Large multinational corporations have historically been the focus of IRS transfer pricing examinations, such as the dispute between Amazon and the IRS over the amounts Amazon charged its European subsidiary for certain intangible assets that were transferred.[i]  However, IRS efforts to address potential income shifting between related entities have expanded to include smaller companies in the middle market.

Section 482. These examinations arise as a result of the IRS’s power under Section 482, which provides that in the case of two or more businesses “owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organizations, trades, or businesses.”  This Section gives the IRS broad discretion to reallocate income so that the income reported by a taxpayer is consistent with the economics and substance of the transactions between the related entities.

The standard under Section 482 is whether a transaction is arm’s length, which is shown by comparing the results of the related party transaction to what the results of the same transaction would be if entered into by unrelated taxpayers.[ii]  The regulations under Section 482 set forth extensive rules and guidance that must be followed in determining whether a controlled transaction satisfies the arm’s length standard.

LB&I Compliance Campaigns. The IRS recently announced that one of LB&I’s new compliance campaigns is the “Related Party Transactions Campaign,” which will be implemented through issue-based examinations.[iii]  The IRS explained in the rollout of the campaign that it will focus on “transactions between commonly controlled entities that provide taxpayers a means to transfer funds from the corporation to related pass through entities or shareholders.”  The IRS specified that it is allocating resources to this issue “to determine the level of compliance in related party transactions of taxpayers in the mid-market segment.  The IRS does not state whether its focus will be on transactions involving foreign entities or whether its focus will include transactions between related domestic entities.  While one of the prime concerns for the IRS in this area is taxpayers shifting income from the U.S. to a jurisdiction with a lower tax rate using non arm’s length transactions, situations arise where taxpayers have an incentive to shift income from one domestic entity to another.  The IRS’s powers under Section 482 apply equally to transactions with a domestic entity as to transactions with a foreign entity.

The IRS also rolled out another campaign targeting specifically one type of cross-border transaction between commonly controlled entities.   The IRS’s “Inbound Distributor Campaign” focuses on U.S. distributors of goods sourced from foreign-related parties, where the U.S. distributor has incurred losses or small profits that are not commensurate with the functions performed and risks assumed by the domestic entity—in such cases, the IRS believes the taxpayer would be entitled to higher returns in arm’s-length transactions.[iv]  For this compliance campaign, which will also be implemented by issue-based examinations, the IRS has “developed a comprehensive training strategy…that will aid revenue agents as they examine this IRC Section 482 issue.”[v]

Transfer Pricing Studies. With the IRS’s expanded focus on related party transactions, it is important for taxpayers who have commonly controlled or related entities to revisit their transfer pricing policies and consider obtaining a transfer pricing study.  In addition to potential substantial or gross valuation misstatement penalties if the IRS makes a transfer pricing adjustment, taxpayers may also be subject to a strict liability penalty depending on the net amount of the adjustment if the taxpayer did not obtain a transfer pricing policy prior to filing its tax return.[vi]  In order to be in the best position in the event of a transfer pricing audit and in order to help avoid the risk of a strict liability penalty in the event of a significant adjustment, taxpayers should have documentation prior to filing their tax returns setting forth the taxpayer’s determination of the price and establishing that the method the taxpayer used was reasonable and consistent with the Section 482 regulations.[vii]

Transfer Pricing Examinations. In an examination, the IRS advises revenue agents to issue a “§6662(e) mandatory Information Documentation Request” at the beginning of an audit, which will request the taxpayer’s documentation regarding its transfer pricing determinations.[viii]  While best practice is to ensure that all related party transactions are done at arm’s length, taxpayers facing a transfer pricing examination should be aware that the regulations under Section 482 allow for a “setoff” of an IRS transfer pricing adjustment, if the taxpayer can establish that the effect of multiple transactions between the related parties, when considered together, reflect an arm’s length arrangement between the entities.[ix]  The procedures that a taxpayer must follow to claim a setoff are set forth in Revenue Procedure 2005-46.

LACEY STRACHAN – For more information please contact Lacey Strachan at Strachan@taxlitigator.com. Ms. Strachan is a senior tax attorney at Hochman, Salkin, Rettig, Toscher & Perez, P.C. and represents clients throughout the United States and elsewhere in complex civil tax litigation and criminal tax prosecutions (jury and non-jury). She represents U.S. taxpayers in litigation before both federal and state courts, including the federal district courts, the U.S. Tax Court, the U.S. Court of Federal Claims, and the Ninth Circuit Court of Appeals. Ms. Strachan has experience in a wide range of complex tax cases, including cases involving technical valuation issues. She routinely represents and advises U.S. taxpayers in foreign and domestic voluntary disclosures, sensitive issue civil tax examinations where substantial civil penalty issues or possible assertions of fraudulent conduct may arise, and in defending criminal tax fraud investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

[i] Amazon.com, Inc. v. Comm’r, 148 T.C. No. 8, Docket No. 31197-12, 2017 (Mar. 23, 2017).

[ii] Treas. Reg. § 1.482-1(b).

[iii] https://www.irs.gov/businesses/large-business-and-international-launches-compliance-campaigns.

[iv] Id.

[v] Id.

[vi] IRC §6662(e)(1)(B); IRC §6662(h)(2)(A)(ii)(I).

[vii] IRC §6662(e)(3)(B).

[viii] IRS Transfer Pricing Audit Roadmap, available at https://www.irs.gov/pub/irs-utl/FinalTrfPrcRoadMap.pdf.

[ix] Treas. Reg. § 1.482-1(g)(4)(i).

A Court of Appeals recently decided that an innocent spouse who relied on the IRS’s bad advice and filed suit in Tax Court too late, couldn’t get “equitable tolling” of the filing deadline.

