TAXLITIGATOR – Tax Controversy (Civil & Criminal) Report

Using a portion of the tens of billions of dollars now set aside for enhanced IRS enforcement under the Inflation Reduction Act of 2022 (the “IRA”),[1] the IRS announced a new campaign under its Large Business & International (LB&I) Division: The Business Aircraft Campaign (the “BAC”) on February 21, 2024.[2] In an effort to ensure tax compliance and increase awareness related to the business aircraft regulations and reporting requirements, the IRS[3] plans to substantially increase its issued-focused examinations to determine whether large corporations, large partnerships, and high-income individual filers are properly allocating private aircraft flights between business and personal use and whether fringe benefit inclusions are properly addressed.[4]  While this is part of a larger effort[5] the IRS is taking to ensure large corporate, large partnerships and high-income individual filers are paying their fair of taxes, the IRS will begin with “dozens” of these BAC audits.[6]

[1] The amount was once $80 billion but was decreased to $60 billion by the Fiscal Responsibility Act of 2023; https://www.congress.gov/bill/118th-congress/house-bill/3746.
[2] https://www.irs.gov/businesses/corporations/lbi-active-campaigns#collapseCollapsible1709079673889_469816.
[3] Id.
[4] Id.
[5] The IRS’s news release discussing new initiatives using the IRA: https://www.irs.gov/newsroom/irs-ramps-up-new-initiatives-using-inflation-reduction-act-funding-to-ensure-complex-partnerships-large-corporations-pay-taxes-owed-continues-to-close-millionaire-tax-debt-cases.
[6] IR-2024-46 (February 21, 2024).

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On February 29, 2024, the IRS announced a new initiative targeting approximately 125,000 high-income taxpayers who have failed to file federal income tax returns since 2017.  With funding from the 2022 Inflation Reduction Act, the IRS will send compliance letters to these individuals, including over 25,000 letters to individuals with incomes above $1 million and over 100,000 letters to those earning between $400,000 and $1 million.  The new initiative aims to address tax non-compliance, with penalties for failure to file ranging up to 25% of the non-filer’s tax bill, potentially a 75% penalty for willful failures, and potential criminal liability.  The IRS believes that hundreds of millions of dollars in unpaid taxes are involved

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We are pleased to announce that Michel R. Stein will be speaking at the upcoming ABA Section of Real Property, Trust & Estates Law webinar on the on the topic of “IRS Exams for High Wealth Individuals and Partnerships” on Tuesday, April 2, 2024, 10:00 a.m. – 11:30 a.m. (PST), along with co-panelists, Eric Cirelli (IRS Field Director for Global High Wealth), Cliff Scherwinski (IRS, LB&I Director Pass-Through Entities) and Hans Famularo (IRS Special Counsel).

In connection with the additional appropriations in the Inflation Reduction Act, the IRS has committed to shift more attention to wealthy taxpayers – including high-income earners and high wealth individuals and large partnerships. This panel will address the IRS’s announced enforcement priorities for high-income earners, the expected timelines for additional enforcement, and strategies for representing clients in corresponding IRS examinations of high-income taxpayers.

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Dear Colleague-

We cannot believe that it is March already and it’s time to Save the Date for the 2024 UCLA Extension Tax Controversy Institute, which will be held this year on October 24, 2024 at the Beverly Hills Hotel. It will be the 40th Anniversary of the Institute and you will not want to miss it. 

We have linked to this Save the Date Sandra’s and my Message from the Chairs published in the UCLA Edition of CCH’s Tax Practice and Procedure Journal which provides some more detail of last years Institute and Claudia Hill’s article from the Editor of the Journal, which contains some amazing pictures from last October.

Last year was an amazing conference with record attendance and where we were honored by the attendance of Commissioner Danny Werfel and covered cutting edge topics and issues facing the tax controversy practitioner. This year will not disappoint with topics including —

Strategies for Handling High Wealth and High Income Examinations

The Fall Out of the Employer Retention Credit – A Good Idea that has caused a
Tax Administration Headache 

An Interim Report Card on the IRS New Non-Filer Initiative and The Best Practices to Avoid Collection Problems and Potential Criminal Prosecution. 

