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Update on IRS Enforcement Efforts

By and on Nov 16, 2022
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We frequently post about the Internal Revenue Service’s (IRS) tax enforcement trends and announcements. Prior examples from this year include the release of a five-year strategic plan emphasizing enforcement, the plan to hire up to 200 additional attorneys to assist with litigation efforts, the implementation of the Large Partnership Compliance (LPC) Pilot Program, a focus on tax compliance of non-US citizens and residents, and the creation of a new Joint Strategic Emerging Issues Team to identify emerging “abusive transactions.” Over the past several weeks, the IRS has provided additional updates on its enforcement efforts and future plans, including the following:

  • The IRS is considering raising the economic substance doctrine more frequently in transfer pricing examinations—even those where taxpayers have transfer pricing documentation—and asserting penalties more often in transfer pricing cases. This follows the announcement last April that executive approval is no longer needed before asserting the codified economic substance doctrine under Internal Revenue Code Section 7701(o).
  • The IRS plans to grow the LPC program and envisions it functioning similar to corporate examinations conducted by the Large Business & International Division.
  • The IRS’s Criminal Investigation (CI) Division is highly focused on criminal digital asset cases and intends to make many of these cases public. This follows the recent release of the CI Division’s annual report.
  • The IRS intends to expend more resources on examinations of high-income/high-net-worth taxpayers.
  • The IRS has proposed to require the disclosure of more information regarding corporate taxpayers’ uncertain tax positions, including citations to contrary authorities, which, if finalized, will likely lead to more examinations and challenges to tax reporting positions.

Practice Point: Tax enforcement has been down over the past several years, including a slowdown in audit operations during the COVID-19 pandemic. With increased funding from the Inflation Reduction Act of 2022 and proposed restrictions on access to IRS Appeals for certain matters, we expect more examinations and tax disputes in the near future. Taxpayers and their advisors should prepare. Consider working with your tax controversy advisor to discuss your more vulnerable return positions to see how to better defend against the impending tax enforcement wave!



2020’s Key Tax Controversy Developments

By and on Dec 16, 2020
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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.



IRS Guidance Signals More Stringent Scrutiny on Transfer Pricing Documentation

By and on Apr 17, 2020
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On April 14, 2020, the Internal Revenue Service (IRS) issued informal guidance in the form of frequently asked questions (the “FAQs”), urging taxpayers to strengthen their transfer pricing documentation required under Internal Revenue Code (IRC) section 6662(e) and Treasury Regulations § 1.6662-6. IRC section 6662 provides several types of accuracy-related penalties on underpayments of taxes. Pursuant to IRC section 6662(e)(1)(B)(ii), a net adjustment penalty could apply to an intercompany transaction when the net IRC section 482 transfer pricing adjustment exceeds the applicable threshold amount. Taxpayers, however, may avoid a net adjustment penalty by maintaining transfer pricing documentation in accordance with IRC section 6662(e)(3)(B) and Treasury Regulation § 1.6662-6. The IRS indicates that without robust documentation, intercompany transactions may be subject to extensive examination process.

The FAQs provide guidelines for preparing high-quality documentation that could increase the chance of early deselection of transfer pricing issues, thereby substantially facilitating the examination process. First, industry and company analysis sections of the report should be clear and provide context for related party transactions. For example, the report should explain economic downturns or other unforeseen special business circumstances that affect the transfer pricing results. The analysis should also address any differences in risks or functions between the tested party and the comparable companies. Second, functional analysis narratives should be robust and link facts to analysis, and risk analysis should be consistent with intercompany agreements. Finally, detailed analysis should be provided to support (i) the best method selection (as well as the rejection of specified methods, if applicable); (ii) the profit-level-indicator conclusion; (iii) the satisfaction of the comparability criteria enumerated in the regulations and (iv) proposed adjustments to the application of a specified method, if selected. Taxpayers are encouraged to conduct a “self-assessment” of the potential indicators of transfer pricing non-compliance to strengthen their transfer pricing documentation reports.

