Editor: Mark G. Cook, CPA, CGMA
The IRS channels its resources into performing examinations, or audits, of the returns of various types of taxpayers. These audits take three forms: correspondence, field, and office audits. Fortunately for taxpayers, the most common type of audit is the correspondence audit, where the taxpayer never has to meet with an IRS agent and will only need to supply additional information. The current trend, however, seems to show the IRS getting more aggressive with the other two types of audits.
The IRS is divided into four divisions: Wage and Investment; Large Business and International (LB&I); Small Business/Self-Employed; and Tax-Exempt and Government Entities. Each division performs audits on taxpayers whose returns coincide with that division's characteristics and develops its compliance campaigns to examine issues within its area of expertise. LB&I examinations are the focus of this discussion.
Beginning in January of 2017, the IRS announced a new audit strategy known as "campaigns." LB&I's goal is to improve return selection, identify issues representing a risk of noncompliance, and make the greatest use of its limited resources. With the implementation of this new strategy, LB&I is focusing its examinations on areas it has determined present greater levels of compliance risk. The IRS originally determined that 13 compliance issues needed to be addressed, but since the inception of this strategy, more issues have been identified. LB&I recently announced it was adding six new compliance campaigns, bringing its total number of campaign types to 59.
The six new issues that have been identified and selected by LB&I for compliance campaigns are S corporation built-in gains (BIG) tax; post-offshore voluntary disclosure program (OVDP) compliance; expatriation; high-income nonfilers; erroneous refundable credits of U.S. territories' filers; and Sec. 457 deferred compensation for services performed before Jan. 1, 2009. These issues were identified through LB&I data analysis and through suggestions from IRS employees. Following is a brief overview of each new campaign and what the noncompliance issues are.
When a C corporation decides to convert to an S corporation, there is often a net unrealized built-in gain on the C corporation's assets. The S corporation can be subject to the BIG tax if it sells those assets within five years after the conversion (Sec. 1374(a)). LB&I intends to increase awareness of and compliance with paying the BIG tax by sending out warning letters that encourage self-correction and voluntary compliance. It will also conduct practitioner outreach and issue-based examinations.
Offshore Voluntary Disclosure Program
The OVDP campaign is aimed at getting U.S. taxpayers to report their foreign financial activities. Taxpayers who live abroad often do not realize they are subject to tax on their worldwide income as U.S. citizens. They are also frequently not aware of the foreign asset reporting obligations, including but not limited to bank accounts, which apply whether they are living abroad or currently reside within the United States. The OVDP was originally instituted to permit taxpayers to avoid criminal charges and to pay reduced penalties if voluntary disclosure was made to the IRS. LB&I will be looking at former OVDP participants to address failure of continued compliance with foreign income and asset reporting requirements. The IRS will use soft letters and examinations in this campaign.
When U.S. citizens or long-term residents decide to give up their U.S. citizenship (or expatriate on or after June 17, 2008), they may potentially owe an "exit tax" (Sec. 877A) and have certain filing requirements. This tax is calculated by determining if there would be a gain or loss if all the property owned by the potential expatriate were sold on the day before the expatriation day for its fair market value. If certain requirements are met, there is an election available to the taxpayer to defer payment of the exit tax until the due date of the return for the tax year in which the property is disposed of. LB&I will be addressing noncompliance in this area through a variety of methods, including outreach, soft letters, and examinations.
As stated earlier, U.S. citizens and resident aliens are subject to tax in the United States on their worldwide income, no matter what form that income takes. Taxpayers are often under the misconception that they are taxed in the United States only on income generated or earned in the United States. Using examinations, LB&I will concentrate in this campaign on bringing into compliance high-income taxpayers who have not filed tax returns.
Erroneous refund claims by residents of US territories
The IRS has determined that a number of residents of U.S. territories are mistakenly claiming refundable tax credits that are unavailable to residents of U.S. territories, on Form 1040, U.S. Individual Income Tax Return. LB&I's campaign will be aimed at bringing these taxpayers into compliance using a variety of methods, including outreach and traditional examinations.
Any compensation deferred under a nonqualified deferred compensation plan is includible in gross income when there is no substantial risk of forfeiture of the rights to that compensation (Sec. 457A). A nonqualified deferred compensation plan allows an employee to earn wages, bonuses, or other compensation in one year but receive the earnings in a later year, at which time he or she will be taxed on those earnings. Doing this provides income in the future (often after the employee leaves the workforce) and may reduce the tax payable on the income if the person is in a lower tax bracket when the deferred compensation is received. There are no federally mandated contribution limits for deferred compensation, so this allows the employee to build a retirement account without restriction. The goal under the new compliance campaign is for LB&I to verify compliance with the requirements of Sec. 457A for deferred compensation services performed before Jan. 1, 2009, using issue-based examinations.
The power of technology in enforcing compliance
In today's digital age, the IRS has access to numerous avenues of information to assist with its compliance campaigns. Banks issue Forms 1099 to both the taxpayer and the IRS, and the IRS can easily match the information on a Form 1099 with the information reported on the taxpayer's return. Employers issue Forms W-2, Wage and Tax Statement, and Forms 1099 to employees and independent contractors, respectively, and copies of those reports are also sent to the IRS. The Service can then make sure the information on those reports matches the taxpayer's return. The IRS can swap information with states and with foreign jurisdictions to gather information on noncompliant taxpayers. These are just a few of the avenues the IRS uses to track down noncompliant taxpayers, and its compliance campaigns are designed to use every tool at its disposal.
Mark G. Cook, CPA, CGMA, MBA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.
For additional information about these items, contact Mr. Cook at 949-261-8600 or email@example.com.
All contributors are members of SingerLewak LLP.