The State of Tax Litigation in the United States Tax Court 

Please join us and celebrate 40 years of the Institute. 

Steven Toscher and Sandra R. Brown, Co-Chairs
2024 UCLA Extension Tax Controversy Institute
Hochman Salkin Toscher Perez P.C.
toscher@taxlitigator.com

We are pleased to announce that Steven Toscher, Evan Davis, and Sandra Brown will be speaking at the upcoming CalCPA webinar “New Corporate Transparency Act: The World is Changing” Tuesday, March 19, 2024, 9:00 a.m. – 10:00 a.m. (PST).

On January 1, 2021, Congress enacted the National Defense Authorization Act for Fiscal Year 2021 (NDAA). Contained within the NDAA is the Anti-Money Laundering Act of 2020 (the AMLA), which introduces extensive reforms to U.S. anti-money laundering (AML) and counter-terrorism financing (CFT) laws. Within the AML, Congress passed the Corporate Transparency Act (CTA). The CTA requires certain corporations and limited liability companies (reporting companies) to disclose beneficial owner information to FinCEN and update ownership information within one year of any changes. More than 32 million entities are estimated to be affected and required to file.

While the reporting requirements became effective January 1, 2024, in March, a Federal District Court held the reporting requirements of the CTA were unconstitutional.  While this decision may appear to lessen the requirements for compliance in the short term, since noncompliance can result in civil and criminal liability and in light of the government having now filed its Notice of Appeal, an awareness of and best efforts in continuing compliance with these new reporting obligations, should be considered by corporations, limited liability companies, limited partnerships, and any entity whose existence is created by the filing with a Secretary of State in any state.

Join our panelists for a discussion on what is next.

We are pleased to announce that Michel R. Stein will be speaking at the upcoming SVBA webinar “IRS Enforcement Priorities for 2024 and Beyond” Tuesday, March 19, 2024, 12:00 p.m. (PST).

Michel Stein will lead a discussion on what tax practitioners can expect from the Internal Revenue Services’ audit priorities and enforcement action after the Inflation Reduction Act of 2022.

Information about signing up for the webinar can be obtained from the following link:

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Each year the majority of taxpayers who retain the services of return preparers to navigate the complexities of the tax laws to ensure the filing of accurate returns are in good hands. However, countless numbers of taxpayers who look to others to assist in this often daunting task discover years later, when the IRS knocks, that their returns were actually prepared by return preparers who are incompetent, poorly trained, or who knowingly prepare false returns claiming deductions and, credits to which the taxpayer is not entitled. The continuing problem with such return preparers has been repeatedly highlighted by the National Taxpayer Advocate in her Annual Report to Congress. These types of return preparers are the targets of IRS civil and criminal investigations.

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The Employee Retention Credit (ERC) is a refundable tax credit created by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) in 2020 to help businesses negatively impacted by the COVID-19 pandemic maintain their payroll. The credit has very specific eligibility requirements including full or partial suspension of business operations because of government orders and significant declines in gross receipts during 2020 or the first three quarters of 2021. Despite, or perhaps because of, these complex eligibility requirements, the IRS received a deluge of dubious claims caused by aggressive third-party promoters encouraging (oftentimes ineligible) employers to claim the ERC – receiving a percentage of the (oftentimes illegitimate) refund as payment for their “service.” For employers who have determined their claim is incorrect but have already received the ERC, the IRS created the Employee Retention Credit Voluntary Disclosure Program (ERC-VDP). The program allows employers to repay 80% of the credit to avoid paying interest or penalties, with an approaching deadline of March 22, 2024. 

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The IRS has taken an important step to strengthen its understanding and oversight of the cryptocurrency space and may signal a bull market of tax enforcement in the crypto realm.

