TAXLITIGATOR – Tax Controversy (Civil & Criminal) Report

On March 30, the Department of Justice, Tax Division, filed a petition for leave to serve a “John Doe” summons on Payward Ventures, also known as “Kraken,” requesting account information for all United States taxpayers who held accounts there with the equivalent value of $20,000 or more in cryptocurrency for any one year from 2016 through 2020.

What does this mean for Kraken and other Crypto Account Holders?

Steve is quoted saying that, “the Court’s decision is important for a number of reasons. First it tells us something we already know – that the IRS is using all of its tools to investigate tax compliance of those who invest and trade in cryptocurrency. More importantly, it reiterates what the District court held in the Coinbase case – that the “ narrowly tailored” language recently added to the statue has real teeth.”

Click Here for full article.

We are pleased to announce that Steven Toscher, Michel Stein and Evan Davis will be speaking at the upcoming Strafford webinar, “Cryptocurrency Tax Compliance in the Post-$50,000 Bitcoin World: Tax Filing Requirements, Managing IRS Examinations” on Thursday, April 22, 2021, 10:00 a.m. – 11:30 a.m. (PST), 1:00 p.m. – 2:30 p.m. (EST). 

This CLE/CPE webinar will provide tax counsel, accountants, and other advisers with a critical first look at new IRS enforcement actions on taxpayer compliance and reporting obligations for cryptocurrency transactions. The panel will discuss the IRS position on the tax treatment of cryptocurrency, analyze IRS monitoring to increase compliance, consider criminal investigations and prosecutions for failing to report cryptocurrency transactions accurately, and define proper reporting and tax treatment for “mining” and exchanging cryptocurrency. The panel will also discuss tactics in managing IRS examinations and audits.

The IRS continues to press its concern over “massive under-reporting” of income from cryptocurrency transactions. Tax advisers for clients with cryptocurrency holdings must understand the reporting requirements for exchange transactions and the IRS scrutiny cryptocurrency investors are likely to face in the future.

Cryptocurrency is a digital currency using encryption techniques–rather than a central bank–to generate, exchange, and transfer currency units. Uniquely, no bank or government authority verifies the transfer of funds.

The value of Bitcoin has topped $50,000 in the past year, prompting a massive compliance initiative aimed at taxpayers holding and trading cryptocurrency. The IRS treats all virtual currency as property rather than currency for U.S. tax purposes. The IRS requires reporting any transaction involving cryptocurrency as a sale or exchange of property, with the taxpayer bearing responsibility for calculating and maintaining basis in their virtual currency holdings.

Listen as our expert panel discusses recent IRS enforcement actions focused on cryptocurrency and provides practical guidance on the U.S. tax reporting and payment duties arising from cryptocurrency transactions.

We are also pleased to announce that we will be able to offer a limited number of complimentary and reduced cost tickets for this program on a first come first serve basis. If you are interested in attending, please contact Sharon Tanaka at sht@taxlitigator.com.

Click Here for more information.

We are very pleased to announce that Sandra Brown is featured in this month’s Los Angeles Lawyer discussing the IRS Voluntary Disclosure Practice. Check out the current state of the practice and Sandra’s insights.

The tax system of the United States is often described as one of “voluntary compliance.”  However, there is little about the filing of required ax returns and paying amounts legally due that is truly voluntary.  The reality is taxpayers have a “legal duty” to comply with U.S. tax laws and, for those who fail to do so, the federal laws provide the IRS with the ability to pursue the imposition of a wide array of sanctions, including criminal prosecution.

In the article Sandra discusses when taxpayers who are not in compliance should consider the IRS Voluntary Disclosure Practice and the benefits it can provide.

Click Here to read full article.

The Internal Revenue Service will continue its focus on collecting delinquent taxes from the wealthiest taxpayers. The Treasury Inspector General for Tax Administration (TIGTA) recently published a report on the IRS efforts to collect delinquent taxes from wealthy taxpayers.

