On Sept. 10 and Oct. 30, 2018, the IRS Large Business and International Division (LB&I) identified 10 new campaigns (available at www.irs.gov and www.irs.gov) that expand the focus areas under its issue-based examination program. These campaigns are in addition to the 13 campaigns announced on Jan. 31, 2017, the 11 campaigns announced on Nov. 3, 2017, the five campaigns announced on March 13, 2018, the six campaigns announced on May 21, 2018, and the five campaigns announced on July 2, 2018. The IRS has now announced a total of 50 campaigns.
Campaigns are designed to select returns with identified potential compliance risks. As before, LB&I plans to address noncompliance through a variety of "treatment streams," including issue-based examinations, outreach/education, and other approaches.
LB&I stated that the campaigns were identified through LB&I data analysis and suggestions from IRS compliance employees. LB&I's stated goal for its campaigns is to improve return selection, identify issues representing a risk of noncompliance, and make the greatest use of limited resources.
In announcing each campaign, LB&I briefly explains each issue, describes the planned treatment streams, and names the lead LB&I executive and practice area.
1. Sec. 199: Claims risk review
The Sec. 199 claims risk review campaign will focus on business entities that file domestic production activity deduction (DPAD) claims under Sec. 199, although the IRS notes that the law known as the Tax Cuts and Jobs Act, P.L. 115-97, repealed the DPAD for tax years beginning after Dec. 31, 2017.
For this campaign, the IRS aims to ensure taxpayer compliance through a claim risk review assessment and issue-based examinations of claims with the greatest compliance risk.
2. Syndicated conservation easement transactions
The syndicated conservation easement transactions campaign seeks to ensure that easement contributions meet legal requirements for deductions and that fair market values are accurate and that similarly situated taxpayers are treated consistently. The IRS also notes that Notice 2017-10 designated specific syndicated conservation easement transactions as listed transactions, requiring disclosure statements by both investors and material advisers.
This campaign will use an initial treatment stream of issue-based examinations, with other treatment streams to be considered as the campaign progresses.
3. Foreign base company sales income: Manufacturing branch rules
The manufacturing branch rules campaign will identify and select for examination returns of U.S. shareholders of controlled foreign corporations (CFCs) that may have underreported Subpart F income based on certain interpretations of the manufacturing branch rules. The IRS explained that, in general, foreign base company sales income (FBCSI) does not include income of a CFC derived in connection with the sale of personal property manufactured by that corporation. If a CFC manufactures property through a branch outside its country of incorporation, however, the manufacturing branch may be treated as a separate, wholly owned subsidiary of the CFC for purposes of computing the CFC's FBCSI, which may result in a Subpart F inclusion to the CFC's U.S. shareholders.
4. Form 1120-F interest expense/home office expense
The interest expense/home office expense campaign addresses compliance with what the IRS states are two of the largest deductions claimed on Form 1120-F, U.S. Income Tax Return of a Foreign Corporation: (1) interest expense deductions under Regs. Sec. 1.882-5 allocable to a foreign corporation's effectively connected income, and (2) home office expense deductions allocated to effectively connected income. In this campaign, the IRS will seek to identify aggressive positions in these areas, such as the use of apportionment factors that may not attribute the proper amount of expenses to the calculation of effectively connected income.
The treatment stream for this campaign is issue-based examinations.
5. Individuals employed by foreign governments and international organizations
The fifth announced campaign will focus on tax compliance of individuals who are employees of foreign embassies, foreign consular offices, and various international organizations. The IRS notes that such entities are not required to withhold federal income and Social Security taxes from their employees' compensation, nor are they required to file information reports with the IRS. The IRS believes this lack of withholding and reporting, combined with employee lack of knowledge of tax obligations, results in unreported income, erroneous deductions and credits, and failure to pay taxes.
The treatment streams for this campaign will include outreach and education by partnering with the State Department's Office of Foreign Missions to inform employees of foreign embassies, consular offices, and international organizations of their filing obligations. The IRS will also issue soft letters and conduct examinations.
6. Individual foreign tax credit: Phase II
Phase II of the individual foreign tax credit campaign focuses on taxpayers who have claimed the Sec. 901 credit against U.S. tax on foreign-source income but do not meet the requirements for claiming the credit. Sec. 901 allows a dollar-for-dollar credit against U.S. tax on foreign-source income for foreign taxes paid on this income. The IRS plans to address noncompliance through various treatment streams, including examinations.
7. Offshore service providers
The offshore service providers campaign addresses U.S. taxpayers who use offshore service providers to facilitate the creation of foreign entities and tiered structures that conceal the U.S. taxpayer's beneficial ownership of foreign financial accounts and assets. The treatment stream for this campaign will be issue-based examinations.
8. FATCA filing accuracy
The FATCA filing accuracy campaign addresses entities that fail to meet their reporting obligations under the Foreign Account Tax Compliance Act (FATCA). Generally, FATCA requires foreign financial institutions and some nonfinancial foreign entities to report foreign assets held by their U.S. account holders and substantial U.S. owners. The IRS plans to address this noncompliance through various treatment streams, including terminating FATCA status.
9. Form 1120-F delinquent returns
The delinquent returns campaign is intended to encourage foreign entities to timely file Form 1120-F returns and to address compliance risks for delinquent 1120-F returns. The IRS plans to accomplish this goal through field examinations of delinquent returns and educational outreach programs.
10. Work opportunity tax credit
The work opportunity tax credit (WOTC) campaign addresses the consequences of WOTC certification delays and the burden of filing amended returns. According to the IRS, delays associated with the WOTC certification process often result in taxpayers' being required to amend multiple years of federal and state returns to claim the WOTC in the year that qualified WOTC wages were paid. The IRS notes that this "requirement, coupled with any resulting examinations of this issue, is an inefficient use of both taxpayer and IRS resources." The IRS agreed to accept the WOTC year-of-credit eligibility issue into the Industry Issue Resolution (IIR) program "to provide remedies to reduce taxpayer burden, promote consistency, and decrease examination time to most effectively use IRS resources."
The IRS's objective in the campaign is to collaborate with industry stakeholders, IRS Chief Counsel, and Treasury to develop an LB&I directive for taxpayers experiencing late WOTC certifications and to promote consistency in examinations of WOTC claims.
With the addition of these 10 new campaigns, as of October 2018, the IRS has announced 50 campaigns in total, demonstrating the continued LB&I transition to an issue-based examination program for which a return is selected for audit based on an identified campaign issue. LB&I has previously stated that its goal is to have campaigns account for more than 50% of its examination program. Taxpayers that may be affected by a campaign should consider developing strategies to effectively respond to any formal or informal inquiries from the IRS (i.e., issue-based examinations or soft letters).
Michael Dell is a partner at Ernst & Young LLP in Washington.
For additional information about these items, contact Mr. Dell at 202-327-8788 or email@example.com.
Unless otherwise noted, contributors are members of or associated with Ernst & Young LLP. Ernst & Young previously published versions of these items as Tax Alerts.