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Does Latest IRS Guidance Signal New Firm Stance on Research Credit Refund Claims?

On October 15, 2021, the Internal Revenue Service (IRS) issued a press release related to required information for valid research credit refund claims. The press release contains a link to a memorandum by two IRS employees, which will be used to evaluate such claims, and states that there will be a grace period (until January 10, 2022) before such information will be required to be included with timely filed research credit refund claims.

The guidance referred to in the press release is from the IRS’s Office of the Chief Counsel, Memorandum 20214101F (the IRS Research Memo) dated September 17, 2021, which focuses on administrative claims for refunds respect to the Internal Revenue Code (IRS) section 41 research credit.

First, we recommend reviewing the IRS Research Memo because it does a good job explaining the necessary elements to claim the credit. Second, the IRS Research Memo is a good reminder that the first requirement is to file a refund claim that is sufficiently detailed in order to give the IRS notice on both the technical and factual basis of the refund claim. In the context of the IRC Section 41 credit, the IRS Research Memo provides the following as minimum requirements for a refund claim:

  • Identify all the business components to which the IRC Section 41 research credit claim relates for the year for which a refund is sought.
  • For each business component:
    • Identify all research activities performed
    • Identify all individuals who performed each research activity
    • Identify all the information each individual sought to discover
  • Provide the total qualified employee wage expenses, total qualified supply expenses and total qualified contract research expenses for the claim year (this may be done using Form 6765, Credit for Increasing Research Activities).
  • The refund claim must be signed under penalties of perjury attesting to the veracity of the facts and information stated therein.
  • Supporting facts should be in the form of a written statement and merely incorporated by reference to documents attached to the claim.
  • The refund claim must be filed within the period of limitations stated in IRC Section 6511. Typically, taxpayers must file a valid claim within three years of the date Form 1040 or Form 1120 was filed or two years from the time the tax was paid—whichever period expires later.

Importantly, the IRS Research Memo does not advise taxpayers on how much information the IRS believes is sufficient to make a valid claim for refund. The IRS Research Memo does, however, highlight some recent court decisions where taxpayers were denied a refund because they did not include sufficient facts in their IRC Section 41 refund claim. In those cases, the courts ruled that the refund claims were defective and untimely.

Practice Point: The IRS Research Memo is a good reminder that when it comes to refund claims, generally, more description and detail is better. Interestingly, if the taxpayer had claimed a research credit on the original return, there would be [...]

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IRS Provides Guidance on Reliance of FAQs for Penalty Protection Purposes

On October 15, 2021, the Internal Revenue Service (IRS) issued a news release and fact sheet for IRS Frequently Asked Questions (FAQs), which are typically posted on the IRS’s website. The purpose of the fact sheet is to confirm and explain the extent to which FAQs can be relied upon for purposes of avoiding civil tax penalties. (For a primer on penalties and defenses, see our prior article in the Tax Executive.)

The Internal Revenue Code and Treasury Regulations, along with relevant case law, provide rules on what can (and cannot) be relied upon for penalty protection purposes. The most common penalty defenses are reasonable basis (sometimes coupled with a disclosure requirement), substantial authority and reasonable cause. Substantial authority is an objective standard, and Treasury Regulation § 1.6662-4(d)(3)(i) contains a laundry list of such authorities. Absent from this list are IRS FAQs. Reasonable basis has generally been viewed as an objective standard as well (at least outside the US Court of Appeals for the Eighth Circuit), and satisfaction of the substantial authority standard suffices for reasonable basis purposes. Reasonable cause is a subjective standard based on consideration of all the facts and circumstances, with the most important factor being the extent to which the taxpayer took steps to determine their proper tax liability.

For many years, taxpayers and practitioners have debated the value of IRS FAQs. On the one hand, they provide much needed guidance that can be helpful to taxpayers. On the other hand, FAQs are not published in the Internal Revenue Bulletin, are not treated as precedential or binding on the IRS and may be removed or changed by the IRS at any time (without any repository available to find prior versions of FAQs). The IRS relies heavily on FAQs to provide immediate guidance to taxpayers—sometimes in the form of substantive guidance—but has historically disclaimed any ability for taxpayers to rely on its FAQs or for IRS personnel to follow its FAQs. This has led to uncertainty in the tax community as to whether (and to what extent) taxpayers can and should follow IRS FAQs for both substantive positions and penalty protection purposes.

Prior to his return to private practice earlier this year, former IRS Chief Counsel Michael Desmond noted the need for better transparency and permanency around certain IRS FAQs. That transparency and permanency has finally arrived, although the weight of its value still remains uncertain. In the new release and fact sheet, the IRS announced as follows:

FAQs are a valuable alternative to guidance published in the Bulletin because they allow the IRS to more quickly communicate information to the public on topics of frequent inquiry and general applicability. FAQs typically provide responses to general inquiries rather than applying the law to taxpayer-specific facts and may not reflect various special rules or exceptions that could apply in any particular case. FAQs that have not been published in the Bulletin will not [...]