This is the second report by  TIGTA on the IRS attempts to increase compliance of this group of the taxpayer population.[i] In response to this earlier report, the IRS agreed to make changes to its non-filer strategy and issue delinquency notices to all high-income non-filers identified.[ii]

The following chart shows that delinquent taxpayers having an average AGI of over $1.5 million paid the IRS an average of 39 percent of what they owed.  These high-income taxpayers still owed over $2 billion.

TIGTA Report – Audit and Conclusions

TIGTA found that the IRS generally prioritizes these  cases by the amount of the tax liability rather than the income level of the taxpayer.[iii] The report suggests that the emphasis by the IRS on the amount of the tax liability as opposed to income of the taxpayer adds  credibility to the belief that the U.S. tax system favors the wealthy.

 In the audit conducted by the TIGTA, they identified 685,555 taxpayers who reported an AGI of $200,000 or more, on at least one Form 1040 for tax years 2013 through 2017, who owe a combined total of $38.5 billion in delinquent tax payments.[iv]  The amount owed represents 22 percent of the total amount owed by all taxpayers with at least one Form 1040 balance due on May 14, 2019.[v]  These high-income taxpayers account for 6 percent of the total taxpayers identified with delinquent tax liabilities. 

TIGTA concluded based on their audit that high-income taxpayers are not a sufficient collection priority.    TIGTA concluded that the failure to address this subgroup is problematic because these high-income taxpayers have the ability to pay their debt and that not addressing this group can lead to this debt being uncollected.[vi] The two concepts of ability to pay and early collection activity are both highly important for successful revenue collection. The probability of collecting unpaid tax debt falls dramatically in the first three years as the accounts age. A majority of IRS Revenue Officers agreed and emphasized the importance of collection activities at the time taxpayers are earning a high income.

In the response to the TIGTA report, Eric Hylton,  Commissioner of the IRS SB/SE division,  assured TIGTA  that high-income taxpayers are a high priority for the IRS collection function and that they have made significant efforts to collect on this group of taxpayers.[vii] He further stated that high-income taxpayers are more likely to resolve their liabilities while in the notice phase of the collection process, and for those who do not, the IRS Automated Collection System is well suited to resolve lower balances owed by high-income taxpayers.[viii] He also reported that IRS Collection was working or had worked 87 percent of the high-income taxpayers who had a tax liability as of May 2019.[ix]

The IRS focus on the collection from high income taxpayers is a continuation of its efforts relating to high income non- filers. A “non-filer” is a taxpayer who either does not timely file a required tax return and timely pay a tax due for the delinquent return. This group can encompass foreign legal entities or individuals that have invested and earned income in the U.S. without knowing that their activity consists of being engaged in a U.S. trade or business and thus having a U.S. tax filing obligation.[x]  Other members of this group could be uncooperative non-filers, tax protestors, or individuals that did not have a chance to file a return due to health conditions or other extraneous factors.

The IRS has several enforcement initiatives targeting high-income non-filers.  The first is the High-Income Delinquent Filer (HiDeF) Sweeps. The HiDef Sweeps target taxpayers with three years of unfiled returns and large tax balances.  They are assigned to experienced revenue officers and may result in unannounced field visits.

Another initiative is Operation Surround Sound. This is the successor effort to HiDef but only targets cases with egregious noncompliance with indicators of potential fraud.  Operation Surround Sound is a collaboration effort between the Office of Fraud Enforcement (OFE), IRS Examinations Operations, and Collections. This operation involves significant use of data analytics that compare numerous data sets for the OFE to make appropriate recommendations.  This can lead to referrals to the IRS Criminal Investigation function, examination referral, or collection for a IRS Substitute Return for the non-filing taxpayer.

