The IRS is putting an increased emphasis on identity theft protections for business returns as a result of an increase in fraudulent business tax returns in recent years. The IRS will be asking tax professionals to gather more information on their business clients to assist the IRS in authenticating that the tax return being submitted is actually a legitimate return filing and not an identity theft return.

IRS Commissioner John Koskinen cautioned:

We know that cybercriminals are planning for the 2018 tax season just as we are. They are stockpiling the names and SSNs they have collected. They try to leverage that data to gather even more personal information. This coming filing season, more than ever, we all need to work diligently and together to combat this common enemy. We all have a role to play in this fight.

The IRS explained that there are some signs that may indicate identity theft, including:

  • A request for an extension is rejected because a return with the Employer Identification Number (EIN) or Social Security Number is already on file.
  • An e-filed return is rejected because a duplicate EIN/SSN is already on file with the IRS.
  • An unexpected receipt of a tax transcript or IRS notice that does not correspond to anything submitted by the filer.
  • Failure to received expected and routine correspondence from the IRS.

To help curb identity theft, tax professionals will begin gathering additional information and asking additional questions, including:

  • The name and SSN of the company individual authorized to sign the business return. Is the person signing the return authorized to do so?
  • Payment history: Were estimated tax payments made? If so, when were they made, how were they made, and how much was paid?
  • Parent company information: Is there a parent company? If so, who?
  • Additional information based on deductions claimed.
  • Filing history: Has the business filed Form(s) 940, 941 or other business-related tax forms?

The IRS is also cautioning taxpayers and tax professionals about an ongoing scam to steal Forms W-2. Identity thieves are creating fake Forms W-2 to accompany fraudulent returns. Going forward, all Forms W-2 will now include a “Verification Code” box. The code is 16 digits and will assist the IRS in authenticating the Forms W-2.

The IRS is also warning all tax professionals and entities holding personally identifiable information to be especially alert to cybercriminals impersonating clients to steal sensitive information from their files. The IRS is urging all tax professionals incorporate verification steps regarding email requests for personal information and to watch out for phishing emails.

 

Today the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) announced that it had fined a California card club, Artichoke Joe’s Casino, $8 million for numerous willful violations of the Bank Secrecy Act occurring since 2009. In its assessment, FinCEN found that during the last eight years, the card club failed to implement and maintain an effective anti-money laundering program and failed to detect and adequately report suspicious transactions in a timely manner. This is the third enforcement action against a card club for FinCEN, the only federal regulator with anti-money laundering enforcement authority over card clubs. Artichoke Joe’s Casino did not consent to imposition of the assessment, which means that the Justice Department must now file suit in federal court to enforce the assessment and collect the penalty amount.

Artichoke Joe’s Casino is located in San Bruno, California, and has been in operation since 1916. A “card club” is a gaming establishment that only offers card games, and most are located in Montana and California. One of the largest card clubs in California, Artichoke Joe’s Casino contains 38 tables offering card and tile games, including baccarat, blackjack, poker, and Pai Gow, and has a history of compliance deficiencies. The Internal Revenue Service, which examines card clubs for compliance with the Bank Secrecy Act, conducted an examination in 2015 that identified significant violations of the Bank Secrecy Act. In addition, on May 9, 2011, Artichoke Joe’s Casino entered into a stipulated settlement with the California Bureau of Gambling Control, agreeing to pay a fine of $550,000, with $275,000 stayed for a two-year period, and agreed to modify its surveillance, work with the city of San Bruno to improve coordination with law enforcement, replace employees at the Pai Gow tables, and provide additional training on loan-sharking, illegal drugs, and compliance with the Bank Secrecy Act.

In a press release announcing the assessment, Jamal El-Hindi, Acting Director of FinCEN, said, “[f]or years, Artichoke Joe’s turned a blind eye to loan sharking, suspicious transfers of high-value gaming chips, and flagrant criminal activity that occurred in plain sight. FinCEN’s $8 million civil penalty results from the card club’s failure to establish adequate internal controls and its willful violations of the Bank Secrecy Act. Casinos, card clubs and others in the gaming industry should consider their risk of exploitation by criminal elements, and understand that they will be held accountable if they disregard anti-money laundering and illicit finance laws. This significant action highlights the need for all entities, including those in the gaming industry, to build a robust culture of compliance into their policies and procedures to ensure they are not facilitating illicit activities.”