Tax law allows spouses and former spouses to escape liability for joint tax debts in certain situations, including when it would be “inequitable to hold the individual liable for any . . . deficiency.” If the IRS denies so-called “innocent spouse” relief, then the taxpayer can petition the United States Tax Court to get a judge to rule on the requested relief.    Taxpayers don’t have to pay the tax first and sue for a refund in Tax Court, as they would in U.S. District Court, so missing out on Tax Court could mean the end of the case, particularly for taxpayers who don’t have the money to pay the tax and sue for a refund.  Like most lawsuits, there’s a deadline to file suit in Tax Court; in this case, it’s 90 days after the IRS denies a claim for relief.

In the unfortunate case of Nancy Rubel, the IRS failed to accurately count to 90 days. In denying her claims for innocent spouse relief, the IRS helpfully told Ms. Rubel that she had a right to appeal to Tax Court.  Instead of telling her that she had 90 days to file the petition – which presumably would have led her to pull out a calendar and accurately figure out the filing deadline – the IRS unhelpfully told her an exact deadline for filing in Tax Court.  The 90-day period according to the IRS’s calendar actually was 105 days on the calendar that everyone else, including the Tax Court, uses.  Ms. Rubel filed after 90 days had expired but before the incorrect deadline told to her by the IRS.  When she got to Tax Court, the IRS moved to dismiss her appeal as untimely.  She appealed, arguing that the IRS was “equitably estopped” from arguing she was late, because all she did was rely on the IRS’s incorrect calculation of the filing deadline.  It was unfair, she argued, for the IRS to tell her she had 105 days to file and then move to dismiss because she didn’t’ file within 90 days.

The Third Circuit Court of Appeals upheld the Tax Court in Rubel v. Commissioner, finding that the statute setting the 90-day deadline was “jurisdictional.”  That means, if the taxpayer doesn’t file within 90 days, the Tax Court isn’t authorized by Congress to hear the case.  That also means, the deadline can’t be ignored through arguments such as equitable tolling that otherwise might allow a court to overlook a late filing.  Interestingly, the Third Circuit didn’t comment on the harsh result from Ms. Rubel’s decision to trust the IRS.  The court also didn’t comment on the perverse incentives resulting from its decision – that the IRS has no incentive to tell taxpayers the right filing deadline and in fact will greatly improve its position by “miscalculating” the appeal period and slipping out of Tax Court jurisdiction if the taxpayer relies on the IRS.  Hopefully the IRS will start telling taxpayers that the deadline is 90 days instead of trying to calculate 90 days for the taxpayer, as they’ve shown that they can’t even read a calendar and taxpayers suffer the consequences.

EVAN J. DAVIS – For more information please contact Evan Davis – davis@taxlitigator.com or 310.281.3288. Mr. Davis is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former AUSA of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) handling civil and criminal tax cases and, subsequently, of the Major Frauds Section of the Criminal Division of the Office of the U.S. Attorney (C.D. Cal) handling white-collar, tax, and other fraud cases through jury trial and appeal. He has served as the Bankruptcy Fraud coordinator, Financial Institution Fraud Coordinator, and Securities Fraud coordinator for the USAO’s Criminal Division.

Mr. Davis represents individuals and closely held entities in criminal tax investigations and prosecutions, civil tax controversy and litigation, sensitive issue or complex civil tax examinations and administrative tax appeals, and federal and state white collar criminal investigations. He is significantly involved in the representation of taxpayers throughout the world in matters involving the ongoing, extensive efforts of the U.S. government to identify undeclared interests in foreign financial accounts and assets and the coordination of effective and efficient voluntary disclosures (OVDP, Streamlined Procedures and otherwise).

 

In a recent Division Opinion[i], the Tax Court granted petitioners a hardship waiver for an untimely IRA rollover, allowing them to exclude the amount from income and avoid an early distribution penalty.  In a broad sense, the case illustrates the pitfalls of retirement account distributions.  A closer examination of the facts, however, suggests a case where the administrative process failed, and the Tax Court was needed to get the right result.  From a distance, but as a former Counsel attorney, I find it hard to fathom why this case went all the way to trial.  Congratulations to the Fordham Clinic that handled the case.

John Trimmer retired from the NYPD after 20 years. Before retiring he had lined up a job as a security officer for the New York Stock Exchange to supplement his pension income.  After retiring, the NYSE job fell through.  Mr. Trimmer couldn’t find another job and the NYPD does not rehire retired officers.  Mr. Trimmer began suffering from major depression.  His behavior changed in all aspects of his life.

After his depression started, Mr. Trimmer received two checks totaling approximately $100,000 from his retirement accounts. The checks sat on his dresser for over a month before they were deposited into his checking account.  Mrs. Trimmer was not involved in this matter and believed her husband was handling his retirement assets.  Mr. Trimmer received a Form 1099-R indicating the distributions were taxable.  Mr. Trimmer’s accountant advised him to put the funds into an IRA, which he did shortly after.  The distribution was reported as not taxable.

The IRS issued a Notice CP2000, an automated notice, indicating the Trimmers failed to report the distribution and were liable for a 10% penalty. Mr. Trimmer responded with an eloquent letter explaining his situation, the depression he suffered, and that the tax liability would cripple his family.  The IRS sent a response indicating the taxpayers didn’t need to do anything further.  Three days later, the IRS issued a letter rejecting the requested relief.  A Notice of Deficiency was subsequently issued.

At trial the Taxpayers agreed the distribution would ordinarily be taxable, but that they qualified for a hardship waiver because of Mr. Trimmer’s depression. The IRS not only disagreed that Mr. Trimmer qualified for the hardship waiver, but argued that the examination division lacked authority to consider a hardship waiver, and that any consideration of a hardship waiver is not subject to judicial review.  The IRS further argued that the Taxpayers’ expert should be excluded.