Options for High-Income Non-Filers

If contacted by the IRS, the taxpayer should consult with an appropriate tax advisor to consider filing their delinquent tax returns and begin to enter into installment agreements or offer in compromises as applicable. The taxpayer should seek representation to assist with any reasonable cause arguments or first time penalty abatement arguments. Taxpayers with criminal exposure – yes the willful failure to file a tax return is a criminal offense- should consult with experienced criminal tax counsel. The OFE is involved with these cases for a reason.

Taxpayers who have not yet been contacted by the IRS should consider the IRS’s voluntary disclosure practice where there is a criminal potential. The IRS voluntary disclosure practice is discussed in Sandra Brown’s article in March 2021 edition of the Los Angeles Lawyer.

Whether the IRS gets to the taxpayer first or the taxpayer takes corrective actions in advance of IRS contact- the preferred approach— there are opportunities to get straight with Uncle Sam and avoid the serious consequences- both civil and criminal if not filing your tax return and not timely paying your income tax.  The IRS has been increasing its focus on high income non- filers and the TIGTA report will insure the focus continues and even increase.

Steven Toscher is a Principal at Hochman Salkin Toscher & Perez P.C., and specializes 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.

Dennis Perez is a Principal at Hochman Salkin Toscher & Perez P.C., and is a Certified Tax Specialist in Taxation, the State Bar of California Board of Legal Specialization. He represents clients throughout the United States involving federal and state, civil and criminal tax controversies and tax litigation.

Tenzing Tunden is a Tax Associate at Hochman Salkin Toscher Perez P.C.

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[i] Treasury Inspector General for Tax Administration, High-Income Taxpayers Who Owe Delinquent Taxes Could Be More Effectively Prioritized, Report Number 2021-30-015, (March 10, 2021), available at https://www.treasury.gov/tigta/auditreports/2021reports/202130015fr.pdf.

[ii] See Treasury Inspector General for Tax Administration, High-Income Non-filers owing Billions of Dollars Are Not Being Worked by the IRS, Report Number 2020-30-015,  34-38, (May 29, 2020), available at https://www.treasury.gov/tigta/auditreports/2020reports/202030015fr.pdf.

[iii] Id. at 1.

[iv] Id. at 4.

[v] Id.

[vi] Id. at 7-8.

[vii] Id. at 26.

[viii] Id. at 29.

[ix] Id.

[x] IRC §882(a)(1) and §11(a). IRC §871(b)(1) and §1.

“Friend of the JTPP, Robert S. Horowitz shares an update on penalties in The News from the FBAR Front Isn’t All Bad, It Only Seems That Way Sometimes. It’s good to hear the phrase “non-willful FBAR cases” even if it is a rare case. It seemed for a while that IRS wasn’t able to find an FBAR case it considered non-willful. Robert’s easy writing style and insight will guide you through the variety of cases he reviews.”

—Claudia Hill Editor-in-Chief

This year has seen several significant decisions in the FBAR penalty arena. While some taxpayers have been successful in defeating motions for summary judgment in FBAR willful cases, in those cases that have gone to trial the taxpayers have ultimately lost. In the non-willful FBAR area, however, the taxpayers this year were successful in convincing two district courts that the maximum non-willful penalty is $10,000 per annual form and not per account. This article will discuss some of the FBAR cases that were decided over the past year.

Click Here to read full article.

The IRS Criminal Investigation division isn’t focusing its enforcement efforts specifically on cannabis businesses, but is instead treating them like any other cash-intensive business, according to a division official.

Jonathan Kalinski of Hochman Salkin Toscher Perez PC told Tax Notes in part that “. . . practitioners with cannabis clients might need to keep a closer watch for potential criminal activity than they do for other clients.”

Click Here to see full article.