In March 2011, Artichoke Joe’s Casino was the subject of a raid by state and federal law enforcement which led to the racketeering indictment and conviction of two customers for loan-sharking and other illicit activities conducted at the casino. Senior-level employees knew that loan-sharks were conducting criminal activity through the card club and using gaming chips to facilitate illegal transactions. Nonetheless, according to FinCEN, Artichoke Joe’s Casino failed to file any Suspicious Activity Reports (SARs) on this activity.

According to FinCEN, Artichoke Joe’s Casino also failed to implement adequate internal controls, which exposed the card club to a heightened risk of money laundering and other criminal activity. In particular, the card club failed to adopt adequate policies and procedures to address risks associated with gaming practices that allow customers to pool or co-mingle their bets with relative anonymity. Further, Artichoke Joe’s Casino did not establish procedures for obtaining and incorporating information from propositional players (players paid by casinos or card clubs to wager at a game) or other employees who may have observed suspicious transactions. The card club also failed to file complete and timely reports on suspicious transactions involving potentially structured chip redemptions and purchases, and redemptions of large volumes of chips with no cash-in or gaming activity.

FinCEN’s action today represents only its third enforcement action against a card club, and its first ever non-consensual card club assessment. Its first action was against Oaks Card Club of Emeryville, California in December 2015. In that proceeding, Oaks Card Club admitted that it violated the program and reporting requirements of the Bank Secrecy Act and agreed to pay a fine of $650,000. In July 2016, FinCEN fined Hawaiian Gardens Casino (also based in California) $2.8 million, which admitted that it violated the Bank Secrecy Act’s program and reporting requirements and agreed to future undertakings, including periodic independent reviews to examine and test its AML program.

Bitcoin

Earlier this week, a federal grand jury in Brooklyn returned an indictment criminally charging a self-described “day trader” with various offenses in connection with an alleged computer hacking scheme involving more than 50 online brokerage accounts. The indictment further alleges that the defendant laundered the proceeds of his crimes using Bitcoin, a cryptocurrency.

The indictment alleges that the defendant and others conspired to hack into victims’ online securities brokerage accounts and used them to place unauthorized trades. As a part of the conspiracy, the defendant is alleged to have used brokerage accounts in his name to place “short sale” offers for publicly-traded companies’ stock at artificially high, above-market prices. Simultaneously, the defendant’s co-conspirators are alleged to have hacked into victims’ online brokerage accounts and used them to place buy orders for the stock at the artificially high prices, matching the defendant’s short sale offers. After using the victims’ accounts to purchase the stock, the defendant and his co-conspirators then re-purchased the stock from the victims’ accounts at market or below-market prices. This series of fraudulent trades usually took place within minutes, and the defendant immediately profited based on the difference between his artificially high short sale price, and the lower price at which he subsequently re-purchased the stock. While discussing the scheme in private messages on Twitter, one of the co-conspirators stated: “legal trading too hard.” The defendant responded that he would be a “good trading partner.”

Shortly before the defendant began the securities fraud scheme, he allegedly agreed to pay one of his co-conspirators one-half of his trading profits. Court documents indicate that the defendant was concerned about sending money to his co-conspirator, noting in a message sent via Twitter direct messaging that it was “sketchy but there are ways.” To mask these payments, the co-conspirator instructed the defendant to pay him in Bitcoin. The defendant opened an account at Coinbase, which is an online platform that allows users to convert currency such as U.S. dollars into Bitcoin, and to send and receive payments in Bitcoin. In total, the indictment alleges that the defendant paid his co-conspirator approximately $237,120 in Bitcoin through his Coinbase account. The defendant’s payments to his co-conspirator using Bitcoin is the basis for the indictment’s conspiracy to commit money laundering in violation of 18 U.S.C. section 1956(h).