The agency recently announced the hiring of two private sector experts as advisors – Sulolit “Raj” Mukherjee and Seth Wilks. Both individuals have extensive experience working with digital assets and blockchain technology.

Raj Mukherjee most recently served as the Global Head of Tax for ConsenSys, a major blockchain software company. ConsenSys is known for its wallet software MetaMask. He has also held tax leadership roles at prominent exchanges like Coinbase, Binance.US, as well as at the Blockchain Association. His background includes over a decade of experience in tax compliance and reporting for both traditional finance and cryptocurrency businesses.

Seth Wilks was previously the Vice President of Government Relations and Success at TaxBit, a leading crypto tax software provider. Before that, he held a similar position at ProfitStance, another firm focused on crypto tax and accounting services. Wilks has worked extensively on digital asset tax policy issues over the past six years.

The IRS clearly sees a need to bolster its internal expertise on cryptocurrency and other digital assets. Commissioner Danny Werfel noted that it’s an evolving sector with major tax administration implications. By bringing in advisors like Mukherjee and Wilks, the IRS aims to successfully develop systems and programs focused on this emerging area.

Expanded work on digital assets is listed as one of the IRS’ key priority areas. This includes efforts to enhance the data on digital asset transactions, like the John Doe summons to seeking information on taxpayer’s transactions on platforms such as against Coinbase, Kraken, Poloniex, and others, or the proposed broker reporting regulations. The hiring of these two advisors should help the IRS stay on top of industry changes and help taxpayers comply with their crypto tax obligations.

This announcement is not the only event showing that the IRS is intent on making digital assets top priority. The IRS is currently working on new guidance that is expected to come trickling in throughout the year.

Additionally, in early February the Department of Justice announced the indictment of an individual for tax charges related to unreported cryptocurrency sales. So far, we have seen crypto-related tax charges being piled on money laundering or fraud charges, but not as standalone indictment. This signals increased enforcement in this domain and emphasizes the importance of compliance for those dealing with digital assets. Overall, the IRS is clearly gearing up its capabilities to oversee the taxation of cryptocurrencies.

The Financial Crimes Enforcement Network, better known as FinCEN.has also become interested in the crypto sphere. In a 2020 FinCEN Notice (Notice 2020-2), the agency expressed their intent to propose amendments to the FBAR regulations that would classify virtual currency accounts and addresses as financial accounts that must be reported under 31 CFR 1010.350. In other words, while cryptocurrency assets themselves are not reportable at present, FinCEN has announced plans to issue regulations requiring such holdings to be disclosed on FBARs  We are still waiting for FinCen to issue these proposed regulations.

Now that the IRS has stepped up federal tax guidance, enforcement and reporting requirements for digital assets, more states may feel pressure to address this evolving area in order to align with federal rules. Only five states (Illinois, Michigan, New York, New Jersey, and Wisconsin) provide some guidance regarding the treatment of digital assets for income tax purposes. Several states have provided some guidance for sales tax purposes, among them California (see Reference #F22-12-084FU, California Department of Tax and Fee Administration, January 19, 2023). However, many uncertainties exist around state tax obligations and filings related to digital currencies.

Over the next year, we could see more state revenue agencies and legislatures exploring how to apply existing sales/use and income tax frameworks to cryptocurrency transactions. Clarified guidance would help both tax authorities and taxpayers understand the relevant compliance duties.

It’s clear the IRS is ramping up both their guidance and enforcement when it comes to cryptocurrency taxation. Other agency may profit from these efforts. With its latest move of bringing in seasoned experts from the industry, the IRS is signaling an intent to more closely monitor this emerging sector. Between expanded reporting obligations, greater reporting from centralized exchanges, and beefed-up enforcement capabilities, the IRS has made it a top priority to single out those not adhering to crypto tax rules. Additional audit resources allocated under the Inflation Reduction Act will allow the IRS to more vigorously pursue taxpayers failing to properly report cryptocurrency transactions and holdings. As the agency works to close the tax gap, those holding cryptocurrencies and engaging in cryptocurrency transactions should expect even more scrutiny in the coming years.