Steven Toscher recently had the opportunity to moderate a Federal Bar Association panel on the IRS new Office of Fraud Enforcement. While much attention was paid on the panel to the  unveiling some of IRS Crown Jewels by the new OFE Director Damon Rowe and it’s “Operation Hidden Jewels” in its cryptocurrency enforcement efforts, Steve was quoted in Forbes on his thoughts on the established of the new OFE and what it will mean for taxpayers and their advisors:

“The new Office of Fraud Enforcement looks like it will be a game changer in tax enforcement. We expect to see more referrals for criminal prosecution and assertions of the 75% civil fraud penalty. When the current leaders of the IRS took over a few years ago they decided that a more vigorous enforcement of the tax laws, including the use of criminal investigations and civil fraud penalties, was essential to fairness for all taxpayers. The Office of Fraud Enforcement is the product of that increased focus.”

Stay tuned.  Click Here for Full Article

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The price of Bitcoin rose dramatically in 2020 and even doubled in price since the beginning of 2021. On January 1, 2021, Bitcoin was $29,336.31 and on February 21, 2021, it was $58,012.09. Many who have sold their Bitcoin have made a profit. Where there’s profit, there’s income – and where there’s income, there’s tax. 

When it comes to money and taxes, one can expect that the IRS will be the most likely government entity to be interested in a financial transaction.  However, the Financial Crimes Enforcement Network (FinCEN) is also very involved with monitoring money and financial transactions. FinCEN’s mission is “to safeguard the financial system from illicit use, combat money laundering and its related crimes including terrorism, and promote national security through the strategic use of financial authorities and the collection, analysis, and dissemination of financial intelligence.”

The IRS and FinCEN have, at times, had interest in the same financial matters. For example, as part of FinCEN’s focus on money laundering, that agency requires the reporting of certain foreign financial accounts on a Foreign Bank Account Report (FBAR). It is no secret that the IRS has also showed a tireless  interest in FBARs beginning in earnest in 2008, after the Department of Justice obtained a deferred prosecution agreement against UBS, the Swiss banking regulator, and thereunder the disclosure of  information about United States citizens with undisclosed foreign accounts in Switzerland.

Now both agencies, in an apparent connection to FBAR disclosures, have also taken steps to publicize their respective, and arguably shared, interest in cryptocurrency. As part of the IRS’s focus on tax compliance, the IRS has designated cryptocurrency, including international transactions, an enforcement priority for the last few years.  Most recently, FinCEN has also make clear that agency’s interest in cryptocurrency, as evidenced by their latest proposed amendment.

FinCEN’s proposed amendment seeks to add virtual currency to the list of financial accounts that need to be reported on an FBAR. Current FBAR regulation, 31 CFR 1010.350(a), states “Each United States person having a financial interest in, or signature or other authority over, a bank, securities, or other financial account in a foreign country shall report such relationship to the Commissioner of Internal Revenue for each year in which such relationship exists…”  

Current regulations provide that  the types of reportable accounts include bank accounts; securities accounts; accounts with a person that is in the business of accepting deposits as a financial agency; insurance or annuity policies with a cash value; an account with a person that acts as a broker or dealer for futures or options transactions in any commodity on or subject to the rules of a commodity exchange or association; mutual funds or similar pooled funs; or other investment funds. (31 CFR 1010.350(c)).

Notably, virtual or cryptocurrency is not a type of account required to be reported to the government under the regulations.  Although that is not a shock, as the statute was enacted in 1970, many years before crypto currency was likely more than a twinkle in the eye of the dark web or any other exchange. It appears that 2021 may be the year that the regulation catches up and addresses foreign cryptocurrency accounts in the context of required disclosures on an FBAR.    

FinCEN recently announced its intention to propose amendments to the regulations implementing the Bank Secrecy Act (BSA) regarding the FBAR to include virtual currency as a type of reportable account under 31 CFR 1010.350.

