On March 1, 2017, the Internal Revenue Service (IRS) released a new International Practice Unit (IPU) summarizing foreign and domestic loss impacts on foreign tax credits (FTC). The IPU provides a summary of the law regarding worldwide taxation and FTC limitations, followed by explanations and analysis for IRS agents examining FTC issues. As we have noted previously, this high-level guidance to field examiners signals the IRS’s continued focus on international tax issues.
This week, the Internal Revenue Service (IRS) Criminal Investigation Division (CID) released its annual report for 2016, continuing a message sent for several years now: that IRS CID’s staffing declines are affecting its core mission tax work. Core mission tax work is distinguished from other types of IRS CID investigations—such as terrorism or health care fraud—where tax elements are not the central focus of the investigation. Over the past four years, since 2012, the division has lost 447 agents, and this loss has resulted in a decline in “core mission” prosecutions (485 fewer cases than in 2012).
Despite these challenges, IRS CID continues to possess a high success rate, with an incarceration rate at or around 80 percent for at least the last 4 years. In 2016, IRS CID initiated 3,395 investigations, down from 5,314 in 2013. Of those, 2,699 were sentenced, with an average sentence of 41 months.
Practice Point: The 2016 annual report is yet more documentation of the long-term decline in IRS CID investigations; however, practitioners and taxpayers cannot count on this trend continuing in the new administration. In his confirmation hearings, Steven Mnuchin, the new Treasury Secretary expressed concern about lowered IRS staffing levels overall, but it is unclear whether these comments will result in substantive changes to reverse this trend. In this report, IRS CID is sending a clear message that budget restrictions and staffing attrition are impacting the division’s core mission of encouraging voluntary compliance through criminal deterrence.
Here at McDermott, we value giving back to the community through pro bono efforts. In particular, we provide substantial assistance in pro bono tax cases to low-income individuals through our relationships with low-income taxpayer clinics throughout the country. Over the years, we have settled dozens of cases for low-income taxpayers in docketed tax cases and routinely reduced or eliminated deficiencies asserted by the Internal Revenue Service (IRS). When settlement has not been possible, we have litigated cases in the Tax Court and obtained favorable results not just for our clients but for the low-income taxpayer community as a whole. For example, we represented a husband and wife on a penalty issue involving an issue of first impression and convinced the Tax Court that the IRS had for years been improperly asserting and collecting penalties on improperly claimed refundable tax credits. In a recent article, we detail some of the pro bono efforts by low-income taxpayer clinics and private practitioners.
Practice Point: In addition to assisting low-income individuals who cannot afford legal representation, providing pro bono tax services benefits tax practitioners in many ways. It provides the opportunity for younger attorneys to take responsibility for a case and to get valuable experience in dealing with clients, negotiating with the IRS, and potentially gaining courtroom experience. Assisting taxpayers on a pro bono basis is also rewarding and can make a significant difference in the lives of low-income individuals.
The judicial substance-over-form doctrine provides the IRS with the ability to set aside carefully orchestrated tax planning arrangements to treat a transaction consistent with its substance. However, the doctrine does not give the Service carte blanche to deny tax benefits. In Summa Holdings, Inc. v. Commissioner, No. 16-1712 (available here), the Sixth Circuit overturned the Tax Court and declined to apply the substance-over-form doctrine when faced with taxpayers who, “to [their] good fortune, had the time and patience (and money) to understand how a complex set of tax provisions could lower [their] taxes” and “complied in full with the printed and accessible words of the tax laws.”
Summa Holdings involved a closely held corporation (Summa Holdings, Inc.) that supercharged the tax benefits provided by paying commissions to an interest charge domestic international sales corporation (IC-DISC) by having the IC-DISC owned by two Roth IRAs. While the dividends paid by the IC-DISC were taxable upon receipt, the dividend amounts (totaling $6 million over 7 years) were vastly larger than the annual contribution limits placed on Roth IRAs. For unfathomable reasons, the IRS did not challenge the $3,000 price that the Roth IRAs paid for the IC-DISC stock. Instead, the IRS asserted that that the substance of the arrangement was that the corporation paid dividends to its shareholders and the shareholders made excess contributions to the Roth IRAs.
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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On January 30, 2017, the Internal Revenue Service (IRS) released an International Practice Unit (IPU) on the use of a summons under IRC Section 6038A (IRC Section 6038A Summons) when a US corporation is 25-percent owned by a foreign shareholder. See IPU here. The IPU describes the steps that the IRS should take when issuing an IRC Section 6038A Summons, and what to do when the US corporation does not substantially comply with the summons.
In general, IRC Section 6038A imposes reporting and recordkeeping requirements (together with certain procedural compliance requirements) on domestic corporations that are 25-percent foreign-owned, which the regulations refer to as a domestic reporting corporation (DRC). Among other requirements, a DRC is required to keep permanent books of account or records per IRC Section 6001 that are sufficient to establish the correctness of the federal income tax return of the DRC, including information, documents, or records to the extent they may be relevant to determine the correct US tax treatment of transactions with related parties. See Treas. Reg. Section 1.6038A-3.
The IRS may issue an IRC 6038A Summons when: (i) the taxpayer under exam is a DRC; (ii) there was a transaction between the DRC and the 25 percent foreign shareholder or any foreign person related to the DRC or to such 25 percent foreign shareholder; and (iii) the DRC is appointed to act as a limited agent with respect to any request by the IRS to examine its records or produce testimony that may be relevant to the tax treatment of any transaction between the DRC and a foreign related party. If the DRC does not substantially comply in a timely manner with the IRC 6038A Summons, the IRS has sole discretion to determine the amount of the DRC’s deductions related to transactions with, and the cost of property purchased from (or transferred to), the foreign related party.
The IPU is particularly relevant in light of final regulations published in the Federal Register on December 13, 2016 (TD 9796) which treat a domestic disregarded entity wholly owned by a foreign person as a domestic corporation for purposes of the reporting, record maintenance and associated compliance requirements under IRC Section 6038A. The regulations are effective for tax years beginning after December 31, 2016, and ending on or after December 13, 2017. The IPU refers to these regulations in describing the criteria which must be met before the IRS issues an IRC Section 6038A Summons.
Practice Point: For US entities that are owned by foreign entities and file US tax returns, it is crucial to have all of the relevant information for the entity in the US. US taxpayers are required to support all of the positions claimed on a return. For example, if there are expenditures of the US entity that are paid for by the foreign affiliate, there should be adequate documentation in the US to support those payments.
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
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.
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.
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.
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.
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.
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.
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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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:
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.
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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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:
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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