s holding on the relevant postmark regulations to conclude that the petition was timely filed.

Practice Point: The Seventh Circuit’s opinion is a good reminder as to the [...]

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National Taxpayer Advocate 2016 Report – Summons Enforcement

by | Jan 19, 2017 | , , , ,

In its Annual Report to Congress, the Taxpayer Advocate Service (TAS) recently reported summons enforcement actions under Internal Revenue Code (Code) Sections 7602, 7604, and 7609 as one of the “Most Litigated Issues” this year. Below, we summarize the general law related to summons enforcements actions and the findings set forth in the Annual Report.

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National Taxpayer Advocate Releases 2016 Annual Report to Congress

by | Jan 19, 2017 | ,

On January 10, 2017, the National Taxpayer Advocate Nina E. Olson released her 2016 Annual Report to Congress.

According to the Taxpayer Advocate Service (TAS), the report was delivered to Congress with no prior review by the Internal Revenue Service (IRS) Commissioner, the Secretary of the Treasury or the Office of Management and Budget.  The primary sections of the report include:

  • 2016 Special Focus – IRS Future State: The National Taxpayer Advocate’s Vision for a Taxpayer-Centric 21st Century Tax Administration
  • Most Serious Problems Encountered by Taxpayers
  • Recommendations to Congress
  • Most Litigated Issues
  • Taxpayer Advocate Service Research and Related Studies
  • Literature Reviews

Practice Point: TAS, an independent organization within the IRS, is an excellent (and often underutilized) resource for individual and corporate taxpayers who may be at a standstill with the IRS – especially on a technical, administrative, or “red-tape” issue. Taxpayers of all shapes and sizes should consider, where appropriate, utilizing the TAS in appropriate circumstances where they are encountering delays in the administration of their tax disputes.

This post is the first in a four-part series addressing highlights of the Annual Report that may be of interest to our readers.



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IRS Practice Unit Advises Examiners to Use Aggregate Approach in Valuing Outbound Transfers

by and | Jan 12, 2017 | ,

On January 4, 2017, the Internal Revenue Service (IRS) released a new “International Practice Unit” (IPU) on the value of intangibles in IRC Section 367(d) transactions in conjunction with cost sharing arrangements (CSA). See IPU here. The IPU notes that transferring highly valuable intangibles offshore has become a routine tax strategy for reducing a company’s effective tax rate for financial statement and tax purposes.

Typically, questions concerning the value of intangibles arise where a US taxpayer enters into a CSA with a controlled foreign corporation (CFC) in a low or no tax jurisdiction, and contributes resources, rights and capabilities (which may include IRC Section 936(h)(3)(B) intangibles) to the CSA. An arm’s length payment to the US taxpayer is then required for the contribution. Simultaneously with, or shortly before entering into a CSA, the US taxpayer transfers certain intangible property to the CFC in an IRC Section 351 or 361 transaction, which is taxable under IRC Section 367(d). Again, there is an arm’s length charge for the use of that intangible property.

Oftentimes in these transactions, the US taxpayer values the intangibles transferred in the IRC Section 367(d) transfer separately from the platform contributions, even though, the IRS says, the intangibles conveyed in both transactions will be exploited on a combined basis. Based on the aggregation principles in the IRC Section 482 regulations, the IPU warns that a non-aggregate approach may not provide an arm’s length result. Moreover, despite taxpayer arguments to the contrary, the IPU maintains that the scope of intangible property for purposes of IRC Section 367(d) is just as broad as the scope of platform contributions.

Practice Point: The IPU is a good source of information of what the IRS’s examination division will consider when auditing an outbound transfer of intangible rights for use in a CSA. If you have or intend to engage in such a transaction, you should study the IPU to ensure that you have adequately documented the arm’s length payments for the transfer.



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Court Opinions – A Year In Review

by | Jan 4, 2017 | , , , ,

Several notable court opinions were issued 2016 dealing with a variety of substantive and procedural matters. In our previous post – Tax Controversy 360 Year in Review: Court Procedure and Privilege – we discussed some of these matters. This post addresses some additional cases decided by the court during the year and highlights some other cases still in the pipeline.

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