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Show Me the Money: IRS Introduces Webpage for Large Refunds Subject to JCT Review

When we previously wrote about the Joint Committee on Taxation’s (JCT) process for reviewing refund claims granted by the Internal Revenue Service (IRS), we explained that the IRS generally must submit proposed refunds in excess of $5 million for corporate taxpayers and $2 million for all other taxpayers to the JCT before any such refunds can be paid. However, getting through the JCT review process can be difficult and time-consuming in some situations—and sometimes taxpayers are left in the dark.

On September 22, 2021, the IRS announced the launch of its new webpage that provides information to taxpayers whose large refunds are subject to JCT review. Topics covered include general information about how a JCT review matter arises and how the IRS handles a JCT review case.

Practice Point: The IRS’s new webpage provides a helpful general overview of the JCT review process but does not provide any new information on it. A more detailed discussion of the JCT review process can be found in our prior post and in the JCT’s 2019 process overview.




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.




Tax Court Holds IRS Chief Counsel Attorneys May Make Initial Penalty Determination

In general, section 6751 requires that a supervisor give written approval before penalties can be asserted against a taxpayer. In Koh v. Commissioner, T.C. Memo. 2020-77, authored by the US Tax Court’s (Tax Court) most recent addition—Judge Travis Greaves—the Tax Court affirmed that an attorney from Internal Revenue Service (IRS) Chief Counsel may be authorized to assert such penalties in an answer to a Tax Court petition.

In Koh, the IRS sent the taxpayer a notice of deficiency that included a determination related to penalties under section 6662(j). The taxpayer filed a petition with the Tax Court contesting the IRS’s determination. In its answer, the IRS Chief Counsel attorney asserted that the taxpayer was liable for accuracy-related penalties under section 6662(b)(1) or (2), in the alternative to the section 6662(j) penalties assessed in the original deficiency notice.

The taxpayer sought partial judgment on the pleadings on the grounds that IRS Chief Counsel attorneys are not authorized to assert penalties in the answer. Under section 6751(b)(1), a penalty may not be assessed unless the “the initial determination of such assessment” was “personally approved (in writing) by the immediate supervisor of the individual making such determination.”

The Tax Court reasoned that as the IRS’s representative, the Chief Counsel attorney (or a delegate) may assert additional penalties in an answer to a Tax Court petition. Moreover, the Tax Court ruled that Chief Counsel attorneys had authority to assert penalties in an answer in Roth v. Commissioner, T.C. Memo. 2017-248, aff’d, 922 F.3d 1126 (10th Cir. 2019). That opinion was based on numerous cases holding that the IRS may assert penalties in an answer. However, Roth pre-dated the Tax Court’s opinion in Clay v. Commissioner, 152 T.C. 223 (2019), which cited US Court of Appeals for the Second Circuit authority for the proposition that “written approval is required no later than the issuance of the notice of deficiency rather than the assessment of the tax.”

Practice Point: Taxpayers continue to face risk from penalties being asserted for the first time in an answer in a Tax Court Proceeding. We believe that there is a strong likelihood that Koh will be appealed to the US Court of Appeals for the Third Circuit. We will continue to follow new developments related to penalties and the supervisory approval requirement.




Weekly IRS Roundup November 4 – 8, 2019

Presented below is our summary of significant Internal Revenue Service (IRS) guidance and relevant tax matters for the week of November 4–8, 2019.

November 4, 2019: The IRS posted a new Large Business and International active compliance campaign on Section 965 transition tax as enacted under the 2017 TCJA. The IRS stated that the goal of the campaign is to promote compliance with Section 965. The treatment stream will include conducting examinations as well as providing technical assistance to teams on Section 965, with a focus on identifying and addressing taxpayer populations with potential material compliance risk. The IRS anticipates that returns selected as part of the Section 965 campaign will also be risked and, if appropriate, examined for other material issues, especially issues related to TCJA planning.  For our coverage of this campaign, see here.

November 6, 2019: The IRS issued a Revenue Procedure and a News Release announcing the tax year 2020 annual inflation adjustments for more than 60 tax provisions, including the tax rate schedules and other tax changes. The tax year 2020 adjustments are generally used on tax returns filed in 2021.

November 8, 2019: The IRS published Proposed Regulations providing guidance relating to the life expectancy and distribution period tables that are used to calculate required minimum distributions from qualified retirement plans, individual retirement accounts and annuities, and certain other tax-favored employer-provided retirement arrangements. The life expectancy tables and applicable distribution period tables were developed based on mortality rates for 2021 and would provide longer life expectancies than the tables in the existing regulations. Public comments regarding the contemplated rules must be received by January 7, 2020.