Numerous government agencies have expressed concern that the anonymous nature of Bitcoin and other virtual currencies facilitates money laundering and other illicit activity. Most recently, the Drug Enforcement Administration published a report that drug trafficking organizations are increasingly using virtual currencies to enable easy transfer of illicit funds internationally, and that Bitcoin is also being used to facilitate trade-based money laundering schemes, particularly those based in China.

In addition to money laundering, Bitcoin and other virtual currencies can readily facilitate tax evasion by users. In 2013, the U.S. Government Accountability Office issued a report concluding that “some taxpayers may use virtual economies and currencies as a way to evade taxes. Because transactions can be difficult to trace and many virtual economies and currencies offer some level of anonymity, taxpayers may use them to hide taxable income.” In 2014, the Internal Revenue Service published guidance on the tax consequences of the use of virtual currencies, making clear that Bitcoin and similar currencies are property for tax purposes, and a taxpayer can therefore have gain or loss on the sale or exchange of a virtual currency, depending on the taxpayer’s basis.

In late 2016, a federal judge authorized the IRS to serve a “John Doe summons” on Coinbase – the same virtual currency exchanger used by the day trader charged this week in the case described above – seeking information about U.S. taxpayers who conducted transactions in virtual currency during 2013, 2014, and 2015. In court documents, the Justice Department stated that Coinbase was the fourth largest exchanger globally of Bitcoin and the largest exchanger in the United States. The Justice Department further stated that Coinbase offered buy/sell trading functionality in 32 countries, maintaining over 4.9 million wallets with wallet services available in 190 countries, serving 3.2 million customers, with $2.5 billion exchanged in Bitcoin. According to the IRS, only 2,500 taxpayers reported transactions in Bitcoin on their U.S. income tax returns during the three years in question, as compared to nearly 500,000 U.S. customers reported by Coinbase during the same period. Coinbase has vigorously resisted the John Doe summons, and the matter has been in litigation for the past year. Just yesterday, the federal judge overseeing the litigation indicated in a hearing that she is inclined to permit the IRS to proceed with its investigation of Coinbase customers.

On Thursday, November 2, the House Ways and Means Committee released the proposed Tax Cuts and Jobs Act, which proposes significant revisions to the Internal Revenue Code. According to Fox Rothschild tax partner Jennifer Benda, “my sense after reading the Bill is that most taxpayers’ tax liabilities will roughly remain the same.” The Tax Policy Center agrees with this general view.

A broad overview of several different parts of the Bill are discussed below.

Individuals

  • The Bill reduces the number of individual income tax brackets from seven to four. In general, rates are lowered.
  • The Bill provides for an increased standard deduction (nearly double the current deduction amount). The intent behind the increased standard deduction is to achieve simplification by reducing the number of filers who itemize deductions from approximately 33% currently to less than 10%. To accomplish this objective, the Bill repeals or reduces many deductions (such as deductions for personal exemptions, moving expenses, tax preparation expenses, medical expenses, and personal casualty losses, among others).
  • The Bill reduces the mortgage interest deduction. Under current law, taxpayers are allowed to deduct $1 million for acquisition indebtedness and $100,000 for home equity indebtedness. The Bill reduces the deduction for acquisition indebtedness from $1 million to $500,000, and interest is deductible only on the taxpayer’s principal residence (under current law, the deduction is available for interest paid on a principal residence and one other residence). Interest on home equity indebtedness will no longer be deductible.
  • The Bill modifies the exclusion of gain from the sale of a principal residence. Under current law, a taxpayer may exclude $250,000 ($500,000 if married filing jointly) on gain of the sale of a principal residence if the property was owned and used as a principal residence for two of the previous five years. The Bill modifies the exclusion to require the taxpayer to own and use the home as a principal residence for five of the previous eight years, and the exclusion if phased out one dollar for every dollar by which the taxpayer’s adjusted gross income exceeds $250,000 ($500,000 if married filing jointly).
  • The Bill narrows property that is eligible for like-kind exchange treatment. Current law allows like-kind exchange treatment for real property and personal property if certain conditions are met. The Bill allows for like-kind exchange treatment only for real property. However, the Bill provides for a transition rule to allow exchanges of personal property to be completed if the taxpayer has either disposed of the relinquished property or acquired the replacement property on or before December 31, 2017.
  • The Bill increases the Child Tax Credit from $1,000 per child to $1,600, and increases the threshold at which the credit is phased out. The Bill also provides for a new family flexibility credit, which is non-refundable and subject to a phase out.
  • The Bill consolidates the current American Opportunity Credit, Hope Scholarship Credit, and Lifetime Learning Credit into a single education credit. The Bill also repeals the deduction for student loan interest and qualified tuition and related expenses.
  • Family law attorneys will want to note that the Bill provides that alimony payments are not deductible by the payor or included in income of the payee.

