The IRS Large Business and International division (LB&I) released an updated list of audit "campaigns" in November that expands the government's tax enforcement and administration efforts, especially in the international arena.
The total number of campaigns now stands at 24 separate issues, which includes the original 13 campaigns the IRS made public in January. These campaigns are part of the IRS's strategy to focus limited resources on areas of noncompliance, including a move toward more issue-based examinations of large and midsize businesses. In September 2015, the IRS announced that LB&I would restructure and focus on these issue-based examinations.
LB&I indicated that the restructuring was driven by four "guiding principles" of LB&I, including (1) a flexible, well-trained workforce; (2) the selection of better work; (3) tailored treatments; and (4) an integrated feedback loop. The IRS intends to meet not just the plain-letter meaning of each principle but, as a whole, to focus its efforts in a more concentrated manner on achieving tax administration effectiveness and compliance while dealing with an era of limited budgets and a diminished workforce.
The campaigns are designed to focus on taxpayer noncompliance and areas in which the IRS believes scrutiny is needed and to drive taxpayer behaviors. For example, an LB&I official recently said that one of its original campaigns, which focused on land developers and the completed-contract method of accounting, resulted in numerous filings of Form 3115, Application for Change in Accounting Method (Athanasiou, "LB&I Campaign Lessons and Selection Process Explained," 157 Tax Notes 1053 (Nov. 20, 2017)).
As originally described, the IRS held up the Offshore Voluntary Disclosure Program (OVDP) as an example of what a campaign may resemble. The OVDP addressed what the government believed was a systemic issue affecting tax administration, that of undisclosed foreign financial accounts, and approached the issue through a combination of examinations, tax enforcement efforts, and a compliance mechanism designed to allow account holders to come forward and disclose these accounts, pay a penalty, and avoid criminal prosecution. This approach of employing multiple "treatment streams" forms the basis of campaign enforcement.
The treatment streams the IRS considered range from informative (the issuance of internal and external guidance; so-called soft letters; and other public information) to action-based (such as examinations).
The IRS identifies the campaigns through agent referrals on topics, feedback from the taxpayer community, and data analysis. In connection with the release of the most recent group of campaigns, the IRS said more than 900 suggestions came from LB&I examiners. The IRS has not disclosed the methods by which it uses public and private data caches, but the government has discussed its role in better using data analytics for purposes of determining campaigns.
For its latest round of campaigns, the IRS identified the following seven international issues:
- Form 1120-F Chapters 3 and 4 withholding: This campaign is designed to verify withholding at source for filers of a Form 1120-F, U.S. Income Tax Return of a Foreign Corporation, claiming tax refunds by ensuring withholding agents have filed required Forms 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons,1042-S, Foreign Person's U.S. Source Income Subject to Withholding,8804, Annual Return for Partnership Withholding Tax (Section 1446), 8805, Foreign Partner's Information Statement of Section 1446 Withholding Tax,8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests, and 8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests. The treatment stream for this campaign is varied and includes examinations.
- Swiss Bank Program: In 2013, the Department of Justice began its Swiss Bank Program, which offered Swiss banks an opportunity to resolve potential criminal liabilities for facilitating tax evasion. Seventy-eight banks ultimately settled issues with the U.S. government, obligations under which included detailing account information of U.S. persons. This campaign will seek to address noncompliance of taxpayers who may be beneficial owners of those accounts, with a treatment stream including, but not limited to, examinations.
- Foreign-earned income exclusion: This campaign focuses on individuals who claimed the foreign-earned income exclusion and/or foreign housing exclusions or deductions, but may not necessarily be eligible for those deductions or exclusions from income. The treatment stream for this campaign includes examinations.
- Verification of Form 1042-S credit claimed on Form 1040NR: This campaign is intended to ensure the amount of withholding credits or refunds claimed on Forms 1040NR, U.S. Nonresident Alien Income Tax Return, is verified and whether the taxpayer has properly reported the income reflected on Form 1042-S. The campaign will address noncompliance through a variety of treatment streams including, but not limited to, examinations.
- Corporate direct Sec. 901 foreign tax credit: This campaign is the first of several to come, according to the IRS, and will focus on domestic corporate taxpayers that elect to take the foreign tax credit (FTC) in lieu of a deduction. Specifically, the campaign will focus on taxpayers that are in an excess limitation position. Future campaigns may address indirect credits and Sec. 904(a) limitation issues.
- Individual foreign tax credit (Form 1116): This campaign addresses compliance by individual taxpayers in computing and claiming FTC limitations on Form 1116, Foreign Tax Credit. Given the complexity of claiming the credit, and considering third-party reporting information, some taxpayers, according to the IRS, face the risk of claiming an incorrect FTC amount.
