Current IRS Enforcement Priorities. The international arena will continue to test the enforcement resources of the IRS for years to come. There will be ongoing, enhanced coordination with treaty partners and international organizations (six of nine LMSB Tier 1 issues involve international components and LMSB Counsel lawyers have been trained in the fundamentals of international taxation). IRS is attempting to develop a protocol to conduct joint audits with treaty partners, ensuring that the taxpayer provides the same information to both tax authorities, reducing opportunities for arbitrage. In a joint audit conducted with a foreign tax authority, the corporate taxpayer will not need to go through a similar exercise twice but will not be able to gain an advantage between the otherwise competing jurisdictions.
Issues regarding undeclared foreign source earnings and financial accounts (Form TD F 90-22.1 Report of Foreign Bank and Financial Accounts – commonly known as an FBAR – filings are due June 30 for the prior calendar year) will continue to generate considerable interest from the IRS and the Department of Justice. The IRS has long encouraged participation in the voluntary disclosure process for all taxpayers, those with interests in offshore accounts and otherwise. The Department has a somewhat similar policy regarding the non-prosecution of taxpayers who have made a timely voluntary disclosure. The IRS policy concerning voluntary disclosure [see Internal Revenue Manual (IRM) 126.96.36.199 (06-26-2009)] provides that a taxpayer’s voluntary disclosure is a factor that “may result in prosecution not being recommended.” To obtain this qualified benefit, the disclosure must be “truthful, timely, complete,” and must demonstrate a willingness by the taxpayer to cooperate, and actual cooperation, in determining the tax liability, and must include “good faith arrangements” by the taxpayer to pay the tax, interest, and any penalties in full.
Those with interests in foreign accounts that have not previously been disclosed should immediately consult competent counsel. They likely remain eligible for the benefits of the longstanding IRS voluntary disclosure program mitigating the possibility of a future criminal prosecution. The IRS is expected to at least temporarily continue its current procedures for a criminal pre-clearance and for disclosures made according to the “three-page letter”. However, it is difficult to determine the potential administrative resolution of civil penalties for those who did not participate in the framework set forth in the Penalty Memos. Undeclared foreign accounts present a target rich environment for the government. The IRS is committed to enforcement concerning offshore accounts and the changing environment concerning bank secrecy may lead the government to many taxpayers with undisclosed interests in foreign financial accounts. For those with undeclared foreign accounts, now is the time to come into compliance – waiting is not a viable option.
Other examination priorities based on a perceived degree of noncompliance include the potential abuse of mortgage interest limitations by claiming deductions exceeding limitations in multiple years; Section 1031 like-kind exchanges including the abuse and possible back-dating of documents intended to circumvent the 45-Day Rule, whether the exchange properties are truly “like-kind”, and whether the exchange property is held for the proper purpose; real estate dispositions where the taxpayer is unable to adequately support the amount realized and the adjusted basis or fails to appropriately provide for the recapture of items when a negative capital account exists; employment tax and worker classifications where the IRS is conducting 6,000 employment tax examinations focused on worker classification issues – independent contractor vs employee status- together with issues regarding executive compensation and fringe benefits; S-corporation examinations with an emphasis on determining the built-in-gains tax focusing on asset valuations for the C-corp assets on conversion to S-corp status together with compensation for S-corporation officers; examinations involving sales of partnership interests will attempt to assure that reported interests match the actual ownership interests reflected in the partnership agreements, that income is properly recognized on distributions of installment notes, and that debt cancellation, general income & expense items reported on partners’ returns – including proper reporting from K-1s, is correctly reported.
Additional examination issues include NOL carryforwards (taxpayers should be prepared to fully document losses incurred in the recessionary economy of 2008-2009); examinations of estate and gift tax returns will continue to focus on valuations and discounts associated with closely-held entities and properties, fractional interests, sales that occur close to death, under-funded marital trusts and over-funded bypass trusts upon the death of the surviving spouse. For matters involving tax exempt organizations, the changes between the historical and the recently revised Form 990 provide a roadmap of issues deemed important to the government, including executive compensation for senior management and key employees, conflicts of interest and – an old favorite – abuse of donor-advised funds. Non-filers, Schedule C taxpayers and “cash intensive” businesses provide a target-rich environment for the IRS. Finally, and of significant importance, return preparers & advisors provide a unique opportunity to leverage ongoing IRS compliance efforts that simply won’t be ignored.