Repeal of Alternative Minimum Tax

  • The Bill repeals the AMT, effective for tax years beginning after 2017. If a taxpayer has an AMT credit carryforward, the taxpayer can claim a refund of 50 percent of the remaining credits in tax years beginning in 2019, 2020, and 2021, and taxpayers can claim a refund of all remaining credits beginning in tax year 2022.

Estate Tax, Gift Tax, Generation Skipping Transfer Taxes

  • The Bill doubles the basic exclusion amount from $5 million under current law to $10 million (indexed for inflation).
  • The Bill repeals the estate and generation skipping transfer taxes beginning after 2023.
  • The Bill lowers the gift tax rate to a top rate of 35% (currently 40%) and retains an annual exclusion of $14,000 (indexed for inflation).

Pass-Through Entities

  • The Bill introduces an option for individual owners or shareholders of pass-through entities to treat a portion of pass-through entity net income distributions as “business income” that would be taxed at a maximum 25% rate. The remaining income would be taxed at the owner or shareholder’s individual income tax rates. Under current law, owners of pass-through entities are taxed on their share of business income at their respective individual income tax rates (i.e., there is currently no option to treat a portion of income as business income that would be taxed at a reduced rate).
  • The proposal offers two different ways to determine business income: (1) a set capital percentage of 30% of the net business income derived from active business activities (treated as business income subject to the 25% rate, and the remaining 70% is taxed at the owner or shareholder’s individual income tax rate), or (2) apply a formula to determine the exact capital percentage. Professional service partnerships are not eligible for the 70/30 rule. If the alternative method is chosen (option 2), the election would be binding for a five-year period. The Bill distinguishes between passive and active activities, to be determined pursuant to already-existing regulations.
  • The Bill repeals the current technical termination rule related to partnerships. Under current law, a partnership terminates if within a 12 month period there is a sale or exchange of 50% or more of the total interests in partnership capital and profits. The Bill repeals the technical termination rule, meaning the partnership would be treated as continuing and new elections that are currently required in the event of a technical termination would not be required or permitted.

Corporations

  • The Bill provides for a flat 20% corporate tax rate (25% for personal service corporations), eliminating the current marginal tax rate structure.
  • The Bill provides for enhanced cost recovery deductions and expands section 179 expensing. Under current law, taxpayers may take additional depreciation deductions when it places qualified property in service through 2019. The additional depreciation is limited to 50% of the cost of the property, at most. The Bill allows taxpayers to fully and immediately expense 100% of the cost of qualified property acquired and placed in service after September 7, 2017 and before January 1, 2023, and expands property that is eligible.
  • The Bill modifies the accounting method rules. Under current law, corporations with average gross receipts exceeding $5 million typically must use the accrual method of accounting. The Bill allows more corporations and partnerships with corporate partners to be eligible for the cash method of accounting by increasing the $5 million threshold to $25 million.
  • The Bill also allows more taxpayers to be eligible to use the completed contract method of accounting for long-term contracts (as opposed to the percentage of completion method) by increasing the threshold amount from $5 million to $25 million. The completed contract method allows eligible taxpayers to deduct costs associated with construction when they are paid and recognize income when the contract is completed.
  • The Bill modifies or repeals several business-related deductions. The Bill provides for interest deduction limitations (although the limitations do not apply to businesses with average gross receipts of $25 million or less), which disallows a deduction for net interest expense in excess of 30 percent of the business’s adjusted taxable income. The Bill also modifies the net operating loss deduction and nonrecognition for like-kind exchanges (discussed above – limited to exchanges of real property under the Bill), among other deductions. The Bill repeals deductions for local lobbying expenses and domestic production activities (DPAD).
  • The Bill repeals a number of business credits.

