IRS Rolls Out Campaigns Showing the Future of Tax Examinations

On January 31, 2017, the Large Business & International division of the IRS rolled out the latest phase in a new effort aimed at improving compliance and updating the agency’s approach to taxpayer examinations. Originally announced in September 2015, the changes first took effect in early 2016 and included the centralization of leadership within the division, which was previously segregated between international and domestic issues.

Additionally, LB&I’s previous industry-based subdivisions were replaced with nine practice areas including five based on subject focus ( pass-through entities, enterprise activities, cross-border activities, withholding and international individual compliance, and treaty and transfer pricing operations) and four based on geography (western, capital, eastern, and northeastern).

To align with these changes, LB&I intends to shift its focus away from general examinations to targeted ones reviewing compliance for specific tax issues. These focused issues have been encompassed within “campaigns” designed to identify higher risk areas of non-compliance, improve return selection for examinations, and make the greatest use of limited resources. “Treatment streams” to address each campaign may include “soft” letters to taxpayers requesting compliance, publishing new guidances, additional training for revenue agents, outreach to practitioners, and issue-focused examinations.

Following is a summary of the first 13 campaigns, excerpted from the IRS website, which rolled out last month:

IRC Sec. 48C Energy Credit Campaign

This campaign ensures that only those 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. These credits must be pre-approved through extensive application to the DOE. The treatment stream for this campaign will be soft letters and issue-focused examinations.

OVDP Declines-Withdrawals Campaign

The Offshore Voluntary Disclosure Program (OVDP) allows U.S. taxpayers to voluntarily resolve past non-compliance related to unreported offshore income and failure to file foreign information returns. This campaign addresses OVDP applicants who applied for pre-clearance into the program but were either denied access to OVDP or withdrew from the program of their own accord. Taxpayers who have yet to resolve their non-compliance and who meet the eligibility criteria are encouraged to consider entering one of the offshore programs currently available. The IRS will address continued non-compliance through a variety of treatment streams including examination.

Domestic Production Activities Deduction, Multi-Channel Video Program Distributors (MVDP’s) and TV Broadcasters Campaign

Multi-channel video programing distributors (MVPDs) and TV broadcasters often claim “groups” of channels or programs as a qualified film eligible for the IRC Section 199 deduction. Taxpayers are asserting that they are the producers of a qualified film when distributing channels and subscriptions packages that often include third-party produced content. Additionally, MVPD taxpayers maintain that they provide online access to computer software for customers’ direct use (incident to taxpayers’ transmission activities, including customers’ use of the set-top boxes). LB&I has developed a strategy to identify taxpayers impacted by these issues and will develop training to aid revenue agents in examining them. The treatment streams for this campaign include the development of an externally published practice unit, potential published guidance, and issue-based exams, when warranted.

Micro-Captive Insurance Campaign

This campaign addresses transactions described in Transactions of Interest Notice 2016-66, in which a taxpayer attempts to reduce aggregate taxable income using contracts treated as insurance contracts and a related company that the parties treat as a captive insurance company. Each entity that the parties treat as an insured entity under the contracts claims deductions for insurance premiums. The manner in which the contracts are interpreted, administered, and applied is inconsistent with arm’s length transactions and sound business practices. LB&I has developed a training strategy for this campaign. The treatment stream for this campaign will be issue-based examinations.

Related Party Transactions Campaign

This campaign focuses on transactions between commonly controlled entities that provide taxpayers a means to transfer funds from the corporation to related pass-through entities or shareholders. LB&I is allocating resources to this issue to determine the level of compliance in related party transactions of taxpayers in the mid-market segment. The treatment stream for this campaign is issue-based examinations.