Currently, the Report of Foreign Bank and Financial Accounts (FBAR) regulations do not define a foreign account holding virtual currency as a type of reportable account. (See 31 CFR 1010.350(c)). For that reason, at this time, a foreign account holding virtual currency is not reportable on the FBAR (unless it is a reportable account under 31 C.F.R. 1010.350 because it holds reportable assets besides virtual currency). However, FinCEN intends to propose to amend the regulations implementing the Bank Secrecy Act (BSA) regarding reports of foreign financial accounts (FBAR) to include virtual currency as a type of reportable account under 31 CFR 1010.350.[1]

FinCEN’s announcement would add a second reporting requirement to taxpayers that own virtual currency. The 2019 Form 1040’s Schedule 1 for the first time added a question to the top of the form that was not previously found in previous Form 1040’s:

“At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” The form provides a checkbox for either “yes” or “no”.

Requiring virtual currency reporting on an FBAR, like other reporting requirements, is often more than an exercise in filing additional paperwork.  As the penalties and potential criminal exposure surrounding FBAR non-compliance have shown, the failure to disclose reportable virtual currency accounts on the FBAR may lead to even greater consequences than the already, often daunting consequences of a failure to report taxable transactions on a Form 1040.

Failure to report virtual currency on a Form 1040 can not only lead to criminal prosecution, but also additional tax, interest, and penalties, including the civil fraud penalty.  The failure to report on the FBAR may lead to penalties as high as 50% of an account’s highest balance per failure to file.  Of course, there is also the potential that the government could pursue both forms of penalties for non-compliance on the two separate forms. 

Reminding Taxpayers of the obligation to report income from all sources, including virtual currency, couldn’t be timelier.  The requirements to report virtual currency transactions may soon extend beyond the Form 1040, Schedule 1. FinCEN’s proposed amendments to regulations reporting of virtual currencies could soon place on U.S. taxpayer a reporting requirement on the annual FBAR form. As the IRS and FinCEN join forces to focus on virtual currency, the message is clear that cryptocurrency enforcement is here to stay. 

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[1] FinCEN Notice 2020-2

[i] Jonathan Kalinski is a principal at Hochman Salkin Toscher Perez P.C., and 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.

[ii] Gary Markarian is an Associate at Hochman Salkin Toscher Perez P.C., and a graduate of the joint JD/LL.M. Taxation program at Loyola Law School, Los Angeles. While in law school, Mr. Markarian served as an intern at the Tax Division of the U.S. Attorney’s Office (C.D. Cal) and Internal Revenue Service Office of Chief Counsel’s Large Business and International Division.

We are pleased to announce that Steven Toscher, Michel Stein and Jonathan Kalinski will be speaking at the upcoming Strafford webinar, “Handling Cannabis Tax Examinations: Sec. 280E, Audits, IRS Guidance, Reporting Requirements” on Wednesday, March 24, 2021, 1:00 pm-2:30 pm (EDT), 10:00 am-11:30 am (PDT).

This CLE/CPE webinar will provide tax counsel and advisers guidance on effective methods in handling IRS cannabis tax examinations for businesses engaged in the cannabis industry. The panel will discuss key federal and select state tax law provisions impacting marijuana businesses, key items of focus by the IRS when examining cannabis operations, and techniques in managing audits.

The sale and distribution of cannabis for recreational or medical use is a powerful economic engine generating billions in annual revenue, with over 40 states and the District of Columbia having some form of legalization of the substance. Despite state relaxation of marijuana prohibition laws, without careful planning, regulated cannabis businesses can be subject to hefty tax assessments and penalties.

Under Section 61, all gross income must be reported from whatever source it is derived. However, under Section 280E, cannabis businesses cannot deduct rent, wages, and other expenses unless it is for cost of goods sold (COGS), resulting in a substantially higher tax rate than other companies on their income. The IRS issued guidance to its agents on conducting audits of cannabis businesses giving IRS agents the authority to change a cannabis business’ accounting method. Under Section 280E, certain costs are not included in COGS. Thus, they remain non-deductible for income tax purposes.

As more states legalize cannabis and make available licenses to grow, manufacture, distribute, and sell cannabis, the IRS has increased cannabis tax audits, which could result in unbearable tax liabilities.