Tax Controversy

  • From a tax controversy perspective, the Bill does not modify any existing procedural rules for dealing with the IRS or provide for additional penalties.

This article touches on only a few topics addressed in the Bill. The Bill also revises taxation of foreign income and foreign persons, multi-national businesses, and exempt entities. You can read the Ways and Means Committee’s section-by-section summary of the Bill here.

 

Today the U.S. Department of the Treasury announced Kenneth A. Blanco as Director of the Financial Crimes Enforcement Network (FinCEN), a bureau in Treasury’s Office of Terrorism and Financial Intelligence. The leading federal anti-money laundering (AML) regulator, FinCEN’s mission is to safeguard the financial system from illicit use and combat money laundering and promote national security through the collection, analysis, and dissemination of financial intelligence and strategic use of financial authorities. Mr. Blanco will replace Jamal El-Hindi, who has served as acting FinCEN Director since May 2016, when Jennifer Shasky Calvery resigned as FinCEN Director and joined HSBC.

Mr. Blanco’s appointment as FinCEN Director continues a recent trend of criminal prosecutors departing the Justice Department to join FinCEN’s leadership ranks. Mr. Blanco has been a federal criminal prosecutor for 28 years, most recently serving as Acting Assistant Attorney General of the Justice Department’s Criminal Division. During his tenure with the Criminal Division, Mr. Blanco has overseen a number of its sections, including the Money Laundering and Asset Recovery Section (formerly the Asset Forfeiture and Money Laundering Section), the Narcotic and Dangerous Drug Section, the Organized Crime and Gang Section, and the Child Exploitation Section. Mr. Blanco has supervised many of the Criminal Division’s most significant national and international investigations into illicit finance, money laundering, Bank Secrecy Act, and sanctions violations, including investigations of global financial institutions and money services businesses. Much of his work is in the international banking and financial services area, working and collaborating with international partners in countries such as Mexico, Colombia, and Panama, among others.

Mr. Blanco’s predecessor, Jennifer Shasky Calvery, was appointed FinCEN Director in August 2012, following a 15-year career as a Justice Department prosecutor, where she led the Asset Forfeiture and Money Laundering Section and also worked in the Organized Crime and Racketeering Section prosecuting cases targeting international organized crime groups and particularly the professional money launderers who supported them. Ms. Shasky Calvery, the first career prosecutor ever to lead FinCEN, subsequently recruited many of her former Justice Department colleagues to join her at FinCEN, thereby bringing a decidedly prosecutorial bent to an agency that was historically viewed as primarily a data-gathering institution rather than a law enforcement agency.

Since Ms. Shasky Calvery’s appointment as FinCEN Director in 2012, the agency has advanced a significantly more aggressive enforcement agenda aimed at combating terrorist financing, trade-based money laundering, money laundering through real estate transactions, the use of third-party money launderers, and money laundering through use of virtual currency. FinCEN has also increased substantially its use of Geographic Targeting Orders, a temporary and geographically-limited anti-money laundering device authorized by the Bank Secrecy Act and the USA Patriot Act. This dramatic change-of-direction was no doubt the product of a prosecutorial mindset that Ms. Shasky Calvery and her Justice Department colleagues brought to FinCEN. With the announcement of Mr. Blanco’s appointment as FinCEN Director, another veteran criminal prosecutor is at the agency’s helm, and he will almost certainly continue the rigorous AML enforcement agenda that his predecessor initiated five years ago.

Tax Court

The issue before the Tax Court in Huzella v. Commissioner, T.C. Memo. 2017-210, centered around a coin business on eBay, and whether the petitioner, Thomas Huzella, could substantiate his cost of goods sold and expense deductions for his business.