The IRS argued that the Taxpayers failed to follow the rules in Rev. Proc. 2003-16, which provided guidance regarding hardship waivers. Specifically, it mentioned that a taxpayer needed to submit a Private Letter Ruling request and include the fee as set out in the Rev. Proc.  In 2016, the IRS revised the Rev. Proc. and made clear that exam could consider the hardship waiver.  The Court held that the exam division always had the authority to consider a hardship waiver.[ii]

The Court additionally held that it had jurisdiction to review the IRS’ determination and used an abuse of discretion standard.  The IRS argument that the Court lacked jurisdiction to review the hardship denial is yet another attempt by the IRS to limit taxpayer’s rights.  The hardship determination is fundamental to the ultimate deficiency determination.  If the hardship is granted, the distribution is not taxable.  The decision has a detailed analysis of this issue, noting that there is a strong presumption that acts of administrative discretion are subject to review.[iii]  Nothing in the statute indicated the hardship decision was not subject to review.[iv]

The IRS next tried to exclude the taxpayer’s expert witness, who was an unpaid clinical professor at Fordham with degrees in social work.[v]  Again the opinion is detailed in this section and a good primer on expert witnesses.  The Court ultimately denied all of the IRS objections.  Any flaws that the Taxpayers’ expert had seemed to stem largely from the fact that because of limited resources the Taxpayers couldn’t hire an outside expert.  The expert also came from a Fordham clinic.

After 44 pages, the Court addresses the merits of the Taxpayer’s hardship claim and grants the waiver, finding that the failure to waive the 60-day rollover requirement was against “equity or good conscience”. The Court found that the Taxpayer’s in no way profited from retaining the funds and the Mr. Trimmer suffered from a disability.

From the outside, it is hard to understand why this case didn’t settle. The deficiency was not large, the Taxpayers’ put the money in an IRA without benefitting, albeit untimely, and most of all, Mr. Trimmer suffered from depression.  The IRS tried to dispute that in part by arguing Mr. Trimmer refereed a soccer game on occasion.  This case seems to show a severe lack of empathy or perhaps a lack of understanding of mental illnesses such as depression.  Other recent cases have shown the IRS to seek restrictive interpretations of hardship as well as trying to avoid producing documents that would reduce the taxpayers liability.  The budget crunch and heavy caseload that IRS employees currently have and will likely have for the foreseeable future, don’t leave me optimistic that we can expect taxpayer friendly changes going forward.

JONATHAN KALINSKI specializes in both civil and criminal tax controversies as well as sensitive tax matters including disclosures of previously undeclared interests in foreign financial accounts and assets and provides tax advice to taxpayers and their advisors throughout the world.  He handles both Federal and state tax matters involving individuals, corporations, partnerships, limited liability companies, and trusts and estates.

Mr. Kalinski has considerable experience handling complex civil tax examinations, administrative appeals, and tax collection matters.  Prior to joining the firm, he served as a trial attorney with the IRS Office of Chief Counsel litigating Tax Court cases and advising Revenue Agents and Revenue Officers on a variety of complex tax matters.  Jonathan Kalinski also previously served as an Attorney-Adviser to the Honorable Juan F. Vasquez of the United States Tax Court.

[i] Trimmer v. Commissioner, 148 T.C. No. 14 (2017)

[ii] Id. at 15.

[iii] Id. at 21.

[iv] Id. at 22.

[v] Id. at 27.

Posted by: Robert Horwitz | April 28, 2017

IRS Gets Slapped Down on Penalties By Robert Horwitz

The IRS often proposes penalties in notices of deficiency. Under IRC section 7491(c), in a proceeding in court, the IRS has the burden of producing evidence to show that the taxpayer is liable for the penalty.  Under IRC section 6751(b)(1), the IRS cannot assess a penalty “unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate.”  There are exceptions to the need for a supervisor’s written approval, including late filing and payment penalties and penalties that are computed by electronic means.

In Chai v. Commissioner, Docket Nos. 15-1653 (2nd Cir. Mar. 20, 2017), the Second Circuit held that the IRS has the burden of proving compliance with section 6751(b). Chai also involves an interesting issue on the relationship between TEFRA partnership adjustments and deficiency proceedings and on whether a taxpayer is engaged in a trade or business, but a discussion of those issues will have to wait for a future blog.

The taxpayer in Chai received a 1099 for $2 million from his employer.  He claimed that the $2 million was a return of capital.  The IRS treated the payment as compensation.  Due to the fact that Chai was “over sheltered,” i.e., his losses from tax shelters exceeded all of his reported income plus the $2 million, he could not have an income tax deficiency unless the partnership losses were disallowed in TEFRA partnership proceedings.  So the IRS issued a notice of deficiency asserting self-employment tax on the $2 million plus a 20% accuracy-related penalty under IRC section 6662.

While Chai’s Tax Court case was pending, the TEFRA partnership proceedings ended with the losses being disallowed. The IRS amended its answer to assert that he owed an income tax deficiency on the $2 million.  The Tax Court ruled that it did not have jurisdiction to decide whether there was an income tax deficiency as a result of disallowance of the partnership losses.  It did, however, hold that the $2 million was compensation and that Chai owed self-employment tax.  It also held that he was liable for the 20% penalty. The Tax Court further held that Chai’s argument that the IRS failed to prove that the supervisor signed off on the penalty was not raised until post-trial briefing and, thus, was too late.  The Second Circuit reversed.

While the appeal was pending in Chai, the Tax Court issued its opinion in Graev v. Commissioner, 147 T.C. No. 16 (2016).  In Graev, the Court held that section 6751(b) only requires written approval before assessment. Since that wouldn’t occur until after the Tax Court’s decision, it was premature to raise the issue in a Tax Court deficiency case.

The IRS had argued in Tax Court that Chai raised the issue of supervisor approval too late. Before the Second Circuit it changed it tune.  It argued that Chair’s claim was premature, relying on Graev.

