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IRS Changes Position on Approval for Assertion of Codified Economic Substance Doctrine

In March 2010, Congress codified the economic substance doctrine in Internal Revenue Code (Code) Section 7701(o). The codification clarified that a conjunctive analysis applies in determining if the doctrine applies. The codified economic substance doctrine applies when a transaction does not have economic substance or lacks a business purpose. When the doctrine applies, a taxpayer is subject to a 20% strict liability penalty (40% in the case of undisclosed transactions) on any underpayment attributable to the disallowed tax benefit claimed.

Congress acknowledged that the codified economic substance doctrine should be applied sparingly, and the Joint Committee on Taxation, in a report issued prior to the enactment of the doctrine, provided detailed guidance on when the doctrine should apply. The Internal Revenue Service (IRS) issued guidance shortly after the codification acknowledging these points. The IRS also put in place detailed procedures for examiners to follow in determining whether to assert the codified economic substance doctrine.

One of the procedures put in place was the approval by the Director, Field Operation before the codified economic substance doctrine could be formally asserted. An approval request was to be made after consultation with the revenue agent’s manager and local counsel. Additionally, taxpayers were to be provided “the opportunity to explain their position.”

On April 22, 2022, the IRS’s Large Business & International (LB&I) Division issued a memorandum—LB&I-04-0422-0014—to all LB&I and Small Business/Self Employed examination employees (Updated Guidance). The Updated Guidance removes the requirement to obtain executive approval before asserting the codified economic substance doctrine. The Updated Guidance states that this change aligns penalties for lack of economic substance with other assessable penalties which do not require executive approval. However, the changes do not remove the supervisory approval requirement under Code Section 6751.

In connection with the Updated Guidance, revisions are being made to the relevant provisions of the Internal Revenue Manual (IRM). The IRM revisions eliminate some of the considerations previously set forth in the four-step process that revenue agents were required to undertake in determining whether the doctrine should be applied.

Practice Points: Although the Updated Guidance has no impact on the substance of the codified economic substance doctrine itself, the change is disappointing news. As a result of the relaxed rules for the doctrine’s assertion, taxpayers can reasonably assume that the doctrine may more frequently be asserted on audit. Thus, it is now even more important to properly document transactions to demonstrate they have sufficient economic substance and a business purpose.




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.




Weekly IRS Roundup December 9 – 13, 2019

Presented below is our summary of significant Internal Revenue Service (IRS) guidance and relevant tax matters for the week of December 9 – 13, 2019.

December 10, 2019: The IRS issued a notice providing that the requirement to report partners’ shares of partnership capital on the tax basis method will not be effective for 2019 for partnership taxable years beginning in calendar 2019. Instead, the requirements will be effective beginning in 2020 (for partnership taxable years that begin on or after January 1, 2020). The notice also defines a partner’s share of “net unrecognized Section 704(c) gain or loss” for purposes of partnership reporting.

December 10, 2019: The Joint Committee on Taxation released a report detailing proposed provisions of the “Restoring Tax Fairness for States and Localities Act.” The bill would increase the maximum state and local tax deduction that married couples can claim in 2019 and would eliminate the limitations on the maximum state and local tax deduction in 2020 and 2021. The bill would also increase the top marginal individual income tax rate under temporary rules.

December 11, 2019: The IRS issued a notice providing guidance on the corporate bond monthly yield curve, the corresponding spot segment rates used under section 417(e)(3), and the 24-month average segment rates under section 430(h)(2). The notice also provides guidance regarding both the interest rate on 30-year Treasury securities under section 417(e)(3) as well as the 30-year Treasury weighted average rate under section 431(c)(6).

December 13, 2019: The IRS issued proposed regulations that provide amendments to regulations under sections 162, 164 and 170 of the IRC. The proposed regulations reflect current law regarding the application of section 162 to a taxpayer that makes a payment or transfer to an entity described in section 170(c) for a business purpose; the regulations also provide safe harbors under section 162 to provide certainty for such payments. The regulations also provide a safe harbor under section 164 for payments made to an entity described in section 170(c) by individuals who itemize deductions and receive or expect to receive a state or local tax credit in return. The proposed regulations are scheduled to be published in the Federal Register on December 17, 2019. Public comments regarding the contemplated rules must be received by January 31, 2020.

December 13, 2019: The IRS released a revenue procedure clarifying that all plan amendments that both relate to a plan’s hardship distribution provisions and that are effective no later than January 1, 2020, shall be treated as integral to the required amendments under newly-updated sections 401(k) and 401(m). The revenue procedure also extended the deadline for pre-approved plans to adopt an interim amendment relating to those regulations.

December 13, 2019: The IRS released a revenue ruling providing that the base period T-bill rate for the period ending September 30, 2019, is 2.32%. Section 995(f)(1) of the IRC provides that a shareholder of a domestic international sales corporation (a “DISC”) shall pay annual interest equal to [...]

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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.




Joint Committee Releases Overview of Its Refund Review Process

Clients ask us all of the time, “What is the Joint Committee on Taxation’s (JCT) process for reviewing refund claims granted by the Internal Revenue Service (IRS)?” Recently, the JCT has released an overview of its process. Wait, what? After the IRS has agreed to issue you a refund, there is a congressional committee that has to check the IRS’s work? Yep!

Internal Revenue Code (IRC) §6405 prohibits the IRS/US Department of the Treasury from issuing certain refund payments to taxpayers until 30 days after a “report” is given to the JCT. Only refunds “in excess” of $5 million for corporate taxpayers and $2 million for all other taxpayers (partnerships, individuals, trusts, etc.) are required to be reported to the JCT. A refund claim is an amount listed on an amended return (e.g., Forms 1140X and 1120X), tentative carrybacks (e.g., Forms 1139 and 1045), and refunds attributable to certain disaster losses. Numerous types of refund payments are excepted from JCT review, including refunds claimed on originally filed returns, resulting from litigation and employment taxes. It is important to note that this process is not limited to the IRS Examination stage; it can also occur at the IRS Appeals stage or even in tax court litigation. (more…)




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