The petitioner had been collecting coins as far back as 1958.  The problem was that the petitioner did not keep records to establish the basis in any of his coins.  In 2013, the petitioner actively bought and sold coins on eBay and was paid through PayPal.  PayPal issued the petitioner a Form 1099-K, Payment Card and Third Party Network Transactions, which reflected the payments he received from PayPal.  The petitioner earned $37,000 from almost 400 separate transactions in 2013.  But he also incurred eBay fees and Paypal fees, as well as packaging and shipping costs.

When he filed his tax return, the petitioner did not report anything on his Schedule C, and the IRS audited his return and issued a notice of deficiency.  The IRS alleged that the petitioner had unreported income of $37,000 from his eBay business and asserted penalties.  At trial, the IRS conceded that the petitioner was engaged in a trade or business in 2013.  The IRS also conceded that the petitioner was entitled to deduct the eBay and PayPal fees, and the Tax Court held that he was entitled to deduct $700 of postage and packaging costs.  The petitioner conceded that he earned – but did not report – gross proceeds of $37,000 from his eBay business.

The court then turned to the cost of goods sold issue.  Taxpayers are required to substantiate any amount they claim as cost of goods sold, and they must maintain sufficient records.  If a taxpayer with insufficient records, however, proves he incurred expenses but cannot substantiate the exact amount, the Tax Court may, in certain circumstances, estimate the amount.

Here, the Tax Court (and the petitioner) relied on the Cohan decision.  See Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930).  In that case, the taxpayer was an actor, playwright, and producer who spent large sums travelling and entertaining actors, employees, and critics.  Although Cohan did not keep a record of his spending on travel and entertainment, he estimated that he incurred $55,000 in expenses over several years.

The Board of Tax Appeals, now the Tax Court, disallowed these deductions in full based on Cohan’s lack of supporting documentation.  On appeal, however, the Second Circuit concluded that Cohan’s testimony established that legitimate deductible expenses had been incurred, holding that “the Board should make as close an approximation as it can, bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making.”  The Cohan rule has been followed by the Tax Court and other federal courts in numerous decisions.

The petitioner in Huzella did not have any records to establish his cost or bases in the coins.  He purchased some coins and inherited others.  But the Tax Court relied on Cohan and, after evaluating the evidence and the petitioner’s testimony, held that the petitioner could substantiate a cost of goods sold of $12,000.  Thus, the petitioner had taxable income of just under $20,600 (gross receipts of $37,000, less cost of goods sold and deductions).

On Friday, November 3, 2017, the IRS Large Business and International division (LB&I) announced the identification and selection of 11 additional compliance campaigns. In January 2017, LB&I unveiled its first 13 campaigns to be implemented as part of its effort to move toward issue-based examinations of taxpayers based upon risk assessments so as to make the greatest use of limited audit resources. (See prior coverage here and here.) According to the IRS, the LB&I compliance campaigns represent “the culmination of an extensive effort to redefine large business compliance work and build a supportive infrastructure inside LB&I. Campaign development requires strategic planning and deployment of resources, training and tools, metrics and feedback. LB&I is investing the time and resources necessary to build well-run and well-planned compliance campaigns.” The 11 new campaigns represent the second wave of LB&I’s issue-based compliance work. According to the IRS, more campaigns will continue to be identified, approved and launched in the coming months.

The 11 new compliance campaigns were selected based upon LB&I data analysis and feedback from IRS compliance employees. The 11 new campaigns, along with LB&I’s brief description of each, are as follows:

Form 1120-F Chapter 3 and Chapter 4 Withholding Campaign

  • This campaign is designed to verify withholding at source for 1120-Fs claiming refunds. To make a claim for refund or credit to estimated tax with respect to any U.S. source income withheld under chapters 3 or 4, a foreign entity must file a Form 1120-F. Before a claim for credit (refund or credit elect) is paid, the IRS must verify that withholding agents have filed the required returns (Forms 1042, 1042-S, 8804, 8805, 8288 and 8288-A). This campaign focuses upon verification of the withholding credits before the claim for refund or credit is allowed. The campaign will address noncompliance through a variety of treatment streams including, but not limited to, examinations.