The Second Circuit sided with the taxpayer and rejected the Graev Court’s interpretation of section 6451(b).  Based on the historical meaning of “assessment” the Second Circuit found the phrase “initial determination of such assessment” ambiguous.  It therefore looked to the legislative history.  Congress enacted section 6571(b) out of concern that the IRS was using penalties as bargaining chips to get taxpayers to agree to larger deficiencies in exchange for not being assessed a penalty.  This would indicate that approval was to be given before a notice of deficiency was issued, since if a taxpayer went to Tax Court and lost, any approval by a supervisor would be meaningless.  The Second Circuit also noted that the IRS’s administrative practice was to require that the supervisor’s written approval be given before the notice of deficiency was issued.  The Second Circuit also emphasized the fact that approval was required before the “initial determination,” which would be no later than when a notice of deficiency is issued.

The Second Circuit next held that proving supervisory approval was part of the IRS’s burden of proof under section 7491(c). The final issue was whether the Tax Court abused its discretion in determining that Chai had raised the issue too late.  It had.  The IRS failed to produce evidence that supervisory approval was given and all Chai was doing was arguing that there was insufficient evidence to permit a finding in favor of the IRS on the penalty issue.

The moral: where the IRS has the burden of proof, hold its feet to the fire. While he won on the penalty issue, it didn’t turn out all that well for Chai.  The Second Circuit reversed the Tax Court’s decision that it did not have jurisdiction to determine whether Chai was taxable on the $2 million.  But that is a story for another day.

ROBERT S. HORWITZ – For more information please contact Robert S. Horwitz – horwitz@taxlitigator.com or 310.281.3200   Mr. Horwitz is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former Assistant United States Attorney of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) and represents clients throughout the United States and elsewhere involving federal and state, administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com

On March 23, 2017, the Tax Court ruled against the IRS in its lengthy transfer pricing dispute with Amazon.com, Inc. (“Amazon U.S.”) over Amazon’s transfer pricing policies relating to intangible assets provided by Amazon U.S. to its European subsidiary in 2005 and 2006 that were required to operate Amazon’s European website business.[i]  In redetermining the IRS’s reallocation of income from Amazon’s European subsidiary to Amazon U.S., the Tax Court held that the IRS abused its discretion and acted arbitrarily and capriciously in its original determinations against Amazon.

Transfer Pricing Adjustments. Under Section 482 of the Internal Revenue Code, the IRS has broad authority to allocate gross income and deductions among commonly controlled entities if necessary “to prevent evasion of taxes or clearly to reflect the income.”[ii]  The purpose of Section 482 is to prevent artificial shifting of income between controlled entities in order to ensure that the amount of income reported by each entity for U.S. tax purposes is consistent with the economics of the transactions between the related entities, which is especially relevant where income is shifted from the U.S. to a jurisdiction with a lower tax rate.[iii]

The IRS has broad powers under Section 482. While the general rule in Tax Court cases is that the taxpayer has the burden of proving by a preponderance of the evidence that the taxpayer’s return was correct, in Section 482 cases, the IRS’s determinations will be upheld unless the taxpayer is able to show that that IRS’s determination was arbitrary, capricious, or unreasonable.[iv]  Note that while the taxpayer’s burden of proving the IRS’s determination to be arbitrary, capricious, or unreasonable is unique to Section 482 adjustments, the arbitrary, capricious, or unreasonable standard is also used for determining when the IRS loses its presumption of correctness for its adjustments in a Notice of Deficiency, allowing the taxpayer to shift the burden of proof to the IRS.[v]

Amazon’s Transfer Pricing Policies. In examining Amazon’s transfer pricing policies, the IRS determined that amounts Amazon’s European subsidiary paid for the intangible assets it received in 2005 and 2006 from Amazon U.S. for use in its business in Europe in 2005 and 2006 were not at arm’s length.[vi]  The arrangement between Amazon’s European subsidiary and Amazon U.S required Amazon’s European subsidiary to make a “buy-in” payment for the preexisting intangibles it received from Amazon U.S. in a series of transactions in 2005 and 2006, as well as a cost sharing arrangement to split the costs of Amazon’s ongoing intangible development costs.  The effect of the cost sharing arrangement was to essentially make Amazon’s European subsidiary a co-owner of the subsequently developed intangibles.  Amazon originally reported a buy-in payment from Amazon’s European subsidiary of $254.5 million, to be paid over 7 years.

The IRS Acted Arbitrarily and Capriciously. The IRS determined that the buy-in payment should have instead been $3.6 billion, which it subsequently reduced to $3.468 billion.  Rather than using a method allowed in the regulations under Section 482 for specifically valuing each of the intangible assets transferred to Amazon’s European subsidiary, the IRS valued the intangible assets using a discounted cash flow analysis, as though Amazon U.S. had transferred an entire operating business to its European subsidiary.  Finding that Amazon’s European subsidiary was already an operating company when it received the intangibles, the Tax Court held the IRS abused its discretion in using this method, because it erroneously included in its determination of the arm’s length buy-in payment the value of the European subsidiary’s existing ongoing business (e.g., its existing goodwill) and also the value of subsequently created intangibles, which were separately compensated for using the cost sharing arrangement.  The IRS’s approach in the Amazon case was the same as the method it had used in the case Veritas Software Corp. v. Commissioner, 133 T.C. 297 (2009), where the Tax Court had held that method to be arbitrary and capricious.[vii]  The Tax Court further held that the IRS abused its discretion in its determination of its adjustments to Amazon’s determination of amounts its European subsidiary owed pursuant to the cost sharing arrangement for subsequently created intangibles, based on its determination that 100% of Amazon’s “Technology and Content” costs are subject to the cost sharing agreement, whereas Amazon’s position was that only 50% were allocable to the ongoing intangible development costs.[viii]

The Tax Court Finds Amazon’s Methods Reasonable. Once finding that the IRS acted arbitrarily and capriciously, the Tax Court evaluated the taxpayer’s arguments in support of the amounts charged and found that the taxpayer’s “comparable uncontrolled transaction” (CUT) method is the best method for calculating the requisite buy-in payment and the taxpayer’s system of allocating costs for the cost sharing arrangement was a reasonable basis for allocating costs, though the Tax Court made certain adjustments to the taxpayer’s application of the methods.