Deferred Variable Annuity Reserves & Life Insurance Reserves IIR Campaign

The IRS and Chief Counsel have agreed to accept the Deferred Variable Annuity Reserves and Life Insurance Reserves issues into the IIR program (pursuant to Rev. Proc. 2016-19) in order to develop guidance to address uncertainties on issues important to the life insurance industry. The issues include amounts to be taken into account in determining tax reserves for both deferred variable annuities with guaranteed minimum benefits, and life insurance contracts. The campaign’s objective is to collaborate with industry stakeholders, Chief Counsel and Treasury to develop published guidance that provides certainty to taxpayers regarding these related issues.

Basket Transactions Campaign

This campaign addresses structured financial transactions described in Notices 2015-73 and 74, in which a taxpayer attempts to defer and treat ordinary income and short-term capital gain as long-term capital gain. The taxpayer treats the option or other derivative as open until a barrier event occurs and, therefore, does not recognize or report current period gains. The gains are deferred until the contract terminates, at which time the overall net gain is reported as a long-term capital gain. LB&I has developed a training strategy for this campaign. The treatment streams for this campaign will be issue-based examinations, soft letters to material advisors, and practitioner outreach.

Land Developers – Completed Contract Method (CCM) Campaign

Large land developers that construct in residential communities may be improperly using the Completed Contract Method (CCM) of accounting. A developer whose average annual gross receipts exceed $10 million may only use the CCM under a home construction contract. In some cases, developers are improperly deferring all gain until the entire development is completed. LB&I will provide training for revenue agents assigned to work on this issue. The treatment stream includes a practice unit, soft letters, and follow-up with issue-based examinations when warranted.

TEFRA Linkage Plan Strategy Campaign

As partnerships have become larger and more complex, LB&I has regularly revised processes to assess tax on the terminal investors. Recent legal advice provides an opportunity to make significant changes to how this process is approached. This campaign focuses on developing new procedures and technology to work collaboratively with the revenue agent conducting the TEFRA partnership examination to identify, link, and assess tax to the terminal investors that pose the most significant compliance risk.

S Corporation Losses Claimed in Excess of Basis Campaign

S corporation shareholders report income, losses, and other items passed through from their corporations. The law limits losses and deductions to their basis in the corporation. LB&I has found that shareholders claim losses and deductions to which they are not entitled because they do not have sufficient stock or debt basis to absorb these items. LB&I has developed technical content for this campaign that will aid revenue agents as they examine the issue. The treatment streams for this campaign will be issue-based examinations, soft letters encouraging voluntary self-correction, stakeholder outreach, and a new form to assist shareholders in properly computing their basis.

Repatriation Campaign

LB&I is aware of different repatriation structures being used for purposes of tax-free repatriation of funds into the U.S. in the mid-market population. It has also been determined that many taxpayers do not properly report repatriations as taxable events on their filed returns. The goal of this campaign is to simultaneously improve issue selection filters while conducting examinations on identified, high-risk repatriation issues, and thereby increase taxpayer compliance.

Form 1120-F Non-Filer Campaign

Foreign companies doing business in the U.S. are often required to file Form 1120-F. LB&I has data suggesting that many of these companies are not meeting their filing obligations. In this campaign, LB&I will use various external data sources to identify these foreign companies and encourage them to file their required returns. The treatment stream for this campaign will involve soft letter outreach. If the companies do not take appropriate action, LB&I will conduct examinations to determine the correct tax liability. The goal is to increase voluntary compliance by foreign corporations with a U.S. business nexus.

Inbound Distributor Campaign

U.S. distributors of goods sourced from foreign-related parties have incurred losses or small profits on U.S. returns, which are not commensurate with the functions performed and risks assumed. In many cases, the U.S. taxpayer would be entitled to higher returns in arms-length transactions. LB&I has developed a comprehensive training strategy for this campaign that will aid revenue agents as they examine this IRC Section 482 issue. The treatment stream for this campaign will be issue-based examinations.

Taxpayers who have entered or are planning to enter into a transaction addressed in one of the above campaigns should consider discussing with their tax advisors potential risk of inquiry from the IRS.

More campaigns will continue to be identified and launched in the coming months.

If you have any questions related to these campaigns and how they may affect your business, please contact your Marcum tax professional for assistance.