- Sec. 956 avoidance: This campaign focuses on situations where a controlled foreign corporation makes a loan to its U.S. parent but the parent fails to make a Sec. 956 inclusion into income. According to the IRS, the goal of this campaign is to determine the extent to which taxpayers are using cash-pooling arrangements and other strategies to avoid Sec. 956 inclusions. The treatment stream is issue-based examinations.
The IRS also identified four campaigns that are more domestic in nature:
- Agricultural chemicals securities credit: The Sec. 45O agricultural chemicals security credit allows a 30% credit for eligible businesses that paid or incurred certain qualifying costs to safeguard agricultural chemicals. The campaign is designed to ensure compliance by verifying qualified expenses and determining that taxpayers are properly defining facilities. The treatment stream for this campaign is issue-based examinations.
- Deferral of cancellation-of-indebtedness income: This campaign focuses on taxpayers who incurred cancellation-of-indebtedness (COD) income from the reacquisition of debt instruments at an issue price less than the adjusted issue price of the instrument in 2009 and 2010, and who elected to defer COD income to 2014. Those deferrals require reporting of COD income ratably from 2014 through 2018. The goal of this campaign is to verify that taxpayers that properly deferred COD income in 2009 or 2010 properly report it in subsequent years beginning in 2014, unless an accelerating event requires earlier recognition or proper deferral under Sec. 108. The treatment stream for this campaign is issue-based examinations. The use of soft letters is under consideration.
- Energy-efficient commercial building property: The deduction for energy-efficient commercial buildings under Sec. 179D allows taxpayers who own or lease commercial buildings to deduct the cost or a portion of the cost of installing energy-efficient commercial building property. The campaign is intended to ensure compliance with the Sec. 179D deduction, and the treatment stream is issue-based examinations.
- Economic development incentives: Taxpayers eligible to receive certain government economic incentives may receive tax benefits in the form of refundable credits, tax credits against other business taxes, nonrefundable credits, transfer of property including land, and grants including cash payments. The IRS is concerned that taxpayers may improperly treat these government incentives as nonshareholder capital contributions, exclude them from gross income, and claim a tax deduction without offsetting it by the tax credit received. The goal of this campaign is to ensure taxpayer compliance. The treatment stream for this campaign is issue-based examinations.
By comparison, the IRS's first 13 issues focused on the following:
- Sec. 48C energy credit;
- Declines and withdrawals of the OVDP;
- Sec. 199 domestic production activities deduction (DPAD) deductions by multichannel video program distributors and TV broadcasters;
- Micro-captive insurance arrangements;
- Related-party transactions between commonly controlled entities;
- Deferred variable annuity reserves and life insurance reserves;
- Basket transactions;
- Land developers and the completed-contract method;
- Tax Equity and Fiscal Responsibility Act linkage;
- S corporation losses claimed in excess of basis;
- Repatriation of foreign earnings for middle-market taxpayers;
- Form 1120-F nonfilers; and
- Inbound distributors.
The IRS's approach to addressing these campaigns is through a variety of treatment streams, as described above. These treatment streams may be in the form of (1) soft letters; (2) issue-focused examinations; (3) the development of an external practice unit; (4) published guidance; (5) internal technology and procedures; and (6) practitioner outreach, among others.
For the original 13 campaigns, while issue-focused examinations were a considered treatment for certain campaigns, a number of the campaigns also relied on softer touches by the government. Notably, however, the latest batch of campaigns seems to focus more on issue-focused examinations and less on soft letters, published guidance, or other approaches that do not result in a direct controversy with a taxpayer.
The IRS also as of yet has not announced a public rollout of the newest campaigns. When it announced the original campaigns, the IRS undertook an extensive public relations effort, partnering with a number of law and accounting firms to organize webcasts to publicize the government's objectives for each of the 13 campaigns. There does not appear to be such an effort this time around.
The IRS also has not yet made public the variety of soft letters that it intends to issue. These soft letters are designed to alert the taxpayer that the IRS believes that a position the taxpayer has taken may be at odds with the IRS's position. The soft letter may ask the taxpayer to take certain actions, including responding to the letter or filing an amended return. In either case, a taxpayer receiving a soft letter should not ignore it.
Taxpayers with issues touching on any of these 24 campaigns should be mindful that the IRS's efforts, even with the intended approach of a soft letter, may result in direct contact from the IRS. As with any large organization, there may be individuals to whom the procedures as outlined may not be well-known. Accordingly, it is incumbent on taxpayers and their advisers to be certain of the appropriate examination procedures currently in place by LB&I.
The author thanks David Auclair and Liz Askey for their counsel with this item.
Greg Fairbanks is a tax managing director with Grant Thornton LLP in Washington.
For additional information about these items, contact Mr. Fairbanks at 202-521-1503 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.