LACEY STRACHAN – For more information please contact Lacey Strachan at Strachan@taxlitigator.com. Ms. Strachan is a senior tax attorney at Hochman, Salkin, Rettig, Toscher & Perez, P.C. and represents clients throughout the United States and elsewhere in complex civil tax litigation and criminal tax prosecutions (jury and non-jury). She represents U.S. taxpayers in litigation before both federal and state courts, including the federal district courts, the U.S. Tax Court, the U.S. Court of Federal Claims, and the Ninth Circuit Court of Appeals. Ms. Strachan has experience in a wide range of complex tax cases, including cases involving technical valuation issues. She routinely represents and advises U.S. taxpayers in foreign and domestic voluntary disclosures, sensitive issue civil tax examinations where substantial civil penalty issues or possible assertions of fraudulent conduct may arise, and in defending criminal tax fraud investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

[i] Amazon.com, Inc. v. Comm’r, 148 T.C. No. 8, Docket No. 31197-12, 2017 (Mar. 23, 2017).

[ii] IRC § 482.

[iii] Treas. Reg. § 1.482-1(a)(1).

[iv] Amazon.com, Inc., 148 T.C. No. 8 at p. 174.

[v] See, e.g., Sealy Power Ltd. v. Comm’r, 46 F.3d 381, 386 (5th Cir. 1995) (“Several courts have recognized, however, that they need not give effect to the presumption of correctness and may instead shift the burden from the taxpayer to the Commissioner when the notice of deficiency is determined to be arbitrary or excessive.”).

[vi] Treas. Reg. § 1.482—7(g)(2).

[vii] Amazon.com, Inc., 148 T.C. No. 8 at pp. 73-88.

[viii] Id. at 174-177.

Posted by: Lacey Strachan | April 17, 2017

LB&I’s New Compliance Campaigns by LACEY STRACHAN

As part of a move toward issue-based examinations, the IRS’s Large Business and International division has rolled out a compliance campaign process in which the IRS decides which issues representing a risk of non-compliance require one or multiple “treatment streams” to achieve the IRS’s compliance objectives.[i]  The IRS has explained that its potential “treatment streams” include “soft letters” (warnings that inform a taxpayer that the position on its return is inconsistent with the IRS’s position and give the taxpayer an opportunity to amend), changes in forms, examinations, and published guidance.

The IRS’s focus on issue-based examinations is intended to improve return selection, identify issues representing a risk of non-compliance and make the greatest use of limited resources, as part of an effort to redefine large business compliance work and to build a supportive infrastructure inside LB&I. Previously, IRS examinations were centered around selecting the returns of large corporate taxpayers to review in order to uncover issues.  With these efforts, the IRS is reorganizing its resources to focus on specific areas of concern.

Announced on January 31, 2017, the IRS has identified and selected 13 compliance campaigns in its first wave of LB&I’s issue-based compliance work, based on the IRS’s internal data analysis, suggestions from IRS compliance employees, and feedback from the tax community.[ii]  These campaigns reflect areas where the IRS has identified significant compliance issues and are an indication of areas LB&I will be focusing on in future examinations.  The following are the initial 13 campaigns:

  1. IRC 48C Energy Credit Campaign
  2. OVDP Declines-Withdrawals Campaign
  3. Domestic Production Activities Deduction, Multi-Channel Video Program Distributors (MVPD’s) and TV Broadcasters
  4. Micro-Captive Insurance Campaign
  5. Related Party Transactions Campaign
  6. Deferred Variable Annuity reserves & Life Insurance Reserves IIR Campaign
  7. Basket Transactions Campaign
  8. Land Developers – Completed Contract Method (CMM) Campaign
  9. TEFRA Linkage Plan Strategy Campaign
  10. S Corporation Losses Claimed in Excess of Basis Campaign
  11. Repatriation Campaign
  12. Form 1120-F Non-Filer Campaign
  13. Inbound Distributor Campaign

Although no materials relating to these campaigns have been released yet, the IRS has been holding a series of webinars to inform the tax community about these new campaigns. Two webinars have already taken place, on March 7, 2017 and on March 28, 2017.  These initial webinars focused generally on the campaign process, including how the campaigns are being implemented and how they will impact taxpayers.  Future webinars will discuss more fully the 13 compliance campaigns that have been launched.  These webinars are free to the public.  Although dates of these upcoming webinars have not yet been announced, information about upcoming webinars can be found on the IRS’s Large Business and International Compliance Campaigns website:  http://www.irs.gov/businesses/large-business-and-international-compliance-campaigns.

The IRS will be announcing and launching more campaigns in the coming months.

LACEY STRACHAN – For more information please contact Lacey Strachan at Strachan@taxlitigator.com. Ms. Strachan is a senior tax attorney at Hochman, Salkin, Rettig, Toscher & Perez, P.C. and represents clients throughout the United States and elsewhere in complex civil tax litigation and criminal tax prosecutions (jury and non-jury). She represents U.S. taxpayers in litigation before both federal and state courts, including the federal district courts, the U.S. Tax Court, the U.S. Court of Federal Claims, and the Ninth Circuit Court of Appeals. Ms. Strachan has experience in a wide range of complex tax cases, including cases involving technical valuation issues. She routinely represents and advises U.S. taxpayers in foreign and domestic voluntary disclosures, sensitive issue civil tax examinations where substantial civil penalty issues or possible assertions of fraudulent conduct may arise, and in defending criminal tax fraud investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

[i] Information about LB&I’s Compliance Campaigns is available here: https://www.irs.gov/businesses/large-business-and-international-compliance-campaigns

[ii] https://www.irs.gov/businesses/large-business-and-international-launches-compliance-campaigns

On March 20, 2017, the IRS issued a “Fast Track Settlement Program” to speed up settlements with individuals and small businesses through its Small Business/Self-Employed Division (“SB/SE”). Although this reform was likely to happen regardless, it does come on the heels of the new administration’s criticism — echoed by the IRS Taxpayer Advocate —that the IRS operates with a “gotcha” mentality and should shift to helping taxpayers avoid errors in the first place and resolve cases quickly and cheaply.

