Emerging Tax Issues Cause Due-Diligence Problems

By Ann Marie Maloney

From foreign accounts to health care, from marijuana businesses to captive insurance, emerging tax issues are presenting practitioners with thorny due-diligence problems. When it comes to issues like the Report of Foreign Bank and Financial Accounts (FBAR) and the Patient Protection and Affordable Care Act (PPACA), “ask more questions than you think you should,” advised Lee Martin, deputy director of the IRS’s Office of Professional Responsibility, in remarks to practitioners at the IRS Nationwide Forum on July 8 in Fort Washington, Md.

Martin reminded his listeners that several sections in Treasury Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), require practitioners subject to its provisions to exercise due diligence when providing tax services.

The growth of foreign accounts subject to disclosure has exploded over the past decade, according to the deputy director, citing data from FinCEN showing that FBAR filings exceeded 1 million for the first time in calendar year 2014, compared with approximately 280,000 filings in 2005.

Subsequent discoveries of foreign accounts that were supposed to be reported prompt some taxpayers to blame the preparer, Martin observed. He recommended that practitioners document questions they ask clients and develop a strong understanding of the requirements of related laws, including the Bank Secrecy Act and Form 8938, Statement of Specified Foreign Financial Assets.

PPACA is presenting similar challenges; preparers will need to probe to ensure they exercised due diligence in asking clients about insurance coverage and dependents. (See AICPA Insights, “Rules and Resources for ACA Due Diligence”). Martin ticked off the numerous publications the IRS has posted on PPACA, including Publications 5200, 5208, and 5215 for employers and 5209 for individuals. “After reading all those pubs, I’m sure you’ll want to find a pub,” he joked.

Advising businesses that dispense medical marijuana and preparing their tax returns is another area where Martin urged caution. He cited two Tax Court cases—Californians Helping to Alleviate Medical Problems (CHAMP) Inc., 128 T.C. 173 (2007), and Olive, 139 T.C. 19 (2012)—as examples of the different outcomes that are possible when tax benefits for these businesses are challenged. In CHAMP, the taxpayer achieved a partial victory when the Tax Court ruled against the IRS (which had disallowed most expenses), determining that Sec. 280E allowed the taxpayer to deduct expenses related to care giving, separating those expenses from expenses related to marijuana trafficking. Olive operated a retail establishment that, unlike CHAMP, did not provide services for sick individuals, and the court largely sided with the IRS. (In June, the AICPA released An Issue Brief on State Marijuana Laws and the CPA Profession, which discusses risk mitigation for practitioners. See also Gramlich and Houser, “Marijuana Businesses and Sec. 280E: Potential Pitfalls for Clients and Advisers,” 46 The Tax Adviser 524 (July 2015).)

What Martin spent more time on, however, was microcaptives. “The IRS is increasingly uncomfortable,” he said, with the growing number of smaller, closely held companies that are purchasing captive insurance, which is meant to provide coverage for nontraditional risks. However, it is often being promoted and bought as a way to lower taxable income with minimal or no substantiation, covering implausible, esoteric, or normal risks.

The number of microcaptives mushroomed from 500 in the 1980s to approximately 7,000 today, Martin noted, and Vermont appears to be the state of choice, accounting for over 1,000 licenses for microcaptives. As a sign of the IRS’s growing concern, this practice made it onto 2015’s “Dirty Dozen” tax scams that the agency publicizes each year, listed under abusive tax shelters.

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