Swiss Bank Program Campaign

  • In 2013, the U.S. Department of Justice announced the Swiss Bank Program as a path for Swiss financial institutions to resolve potential criminal liabilities. Banks that are participating in this program provide information on the U.S. persons with beneficial ownership of foreign financial accounts. This campaign will address noncompliance, involving taxpayers who are or may be beneficial owners of these accounts, through a variety of treatment streams including, but not limited to, examinations.

Foreign Earned Income Exclusion Campaign

  • Individuals who meet certain requirements may qualify for the foreign earned income exclusion and/or the foreign housing exclusion or deduction. This campaign addresses taxpayers who have claimed these benefits but do not meet the requirements. The Internal Revenue Service will address noncompliance through a variety of treatment streams, including examination.

Verification of Form 1042-S Credit Claimed on Form 1040NR

  • This campaign is intended to ensure the amount of withholding credits or refund/credit elect claimed on Forms 1040NR, U.S. Nonresident Alien Tax Return, is verified and whether the taxpayer has properly reported the income reflected on Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding. Before a refund is issued or credit allowed, the Internal Revenue Service verifies the withholding credits reported on the Form 1042-S. The campaign will address noncompliance through a variety of treatment streams including, but not limited to, examinations.

Agricultural Chemicals Security Credit Campaign

  • The Agricultural chemicals security credit is claimed under Internal Revenue Code Section 45O and allows a 30 percent credit to any eligible agricultural business that paid or incurred security costs to safeguard agricultural chemicals. The credit is nonrefundable and is limited to $2 million annually on a controlled group basis with a 20-year carryforward provision. In addition, there is a facility limitation as outlined in Section 450(b). The goal of this campaign is to ensure taxpayer compliance by verifying that only qualified expenses by eligible taxpayers are considered and that taxpayers are properly defining facilities when computing the credit. The treatment stream for this campaign is issue-based examinations.

Deferral of Cancellation of Indebtedness Income Campaign

  • During 2009 and 2010, taxpayers who incurred cancellation of indebtedness (COD) income from the reacquisition of debt instruments at an issue price less than the adjusted issue price of the original instrument may have elected to defer the COD income. Taxpayers must report the COD income ratably over five years beginning in 2014 and running through 2018. Further, when a taxpayer defers the COD income, any related original issue discount (OID) deductions on the new debt instrument, resulting from debt-for-debt exchanges that triggered the COD must also be deferred ratably and in the same manner as the deferred COD income. The goal of this campaign is to ensure taxpayer compliance by verifying that taxpayers who properly deferred COD income in 2009/2010 properly report it in subsequent years beginning in 2014, unless an accelerating event requires earlier recognition under IRC §108(i); and/or properly defer reporting OID deductions during the deferral period under IRC Section 108(i)(2). The treatment stream for this campaign is issue-based examinations. The use of soft letters is under consideration.

Energy Efficient Commercial Building Property Campaign

  • The Energy Efficient Commercial Building Deduction (Section 179D) allows taxpayers who own or lease a commercial building to deduct the cost or portion of the cost of installing energy efficient commercial building property (EECBP). If the equipment is installed in a government-owned building, the deduction is allocated to the person(s) primarily responsible for designing the EECBP. This goal of this campaign is to ensure taxpayer compliance with the section 179D deduction. The treatment stream for this campaign is issue-based examinations.

Corporate Direct (Section 901) Foreign Tax Credit (“FTC”)

  • Domestic corporate taxpayers may elect to take a credit for foreign taxes paid or accrued in lieu of a deduction. The goal of the Corporate Direct FTC campaign is to improve return/issue selection (through filters) and resource utilization for corporate returns that claim a direct FTC under IRC section 901. This campaign will focus on taxpayers who are in an excess limitation position. The treatment stream for the campaign will be issue based examinations. This is the first of several FTC campaigns. Future FTC campaigns may address indirect credits and IRC 904(a) FTC limitation issues.