In Rev. Proc. 2017-25, the IRS noted that large business taxpayers already have a successful fast-track resolution procedure, and that the IRS had been operating a SB/SE fast-track pilot program since 2003. The IRS is now rolling out a permanent version of the pilot program, and the permanent version contains many of the best features of that pilot program.  It takes effect immediately.

Before Rev. Proc. 2017-25, if a taxpayer couldn’t resolve an issue with an SB/SE agent who was auditing the taxpayer, then the taxpayer would have to wait until the agent finalized the audit and issued a notice. That notice would trigger the taxpayer’s right to seek review of the agent’s decisions by the IRS’s Office of Appeals.  In this normal (non-fast-track) mode, Appeals takes a second look at the IRS agent’s position and offers to settle with the taxpayer on the same or more-generous terms than were offered by the case agent.  Appeals thereby provides an off-ramp for cases that are easily resolved and should not go through the even-more-expensive Tax Court and U.S. District Court routes.  The downside of the current approach of only bringing in Appeals after the examination ends, is that the IRS and taxpayers spend time and money while the agent pushes the audit over the finish line.

The new fast-track procedure is designed to allow for even earlier dispute resolution, which saves money for both the IRS — the agent can move on to another case instead of completing the present audit — and the taxpayer, who can limit legal and accounting bills through early intervention.

Now, the taxpayer can get two bites at the apple. If there’s a disputed “fully developed” factual or legal issue in an examination — meaning the IRS agent has all necessary legal advice and documentation — then the taxpayer can invoke the fast-track process and the Appeals office will try to resolve the issue in no more than 60 days. Even if this fast-track process is unsuccessful, the taxpayer can still take the case through the “traditional Appeals process” after the IRS has finished the examination, permitting a second bite at the apple.

Of course, what would an IRS procedure be without a large helping of red tape? The final fast-track procedure differs from the pilot program in that: the IRS added a “good faith” requirement that taxpayers be fully cooperative – in the IRS’s exclusive opinion – during the audit; the IRS Group Manager must have tried and failed to resolve the issue; and the IRS added a catch-all provision that the fast-track procedure is inapplicable where employing it “would not be in the interest of sound tax administration” (aka, if the IRS doesn’t want to do it).

The bottom line: this is great news for taxpayers, particularly those who are represented in audits. There is no downside for the taxpayer of bringing in an Appeals officer to help resolve an issue, because at worst the Appeals officer will agree with SB/SE.  On the upside, Appeals officers frequently disagree with SB/SE agents, and they can be a powerful ally for the taxpayer and her representatives in trying to resolve disputed legal or factual issues.  This isn’t a cure-all for dealing with unreasonable IRS revenue agents, but it will provide a cost-effective way to challenge agents, particularly when they appear to be taking an unreasonable position during the audit.

EVAN J. DAVIS – For more information please contact Evan Davis – davis@taxlitigator.com or 310.281.3200. Mr. Davis is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former AUSA of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) handling civil and criminal tax cases and, subsequently, of the Major Frauds Section of the Criminal Division of the Office of the U.S. Attorney (C.D. Cal) handling white-collar, tax and other fraud cases through jury trial and appeal. He has served as the Bankruptcy Fraud coordinator, Financial Institution Fraud Coordinator, and Securities Fraud coordinator for the Criminal Division.

Mr. Davis represents individuals and closely held entities in criminal tax investigations and prosecutions, civil tax controversy and litigation, sensitive issue or complex civil tax examinations and administrative tax appeals, federal and state white collar criminal investigations. He is significantly involved in the representation of taxpayers throughout the world in matters involving the ongoing, extensive efforts of the U.S. government to identify undeclared interests in foreign financial accounts and assets and the coordination of effective and efficient voluntary disclosures (OVDP, Streamlined Procedures and otherwise).

Over the last five years, enforcement of employment tax violations has become a priority to the Internal Revenue Service and the Department of Justice, Tax Division.  Notwithstanding the increase in enforcement, the increasing cost to the Treasury indicates the increased attention to employment tax violations has not been enough – – and the Treasury Inspector General for Tax Administration (TIGTA) has just issued a report noting that criminal enforcement must increase.  Interestingly, the report refers to employment tax violations as “employment tax embezzlement, a felony punishable by up to five years in prison.”

On March 21, 2017, TIGTA issued a report to the Commissioner for Small Business/Self-Employed Division and the Chief for Criminal Investigation (CI) Divisions(Report No. 2017-IE-R004).  TIGTA recommended that the Commissioner and the Chief of CI should consider a strategy to address “egregious employment tax cases.”  Importantly, they recommended that the Collection function should expand the criteria used to refer potential criminal cases to CI, to include cases such as those over $1 million or individuals involved in ten or more companies that fail to remit payroll taxes.  The Collection Division indicated that they did not want to expand the criteria to refer cases to CI, given the balancing factors and importantly “limited resources.”  TIGTA however, indicated that additional “egregious” cases should be referred for criminal investigation and prosecution.

The report found that employment tax noncompliance is a growing problem.  As of December 2015, 1.4 million employers owed approximately $45.6 billion unpaid employment taxes, interest and penalties.  It noted that in fiscal year 2015, the IRS asserted trust fund recovery penalties against approximately 27,000 responsible persons, 38% fewer than just five years before.  They attribute this to a diminished resources to the Internal Revenue Service.  On the other hand, the number of employers with employment tax compliance for 20 or more quarters has been steadily growing – – more than tripling in a 17-year period.