The FAQs also identify some of the most helpful features in a transfer pricing report.  These features include (i) a full explanation of the data used in the transfer pricing analysis; (ii) descriptions of the general business risks of the transaction and detailed descriptions of how these risks are allocated among the controlled participants to the transaction based on the intercompany policies/agreements and (iii) detailed explanations of how profits are allocated among all parties, especially where a party is allocated profits that are disproportionate to its relative contributions. High-quality transfer pricing documentation may also include useful features such as reports of a functional and risk analysis for each transaction, an analysis of special business circumstances that may have affected profitability, descriptions of challenges of the analysis and any user-friendly features such as a summary of information.

These guidelines are consistent with  recent IRS efforts to encourage taxpayers to improve the quality of transfer pricing documentation, and suggest that the IRS may apply a higher standard in future examination when reviewing the documentation.

Practice Point: The IRS is signaling that there are some persistent deficiencies in taxpayers’ contemporaneous transfer pricing documentation. It may be a good idea to [...]

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Government Questions the Benefits of IRS Audit Campaigns

By and on Oct 25, 2019
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On September 28, 2019, the Treasury Inspector General for Tax Administration (TIGTA) issued a report titled Initial Compliance Results Warrant a More Data-Driven Approach to Campaign Issue Selection.

As the name of the report describes, the TIGTA analyzed whether the Internal Revenue Service (IRS) audit campaigns were effective and efficiently administered. We have written at length regarding the IRS’s “campaign” methodology:

The report questions how the IRS selected the campaigns it has unleashed on taxpayers. Upon inspection, it appears that the IRS did not have a systematic approach to choosing which issue would become a campaign. Instead, the approach was seemingly ad hoc, and was open to employee suggestions instead of empirical analysis. The TGITA suggests that going forward the IRS use a more data-driven selection process for its campaigns. The idea would be to analyze where the IRS could get the biggest bang for its resource bucks in terms of dollars as well as compliance goals. Accordingly, the TGITA recommends the IRS adopt a formal process for selecting and prioritizing issues for campaigns, and the IRS use actionable metrics, based in part on compliance results, to select the most productive inventory.

Practice Point:  We have heard in the past that some campaigns were based on issues that revenue agents and other field personnel identified, but it was never clear whether the IRS was applying a systematic approach. We expect now that the IRS will be more mindful with its approach, focusing on issues with substantial dollars associated with them, and also where the IRS wants to ensure taxpayer compliance with the Internal Revenue Code.



The Internal Revenue Service Is Expanding the 2020 Compliance Assurance Process

By and on Sep 17, 2019
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The Large Business and International Division of the Internal Revenue Service (IRS) developed the Compliance Assurance Process (CAP) program to improve large corporate taxpayer compliance with US federal tax obligations through the use of real-time issue resolution tools and techniques.

On September 12, 2019, the IRS announced that it was accepting applications—for the first time since 2015—from new corporate taxpayers that meet the eligibility requirements for the CAP program. The application period for the 2020 CAP year begins on September 16, 2019, and ends on October 31, 2019. Generally, applicants must meet the following requirements in order to be eligible to apply for CAP: (1) applicants must have assets of $10 million or more; (2) applicants must be a US publicly traded corporation with a legal requirement to prepare and submit SEC Forms 10-K, 10-Q, and 8-K; and (3) the applicant must not be under investigation by, or in litigation with, any government agency that would otherwise limit the IRS’s access to current tax records.

Taxpayers interested in applying for the 2020 CAP year must submit an application with several forms:

  • Form 14234 – CAP Application
  • Form 14234-A – CAP Research Credit Questionnaire
  • Form 14234-B – Material Intercompany Transactions Template
  • Form 14234-C – Taxpayer Initial Issues List
  • Form 14234-D – Tax Control Framework Questionnaire

If the taxpayer also meets the eligibility and suitability criteria, the application will be forwarded for an evaluation of the application. Accepted taxpayers will be notified in writing by the Territory Manager assigned to the taxpayer.

However, acceptance is not automatic; the IRS, in its sole discretion, may reject the application when warrants by the facts and circumstances of the application or in the interest of sound tax administration. If an application is rejected, the taxpayer will be notified in writing and provided with the reasons why it was not accepted.

Further information regarding the IRS’s CAP program may be found here. Earlier coverage of the IRS’s 2018 recalibration of the CAP program can be found here.

Practice Point: The CAP program is a valued tool for many large corporate taxpayers. Eligible taxpayers that are interested in the CAP program for 2020 should prepare and submit an application as soon as possible.