November 8, 2019: The IRS released a Revenue Procedure providing the list of automatic changes to which the automatic change procedures in Revenue Procedure 2015-13, as clarified and modified by other listed guidance. The revenue procedure is effective for a Form 3115 filed on or after November 8, 2019, for a year of change ending on or after March 31, 2019. It supersedes the previous list in Rev. Proc. 2018-31.

November 8, 2019: The IRS released its weekly list of written determinations (e.g., Private Letter Rulings, Technical Advice Memorandums and Chief Counsel Advice).

Special thanks to Robbie Alipour and Jenni Saperstein in our Chicago office for this week’s roundup.




IRS Issues Transition Tax Compliance Campaign

On November 4, 2019, the Internal Revenue Service (IRS) announced a new Large Business and International (LB&I) compliance campaign regarding Section’s 965 transition tax under the Tax Cuts and Jobs Act (TCJA). This is one of several dozen compliance campaigns that LB&I has announced since the initial 13 campaigns were identified in 2017, and is part of LB&I’s larger goals of improving return selection, identifying issues representing a risk of noncompliance and making the greatest use of limited resources. We have written at length regarding the IRS’s campaigns. Click here for prior coverage of the IRS’s campaigns. This announcement comes just over a month after the Treasury Inspector General for Tax Administration (TIGTA) issued a report questioning the effectiveness and efficiency of campaign issue selection. We wrote about the TIGTA report here. The IRS is presumably heeding TIGTA’s recommendation and is focused on Section 965 because of the substantial dollars associated with compliance. A list of all campaigns can be found here (the newest campaign is found under the tab “IRC 965”).

Section 965 was part of tax reform in the TCJA. It generally imposes a transition tax on a US shareholder’s pro rata share of accumulated earnings and profits of certain foreign corporations, as if those earnings had been repatriated to the US. The new campaign will focus examinations on US-based multinational companies’ 2017 and 2018 returns to ensure compliance with the transition tax in Section 965. The campaign will also provide technical assistance to IRS teams working on Section 965 issues, with a focus on identifying and addressing taxpayer populations with potential material compliance risk.

Practice Point: Multinational taxpayers should be mindful of this new campaign and aware of any compliance issues they may face. Taxpayers should be aware that returns selected for the transition tax campaign will also be examined for other material issues, especially those related to TCJA planning.




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

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…)




Taxpayers Should Prepare for the Next Penalty Battleground

The IRS is using a new tool from its arsenal to enforce compliance for tax refund and credit claims: the Internal Revenue Code Section 6676 penalty. Taxpayers and their advisers need to be aware of the mechanics of this penalty and how best to avoid it being sustained.

Andrew R. Roberson, Kevin Spencer and Evan Walters authored a comprehensive article on IRC Section 6676. They discuss:

  • The origins of IRC Section 6676
  • How to contest the penalty and privilege concerns
  • What taxpayers who are considering filing—or have already filed—refund claims should keep in mind now that the penalty is the IRS’s favorite new compliance tool

Read the article here.




Weekly IRS Roundup March 25 – 29, 2019

Presented below is our summary of significant Internal Revenue Service (IRS) guidance and relevant tax matters for the week of March 25 – 29, 2019.

March 25, 2019: The IRS issued Proposed Regulations under Section 301 of the code updating existing regulations to reflect changes made by the Technical and Miscellaneous Revenue Act of 1988.

March 25, 2019: The IRS issued Proposed Regulations partially withdrawing and re-proposing 2016 proposed regulations addressing transactions where property of a corporation becomes property of a real estate investment trust (REIT) following certain corporate distributions of controlled corporation stock.

March 26, 2019: The IRS issued Notice 2019-22 announcing the phase out of the Section 30D plug-in electric drive motor vehicle credit for purchasers of eligible General Motors’ vehicles beginning April 1, 2019.

March 27, 2019: The IRS issued Announcement 2019-03 providing an annual report on advance pricing agreements and the Advance Pricing and Mutual Agreement Program.

March 28, 2019: The IRS withdrew proposed regulations (REG-143686-07) that provided guidance on the allocation and recovery of basis in corporate stock redemptions under Section 301 of the code.

March 28, 2019: The IRS issued Revenue Procedure 2019-15 providing a waiver from time requirements for individuals electing to exclude their foreign earned income who must leave a country due to war, civil unrest or similar circumstances.

March 28, 2019: The IRS issued Notice 2019-24 providing adjustments to the limitation on housing expenses under Section 911 of the code.

March 29, 2019: The IRS issued Revenue Ruling 2019-11 providing guidance to taxpayers regarding the inclusion in income of recovered state and local taxes in the current year when the taxpayer deducted state and local taxes paid in a prior year.

March 29, 2019: The IRS withdrew proposed regulations (REG-124627-11) that provided guidance on the continuity of interest requirement under Section 368 of the code.

Special thanks to Terence McAllister in our New York office for this week’s roundup.




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