Importantly, the Report found that even the use of the trust fund recovery penalty did not stop the abuse, finding that a review of a number of taxpayers who had been assessed the trust fund recovery penalty who had ten or more entities involved, only 8.5% of the individuals had been investigated by the Criminal Investigation Division.

The Report also noted that of approximately the 700 individuals who were assessed in excess of $1 million during the years 2010 to 2015, CI opened investigation on fewer than fifty of these individuals, or approximately 7%.

TIGTA concluded that given the small number of criminal investigations for employment tax violations, the criminal sanction and its goal of general deterrence was not having its intended positive impact on tax compliance.

While we are in a period of limited government resources, employment taxes have become a bigger source of revenue and a larger tax compliance problem.   Expect to see an increase in employment criminal investigations and prosecutions in light of TIGTA’s Report.

STEVEN TOSCHER – For more information please contact Steven Toscher – toscher@taxlitigator.com  Mr. Toscher is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., specializing in civil and criminal tax litigation. Mr. Toscher is a Certified Tax Specialist in Taxation, the State Bar of California Board of Legal Specialization and represents clients throughout the United States and elsewhere involving federal and state, civil and criminal tax controversies and tax litigation. Additional information is available at www.taxlitigator.com

EVAN J. DAVIS – For more information please contact Evan Davis – davis@taxlitigator.com or 310.281.3200. Mr. Davis is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former AUSA of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) handling civil and criminal tax cases and, subsequently, of the Major Frauds Section of the Criminal Division of the Office of the U.S. Attorney (C.D. Cal) handling white-collar, tax and other fraud cases through jury trial and appeal. He has served as the Bankruptcy Fraud coordinator, Financial Institution Fraud Coordinator, and Securities Fraud coordinator for the Criminal Division.

Mr. Davis represents individuals and closely held entities in criminal tax investigations and prosecutions, civil tax controversy and litigation, sensitive issue or complex civil tax examinations and administrative tax appeals, federal and state white collar criminal investigations. He is significantly involved in the representation of taxpayers throughout the world in matters involving the ongoing, extensive efforts of the U.S. government to identify undeclared interests in foreign financial accounts and assets and the coordination of effective and efficient voluntary disclosures (OVDP, Streamlined Procedures and otherwise).

It is time for a little change of pace from substantive tax discussions.

In tax controversy cases you occasionally must cross examine someone. Whether in litigation, or just sitting in an office interviewing witnesses or clients, it is comforting knowing how to expose a lying witness.

If you have an objective piece of evidence showing the witness is lying, say a contradictory statement in writing or otherwise, it takes no great skill to demonstrate the witness’s lie. (Note it is still possible to botch this cross examination with an inept questioning technique, but that is a topic for another day.)  For an example of a Master using this basic technique see Wellman, The Art of Cross Examination, pp 57-59 (paperback).

What you will learn in this essay is how to cross examine the lying witness when you have only your belief that the witness is lying.  Here is the outline I use when I teach this technique.

Ladies and gentlemen, while this may come as a shock to some of you, there exists something out there in the world we call “objective reality.” (Use finger quotes while saying “objective reality”).  This “objective reality” comprises things we call “facts” (finger quotes).  None of these “facts” exist in isolation; they are all connected to other “facts” making up “objective reality.”

The problem with a lie is that, although it pretends to be a “fact,” it is not. The lie connects to nothing.  The lie is just floating out there unconnected to “objective reality.”

To learn how to attack the lie, we must go back to eighth grade geometry, where we were taught basic logic. (At least that was taught to me in eighth grade in 1963).  Recall the basic formula:

True Formula #1: A ⇒ B. Or translated:  If A is true, then B is true.

Example: If I fall unclothed into the ocean, then I get wet.

One we establish the truth of Formula #1, Formula #2 follows as true:

True Formula #2 follows (this is the important one): ∼ B ⇒ ∼A. Or translated:  If not B is true, then not A is true.

Continuing example: If I am not wet, then I have not fallen unclothed into the ocean.

Apply this to the lie we are trying to attack. The attack on the lie comes from multiple directions.  Hence the name of this essay.

STEP 1: Assume that the lie is true.  Call it “A.”

STEP 2: If the lie is true, what “facts” might we reasonably expect to see connecting the lie to objective reality. Call them “B.”  Recall A ⇒ B.

Pick five connecting “facts.” (You can pick more, you can pick fewer.  Suit your taste).

A ⇒ B1;  A ⇒ B2;  A ⇒ B3;  A ⇒ B4;  A ⇒ B5.

Get the witness to agree that the five connecting “facts” are false. The witness agrees ∼B1;  ∼B2;  ∼B3;  ∼B4;  ∼B5.

Therefore:

∼ B1 ⇒ ∼A: A is false.  The lie is proven false.

∼ B2 ⇒ ∼A: A is false.  The lie is proven false.

∼ B3 ⇒ ∼A: A is false.  The lie is proven false.

∼ B4 ⇒ ∼A: A is false.  The lie is proven false.

∼ B5 ⇒ ∼A: A is false.  The lie is proven false.

Or at least, you argue that.

Let’s use this technique in an easy example. You are prosecuting a young man for robbing a bank.  At the last minute, his mom takes the witness stand and says her son was with her the entire day of the bank robbery.

The basic cross examination, if you have the evidence, is easy. If you have a prior contradictory statement she gave to a neighbor or the police, if you have her employment records showing she worked all that day; if you have a film of what is obviously her son with a gun in his hand inside the bank during the robbery, the cross examination is easy.  But what if you have none of those things?  All you have is your belief she is lying.

Use the Five Different Directions Technique of Cross Examination. It goes like this:

Assume that mom is telling the truth. What would follow, if her son was with her during the day of the bank robbery?

Direction 1: She would have told the investigating detectives that story when she was first interviewed about the bank robbery.  She didn’t.

A ⇒ B1:  If her son was with her, then she would have told the police in her interview.∼ B1 ⇒ ∼A: She did not tell the police in her interview; therefore her son was not with her.  A is false.  The lie is proven false.