IRS Resumes Examinations of Stock Based Compensation in Cost Sharing Agreements

By , and on Aug 8, 2019
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On July 31, 2019, the Internal Revenue Service (IRS) Large Business and International (LB&I) division formally withdrew its Directive (LB&I-04-0118-005) instructing examiners on transfer pricing selection related to stock based compensation (SBC) in Cost Sharing Arrangements (CSAS). See here for IRS Notice of Withdrawal.

The Directive was issued January 12, 2018, after the Tax Court’s opinion in Altera which invalidated Treasury Regulation § 1.482-7A(d)(2). The IRS appealed Altera and issued Directive LB&I-04-0118-005, which we previously discussed here. The Directive instructed examiners to “[s]top opening issues related to stock-based compensation (SBC) included in cost-sharing arrangements (CSAS) intangible development costs (IDCs) until the Ninth Circuit issues an opinion in the Altera case on appeal.” At the time, the IRS indicated that it would issue further guidance once Altera was finally decided. On June 7, 2019, the Ninth Circuit reversed the Tax Court’s decision. (more…)



More IRS “Campaigns?! IRS Announces Six More Examination Campaigns

By and on Jul 23, 2019
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On July 19, 2019, the Internal Revenue Service (IRS) Large Business & International (LB&I) division announced the approval of six new campaigns. As in the past, the IRS stated that “LB&I’s goal is to improve return selection, identify issues representing a risk of non-compliance, and make the greatest use of limited resources.” This brings the total number of campaigns to 59! LB&I’s campaign announcements and approved campaigns are available on the IRS’s website.

The six new LB&I campaigns are listed below, verbatim by title and description.

S Corporations Built in Gains Tax
C corporations that convert to S corporations are subjected to the Built-in Gains tax (BIG) if they have a net unrealized built-in gain and sell assets within 5 years after the conversion. This tax is assessed to the S corporation. LB&I has found that S corporations are not always paying this tax when they sell the C corporation assets after the conversion. LB&I has developed comprehensive technical content for this campaign that will aid revenue agents as they examine the issue. The goal of this campaign is to increase awareness and compliance with the law as supported by several court decisions. Treatment streams for this campaign will be issue-based examinations, soft letters, and outreach to practitioners. (more…)



More Developments on IRS’s Real-Time Audit Program

By and on Oct 2, 2018
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We have previously discussed ongoing developments with the Internal Revenue Service’s (IRS) Compliance Assurance Process (CAP) program. In brief summary, CAP is a real-time audit program that seeks to resolve the tax treatment of all or most return issues before the tax return is filed. The CAP program began in 2005 on an invitation-only basis with 17 taxpayers, and was subsequently expanded to include pre-CAP, CAP and CAP Maintenance components. Taxpayers and IRS leadership generally praised the CAP program as one of the most successful corporate tax enforcement programs, with surveys showing that more than 90 percent of CAP taxpayers reported overall satisfaction with the program.

The fate of CAP has been uncertain in recent years given the IRS’s shift in the examination process to identifying and focusing on specific areas of risk and the continued dwindling of IRS resources. In 2016, we discussed whether this change might result in the death of the CAP program and the IRS’s announcement that it was formally assessing the program. In August of this year, the IRS announced that the CAP program will continue, with some modifications.

At a September 26 conference, the IRS indicated that it wanted to expand the CAP program, but that changes were needed to keep the program sustainable over the long term given issues with increased examination times for CAP audits based primarily on issues involving transfer pricing, research credits under Internal Revenue Code (Code) Section 41, and former Code Section 199. The IRS indicated that it needed to resolve two issues for the CAP program: (1) eligibility and (2) suitability. Regarding eligibility, the IRS indicated that only public companies will likely be allowed into the program. Regarding suitability, factors include: (1) responses to IRS information requests; (2) good-faith efforts to resolve issues; (3) disclosure of tax shelters, material items, investigation or litigation; (4) frequency of claims; and (5) complying with the terms of the program’s memorandum of understanding.