What It’s About

On February 7, the Justice Department announced a seven-count indictment against Frank Richard Ahlgren III, charging him with filing false tax returns and structuring transactions based on his cryptocurrency dealings between 2017 and 2019. Ahlgren faces three counts of filing false tax returns under 26 U.S.C. section 7206(1), related to underreporting or not reporting the sale of $4 million worth of bitcoin. In 2017, he allegedly inflated the basis of bitcoin sold and failed to report several bitcoin sales in subsequent years. Additionally, he is charged with four structuring charges for attempting to evade currency reporting requirements during cash deposits of sale proceeds.

Significance of the Case

This indictment represents a departure from previous cases primarily focused on money laundering or fraud, instead centering squarely on tax charges stemming from cryptocurrency transactions. This shift marks a significant move towards criminal enforcement for tax non-compliance in the crypto space.

What sets this case apart is its temporal context. Many tax professionals anticipated that the first instance of solely tax-related charges would occur for tax periods starting with tax year 2020 or later, given the prominent placement of the crypto question on the first page of the tax returns during those periods, making it more conspicuous. However, these charges span the years 2017 through 2019. Notably, while the 2019 tax return included a crypto-related question, albeit not on the front page, the 2017 and 2018 returns lacked any crypto-related question.

As an aside, what may have contributed to DOJ’s reach back to 2017 is the very public civil litigation between the defendant and the trustees of the Ahlgren Management Trust, Case no. D-1-GN-20-001472 261st Judicial District, Travis County, Texas, which was filed in 2020. A June 15, 2023 Memorandum Opinion by the Texas Court of Appeals spent a fair amount of time discussing the 2017 Bitcoin traceable transactions. 

Lessons for Taxpayers

The Ahlgren case serves as a sobering reminder for taxpayers involved in cryptocurrency transactions. Despite ongoing debates surrounding reporting thresholds and requirements, the obligation to report capital gains and ordinary income remains non-negotiable.

While the outcome of the case in court remains uncertain, it signifies the commencement of a heightened level of tax enforcement within this domain. The Department of Justice is sending a clear message – tax charges are a real possibility for failure to report cryptocurrency transactions, thus elevating the stakes of tax compliance in the cryptocurrency realm.

The DOJ press release highlighted that the IRS is investigating the case, underscoring the collective commitment to lift its structural enforcement deficits in the crypto space. Tax compliance is key to staying out of trouble, both civilly and criminally.

Historically, taxpayers holding crypto were often left with very little guidance when it came to filing their taxes, leading to non-compliance with rules that are now becoming more clear. By taking proactive steps with knowledgeable counsel, you can rectify past discrepancies and avoid potential legal ramifications. Investing in experienced tax counsel today can safeguard your financial future tomorrow, ensuring compliance and peace of mind as you navigate the complex landscape of tax regulations.

Sandra R. Brown is a Principal at Hochman Salkin Toscher Perez P.C., and former Acting United States Attorney, First Assistant United States Attorney, and the Chief of the Tax Division of the Office of the U.S. Attorney (C.D. Cal). Ms. Brown specializes in representing individuals and organizations who are involved in criminal tax investigations, including related grand jury matters, court litigation and appeals, as well as representing and advising taxpayers involved in complex and sophisticated civil tax controversies, including representing and advising taxpayers in sensitive-issue audits and administrative appeals, as well as civil litigation in federal, state and tax court.

Philipp Behrendt is an Associate at Hochman Salkin Toscher Perez P.C., licensed in California as well as in Germany and assists in advising clients in civil and criminal tax controversies as well as international money laundering investigations stemming from tax avoidance structures. He also focuses on the technical aspects involved in advising voluntary disclosures in connection with DeFis, NFTs, and other crypto assets.