The questioning is simple:

Question: Mam, you were interviewed by two police officers after the bank robbery, right?

Answer: Yes.

Question: The police officer asked you questions about the bank robbery?

Answer: Yes.

Question: The police officers asked you questions about your son, didn’t they?

Answer: Yes.

Question: Never during this interview did you tell them your son was with you all day?

Answer: I didn’t, but I was afraid to talk to them.

Direction 2: If she were too frightened initially, she would have told the police or the prosecutors eventually. She didn’t. 

A ⇒ B2:  If her son was with her, then she would have eventually told the police.

∼ B2 ⇒ ∼A: She never told the police; therefore her son was not with her.  A is false.  The lie is proven false.

Question: You have a telephone in your home, right?

Answer: Yes.

Question: And since your interview with the police and until today, your phone has worked properly, hasn’t it.

Answer: Yes.

Question: Never since your interview did you call the police and inform them they had arrested the wrong man, that your son was with you all day, right?

Answer: Right.

Alternative Question Form: Of course, after your interview you called the police and informed them they had arrested the wrong man, that your son was with you all day, right?

Answer: No.

Direction 3: If she were too frightened initially, she would have written the police or the prosecutors eventually.  She didn’t.

A ⇒ B3:  If her son was with her, then she would have eventually written the police.

∼ B3 ⇒ ∼A: She never wrote the police; therefore her son was not with her.  A is false.  The lie is proven false.

Question: You know how to find the address of the police, don’t you?

Answer: Yes.

Question: Mam, you have 34¢ to buy a postcard, don’t you?

Answer: Yes.

Question: Despite knowing the address of the police and despite have 34¢ you did not write a postcard to the police and tell them they had arrested the wrong man, that your son was with you all day, right?

Answer: No answer.

Direction 4: If her son misses school and stays home all day, either she calls the school or the school calls her to make sure her son is OK.  Neither call happened.

A ⇒ B4:  If her son was with her, then she would have called the school or they would have called her.

∼ B4 ⇒ ∼A: No such call occurred; therefore her son was not with her.  A is false.  The lie is proven false.

Question: On the day of the bank robbery, a school day, you never called the school to tell them you son was with you at home, did you?

Answer: No.

Question: On the day of the bank robbery the school did not call you and ask about your son, did they?

Answer: No.

Direction 5: Your turn, dream one up.

You can also use the Five Different Directions Technique on your friends, your spouse, your children, and your co-workers to expose all sorts of lies. Of course you will end up divorced, unemployed and friendless, but no matter, you will have exposed the truth.

Seriously, this is a very aggressive and effective technique. Use it carefully.

EDWARD M. ROBBINS, Jr. – For more information please contact Edward M. Robbins, Jr. -EdR@taxlitigator.com  Mr. Robbins is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., the former Chief of the Tax Division of the Office of the U.S. Attorney (C.D. Cal)  and represents clients throughout the United States and elsewhere involving federal and state, civil and criminal tax controversies and tax litigation. Additional information is available at http://www.taxlitigator.com

 

 

The IRS has announced new rules regarding an Offer-In-Compromise (OIC). Beginning with OIC applications received on or after March 27, 2017, the IRS will return any newly filed OIC applications if the taxpayer has not filed all required tax returns.  Additionally, any application fee included with the OIC will also be returned.  Any initial payment required with the returned application, however, will be applied to reduce the taxpayer’s balance due. The new rules do not apply to 2016 tax returns with a valid extension.

Prior to this new policy, the return of an OIC was not mandatory. An OIC can be a great alternative if you owe taxes and cannot fully pay your liability, but the approval process can be lengthy, and you will generally have to make a payment with your offer.  If you aren’t eligible or if the IRS ultimately rejects your OIC, your payment will not be return and will be applied to your tax liability.  If you aren’t sure whether you have filed all required returns, request account transcripts before making assumptions and losing your initial payment.

Several years ago the IRS liberalized the OIC rules under its Fresh Start initiative. Before your offer can be considered, you must: (1) file all tax returns you are legally required to file, (2) have received a bill for at least one tax debt included on your offer, (3) make all required estimated tax payments for the current year, and (4) make all required federal tax deposits for the current quarter if you are a business owner with employees.  If you or your business are in bankruptcy, you are not eligible for an OIC.

The two basic payment methods for an OIC are the lump sum cash and the periodic payment. Lump sum cash option requires 20% of the total offer amount to be paid with the offer and the remaining balance paid in 5 or fewer payments within 5 or fewer months of the date your offer is accepted.  Under the periodic payment option you must make the first payment with the offer and pay the remaining balance within 6 to 24 months, in accordance with your proposed offer terms.

Before submitting an OIC make sure you are eligible. The IRS has a helpful online OIC Pre-Qualifier that can be found at https://irs.treasury.gov/oic_pre_qualifier/. After answering eligibility questions, you will be asked to input your assets, income, and expenses.  At the end the calculator will tell you what your OIC should be under the two payment options.

If an OIC is not the best option for you, consider an installment agreement, which is generally much easier to obtain because in most circumstances you will pay the entire amount of the liability.

JONATHAN KALINSKI specializes in both civil and criminal tax controversies as well as sensitive tax matters including disclosures of previously undeclared interests in foreign financial accounts and assets and provides tax advice to taxpayers and their advisors throughout the world.  He handles both Federal and state tax matters involving individuals, corporations, partnerships, limited liability companies, and trusts and estates.

Mr. Kalinski has considerable experience handling complex civil tax examinations, administrative appeals, and tax collection matters.  Prior to joining the firm, he served as a trial attorney with the IRS Office of Chief Counsel litigating Tax Court cases and advising Revenue Agents and Revenue Officers on a variety of complex tax matters.  Jonathan Kalinski also previously served as an Attorney-Adviser to the Honorable Juan F. Vasquez of the United States Tax Court.

Older Posts »

Categories