Listen as our panel discusses federal and select state tax law provisions impacting cannabis businesses, key items of focus by the IRS when examining cannabis operations, and tactics for managing audits. We are also pleased to announce that we will be able to offer a limited number of complimentary and reduced cost tickets for this program on a first come first serve basis. If you are interested in attending, please contact Sharon Tanaka at sht@taxlitigator.com

Click Here for more information.

On December 16, 2020, the Eighth Circuit issued its opinion in Coffey v. Commissioner, holding that a tax return filed with the U.S. Virgin Islands Bureau of Internal Revenue (“VIBIR”) was not a filing with the IRS and, thus, the three year statute of limitations on assessment was not triggered. See https://www.taxlitigator.com/a-return-by-any-other-name-by-robert-s-horwitz/.  On February 10, 2021, the Eighth Circuit granted a petition for rehearing before the three-judge panel that wrote the December 16 opinion.  On February 12, the Eighth Circuit issued its new opinion, which reached the same result as its earlier opinion: filing a return with VIBIR was not the same as filing it with the IRS.

The result was the same and the reasoning of the Eighth Circuit in its new opinion in Coffey was similar.  The Coffeys claimed to be residents of the U.S.V.I.  They filed a Form 1040 with the VIBIR, which sent the first two pages of the return to the IRS.  More than three years after receipt of the two pages, the IRS determined that the Coffeys were not residents of the U.S. Virgin Islands and issued a notice of deficiency.  The Coffeys petitioned the Tax Court, which held that since the IRS received the first two pages of the return, it had been “filed” with the IRS, thus starting the statute of limitations on assessment.  Since the notice of deficiency was issued more than three years after filing, it was time barred.

After reciting briefly the facts, the new opinion stated that the U.S. Virgin Islands non-resident must “file” their “return” with both VIBIR and the United States under IRC sec. 932(a)(2).  For purposes of the appeal, the Court assumed that the Coffeys were not U.S.V.I. residents.

The taxpayers’ first argument was that the document sent by the VIBIR to the IRS was “filed” for purposes of both secs. 932(a)(2) and 6501(a).  The Tax Court had agreed with this argument since the first two pages of the Coffeys’ return wound up at the IRS.  According to the Eighth Circuit, this was not enough: returns are filed “if delivered, in the appropriate form, to the specific individual or individuals identified in the Code or Regulations.”  A taxpayer must show “meticulous compliance” with the Code and Regulations.  The Court noted that the Coffeys did not intend to file tax returns with the IRS, but only with the VIBIR.  That the IRS had actual knowledge of the taxpayers’ tax liability was not a filing and without a filing, the statute of limitations on assessment did not begin to run.  The Coffeys had not complied with the federal tax return filing requirements, the VIBIR did not file the Coffeys’ returns with the IRS and the Coffeys had never authorized the VIBIR to do so.

The taxpayers’ second argument was that filing a return with the VIBIR began the statute of limitations under sec. 6501(a) because they intended to comply with all filing requirements under the belief that they qualified as U.S.V.I. residents.  The Court held that the taxpayers’ intent was irrelevant to whether they filed an honest and genuine return.  To be an honest and genuine return, it must be filed with the correct individual.  The U.S.V.I. is a separate taxing entity from the United States.  That the Coffeys may have made an honest attempt to satisfy the tax law is irrelevant, since the filing requirements do not contain an exception for a mistaken belief about residency.  The mistake does not create a “filing.”  While the VIBIR uses the same tax forms as the IRS, filing a return with the VIBIR is not filing it with the IRS.  Thus, the Tax Court was reversed.

Same facts, same legal arguments, slightly different route to get to the same result. Does the Eighth Circuit’s emphasis on “meticulous compliance” indicate that the Beard test for determining what is a return may come under attack?  Only time will tell.

Robert S. Horwitz is a Principal at Hochman Salkin Toscher & Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He 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.