Wrapping up July—and Looking Forward to August

Tax Controversy Activities in August:

August 7, 2017: Elizabeth Erickson and Kristen Hazel will be representing McDermott Will & Emery at the 2017 US Captive Awards in Burlington, Vermont. McDermott has been shortlisted in the Law Firm category.

August 8, 2017: Tom Jones is presenting an update on Captive Insurance Tax in Burlington, Vermont, at the Vermont Captive Insurance Association Annual Conference “Mission: Possible”— the largest captive insurance conference in the US by number of paid attendees.

August 18, 2017: Todd Welty is speaking at the Texas Society of Certified Public Accountants Advanced Estate Planning Conference about:

  • Current developments in federal transfer taxes
  • Current state of federal tax reform
  • Proposed changes to state death tax laws and the impact of those changes on estate
  • Gift and trust planning
  • Consistent basis regulations
  • The state of valuation discounts
  • Recent rulings on defined value clauses and charitable gifts

August 23, 2017: Tom Jones is presenting an update on Annual Federal & State Tax at the North Carolina Captive Insurance Association Annual Conference in Charlotte, North Carolina.

Wrapping up July:

Our July 2017 blog posts are available on taxcontroversy360.com, or read each article by clicking on the titles below. To receive the latest on state and local tax news and commentary directly in your inbox as they are posted, click here to subscribe to our email list.

July 14, 2017: Tracking Tax Guidance and Court Cases

July 17, 2017: New IRS CbC Resource

July 18, 2017: Courts Rejects Challenge to OVDP Transition Rules

July 19, 2017: Tax Court Rejects IRS Reliance on “Cursory” Analysis in Revenue Ruling

July 21, 2017: John Doe Intervenes in Virtual Currency Summons Enforcement Case

July 24, 2017: BEWARE: Whistleblowers Can “Out” You to the IRS!

July 26, 2017: Virtual IRS Appeals – A New Frontier?

July 27, 2017: IRS Rules (Again) That Taxpayers Are Not Entitled to Claimed Refined Coal Credits

July 28, 2017: Tax Court Hands Eaton a Complete Victory on the Cancellation of its Advance Pricing Agreements

July 31, 2017: Senate Attempts to Repeal Chevron Deference

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 response to the Tax Court’s opinion in the Shea Homes case (available here.

  • TEFRA Linkage Plan Strategy

This campaign is focused on developing new procedures and technology to work collaboratively with revenue agents conducting TEFRA partnership examinations to identify, link, and assess tax to terminal investors that pose the most significant compliance risk.

  • S Corporation Losses Claimed in Excess of Basis

This campaign is in response to LB&I’s views that shareholders in S corporations may be claiming losses and deductions in excess of stock or debt basis.

International Campaigns

  • Repatriation

This campaign focuses on tax transactions that LB&I believes are being used for purposes of tax-free repatriation of funds into the U.S. in the mid-market population.  The goal of the campaign is to improve issue selection filters while conducting examinations on identified, high risk repatriation issues to increase taxpayer compliance.

  • Form 1120-F Non-Filer

This campaign is designed to identify and contact foreign companies doing business in the United States that are not meeting their Form 1120-F filing obligations.  The goal is to increase voluntary compliance, starting with soft letter outreach and escalating to examinations.

  • Inbound Distributor

This campaign addresses transfer pricing in the context of United States distributors of goods sourced from foreign-related parties that may have reported gains or losses that are no commensurate with the functions performed and the risk assumed.  This campaign, along with the captive insurance and basketing campaigns, were among those announced last summer by LB&I.

  • OVDP Declines-Withdrawals

This campaign addresses situations where taxpayers that have sought to enter the Offshore Voluntary Disclosure Program (OVDP) have been either denied access to OVDP or have withdrawn from OVDP. After seven years of the program, with a number of very old offshore cases still unresolved, this campaign appears to be the first formal effort to deal with rejected OVDP cases in an expressly coordinated manner.  It will be interesting to see how this campaign develops in light of recent suggestions that the formal OVDP may be nearing an end.

Practice Point: Taxpayers with any of the above issues should be prepared for focused audits directed at the issue and would be well-served preparing in advance for audits. The above is the “initial” list of the IRS’s focused examination program.  Taxpayers should be prepared for the roll-out of additional IRS “campaigns” in the coming months.  It is clear that the IRS is mounting a coordinated attack, leveraging its ever-shrinking resources in overly complicated tax-environment.

The recently released regulations under Internal Revenue Code Section 385, addressing the circumstances under which related company debt will be classified as equity for federal income tax purposes, will have a significant impact on not only federal taxes but also on state and local taxes. For a more detailed discussion of these implications by our own Peter Faber, please see here.

On April 11, 2016, the US Tax Court issued its T.C. opinion in Ax v. Commissioner.  The notice of deficiency in the case determined that certain premium payments made to a captive insurance company were not established by the taxpayer to be (1) insurance expenses and (2) paid.  But this is not a run of the mill captive insurance case—at least not yet.

The Internal Revenue Service (IRS) moved for leave to amend its answer in the case to assert additionally that (1) the taxpayers’ captive insurance arrangement lacked economic substance and (2) amounts paid as premiums were neither ordinary nor necessary (and to allege facts in support of both assertions).  The taxpayers opposed, citing Mayo Foundation for Med. & Educ. Research v. United States, 562 U.S. 44, 55 (2011), and arguing that the Administrative Procedure Act (APA) and SEC v. Chenery, 318 U.S. 80 (1943) barred the IRS from “raising new grounds to support [the IRS’s] final agency action beyond those grounds originally stated in the notice of final agency action.”  The taxpayers also argued that the IRS’s new assertions constituted “new matters” that did not meet required heightened pleading standards under the Tax Court’s Rules of Practice and Procedure.  Ultimately, the Tax Court sided with the IRS.

Continue Reading Ax v. Commissioner: The Tax Court Reaffirms that It Is Not Subject to the APA