The IRS has also released a Compliance Assurance Process (CAP) Recalibration discussion document, dated September 28, 2018. The discussion document provides more detail on the IRS’s current thinking regarding the CAP program and the two issues identified above. The document indicates that no new applications will be accepted for 2019 but that the IRS expects to accept new application for the 2020 tax year. In addition to general application information, taxpayers with international cross-border activity and research and experimentation activities will be required to submit additional information.

Practice Point: Taxpayers that are currently in the CAP program or that are considering applying to the program should review the IRS’s recent discussion document to identify potential changes to the program and whether the program would be a good fit. For many taxpayers, the CAP program has been—or could be­—a great program for resolving tax disputes in a timely fashion and gaining finality on tax position at an early date. The [...]

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LB&I Announces Five New Campaigns

By , and on Sep 17, 2018
Posted In , ,

On September 10, 2018, the Internal Revenue Service (IRS) Large Business and International (LB&I) Division announced five new audit “campaigns.” These new campaigns follow: (1) the initial 13 campaigns announced on January 31, 2017; (2) followed by 11 campaigns announced on November 3, 2017; (3) five campaigns announced on March 13, 2018; six campaigns announced on May 21, 2018; and five campaigns announced on July 2, 2018.

The following five new LB&I campaigns are listed by title and description:

Section 199 – Claims Risk Review

Public Law 115-97 repealed the Domestic Production Activity Deduction (DPAD) for taxable years beginning after December 31, 2017. This campaign addresses all business entities that may file a claim for additional DPAD under Internal Revenue Code (IRC) Section 199. The campaign objective is to ensure taxpayer compliance with the requirements of IRC Section 199 through a claim risk review assessment and issue-based examinations of claims with the greatest compliance risk.

Syndicated Conservation Easement Transactions

The IRS issued Notice 2017-10, designating specific syndicated conservation easement transactions as listed transactions, requiring disclosure statements by both investors and material advisors.

This campaign is intended to encourage taxpayer compliance and ensure consistent treatment of similarly situated taxpayers by ensuring the easement contributions meet the legal requirements for a deduction, and the fair market values are accurate. The initial treatment stream is issue-based examinations. Other treatment streams will be considered as the campaign progresses.

Foreign Base Company Sales Income: Manufacturing Branch Rules

In general, foreign base company sales income (FBCSI) does not include income of a controlled foreign corporation (CFC) derived in connection with the sale of personal property manufactured by such corporation. However, if a CFC manufactures property through a branch outside its country of incorporation, the manufacturing branch may be treated as a separate, wholly owned subsidiary of the CFC for purposes of computing the CFC’s FBCSI, which may result in a subpart F inclusion to the U.S. shareholder(s) of the CFC.

The goal of this campaign is to identify and select for examination returns of U.S. shareholders of CFCs that may have underreported subpart F income based on certain interpretations of the manufacturing branch rules. The treatment stream for the campaign will be issue-based examinations.

1120F Interest Expense/Home Office Expense

This campaign addresses compliance on two of the largest deductions claimed on Form1120-F, U.S. Income Tax Return of a Foreign Corporation. Treasury Regulation Section 1.882-5 provides a formula to determine the interest expense of a foreign corporation that is allocable to their effectively connected income. The amount of interest expense deductions determined under Treasury Regulation Section 1.882-5 can be substantial. Treasury Regulation Section 1.861-8 governs the amount of home office expense deductions allocated to effectively connected income. Home office expense allocations have been observed to be material amounts compared to the total deductions taken by a foreign corporation.

The campaign compliance strategy includes the identification of aggressive positions in these areas, such as the use of apportionment [...]

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IRS Announces That CAP Will Continue

By and on Aug 28, 2018
Posted In , , , , , , ,

On August 27, 2018, the Internal Revenue Service (IRS) announced that the Compliance Assurance Process (CAP) program will continue, with some modifications.  As we previously discussed, the IRS began an assessment of the CAP program in August 2016 to determine if any recalibration was needed.

CAP is an IRS program that seeks to identify and resolve tax issues through open, cooperative, and transparent interaction between the IRS and Large Business and International (LB&I) taxpayers prior to the filing of a return.  The goal of CAP is greater certainty of the treatment of tax positions sooner and with less administrative burden than conventional post-file audits.  The program began in 2005, and became permanent in 2011.  Several notable taxpayers publically disclose their involvement in the CAP program. (more…)



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