Section 956 Avoidance

  • If a Controlled Foreign Corporation (CFC) makes a loan to its US parent, Section 956 generally requires an income inclusion equal to the amount of the loan. This campaign focuses on situations where a CFC loans funds to a US Parent (USP), but nevertheless does not include a Section 956 amount in income. The goal of this campaign is to determine to what extent taxpayers are utilizing cash pooling arrangements and other strategies to improperly avoid the tax consequences of Section 956. The treatment stream for this campaign is issue based examinations.

Economic Development Incentives Campaign

  • Taxpayers may be eligible to receive a variety of government economic incentives. These incentives include refundable credits (refunds in excess of tax liability), tax credits against other business taxes (i.e. payroll tax), nonrefundable credits (refunds limited to tax liability), transfer of property including land, and grants including cash payments. Taxpayers may improperly treat government incentives as non-shareholder capital contributions, exclude them from gross income and claim a tax deduction without offsetting it by the tax credit received. The goal of this campaign is to ensure taxpayer compliance. The treatment stream for this campaign is issue based examinations.

Individual Foreign Tax Credit (Form 1116)

  • Individuals file Form 1116 to claim a credit that reduces their U.S. income tax liability for the amount of foreign taxes paid on foreign source income. This campaign addresses taxpayer compliance with the computation of the foreign tax credit limitation on Form 1116. Due to the complexity of computing the Foreign Tax Credit and challenges associated with third-party reporting information, some taxpayers face the risk of claiming an incorrect Foreign Tax Credit amount. The IRS will address noncompliance through a variety of treatment streams including examinations.

The White House, Washington, D.C.On October 16, 2017, the White House released the Council of Economic Advisers’ Report, entitled Corporate Tax Reform and Wages: Theory and Evidence.  The Report comes in the wake of the current administration’s push for major tax reform.  With $299 billion in corporate profits abroad in 2016, the focus of the Report is to make the U.S. corporate tax rate more competitive in a global market.  The ultimate goal is for the benefits of the competitive U.S. corporate tax rate to trickle down to an increase in wages.  The Report reaches the conclusion that decreasing the U.S. corporate tax rate from the current thirty five percent to twenty percent will increase the average household income by $4,000 up to $9,000 annually.

Theory

The Report is rooted in the economic theory that there is a correlation between corporate tax rates and labor wages.  The Report states that U.S. companies move capital abroad to take advantage of lower capital tax rates in other countries.  It offers data showing that U.S. corporate profits have soared while wage growth has stagnated.  Over the past eight years, U.S. corporate profits increased at an average rate of eleven percent, but the average household income only increased at a rate of 1.1 percent.

The Report states that lowering the U.S. corporate tax rate to a more global competitive rate would not only bring profits back to the U.S., but also create an incentive for companies to invest the extra capital domestically.  It cites to research suggesting that increased domestic capital investments increases the demand for labor.  An increased demand for labor would theoretically create jobs and raise the price for labor, or workers’ wages.  Under this theoretical basis, the Report uses empirical data gathered from various sources to calculate an estimated dollar amount of the average wage benefits to the proposed lower corporate tax.

Empirical Evidence

The Report relies on different sources that use economic models to predict how a country’s corporate tax rate affects labor.  First, the Report cites to different sources that each offer a percentage of how much workers’ wages bear the burden of corporate tax in order to support the theory that wages bear most of the burden of corporate tax.  The percentages offered in the Report range from twenty-one to ninety-one percent, depending on the specifications used in the economic model.  This means that there are sources cited in the Report that calculated that workers’ wages bear the burden of only twenty-one percent of corporate tax, while other sources cited calculated that workers’ wages bear the burden of ninety-one percent of corporate tax.  The Report concludes that the disparity among the percentages depends on how much the economic model accounted for the flow of corporate capital to other countries, expressing the notion that workers’ wages bear more corporate tax burden as more corporate capital moves abroad.

Next, the Report cites to sources that used economic models to measure the direct relationship between corporate tax and workers’ wages to determine the elasticity of average wages, which is how much wages change when the corporate tax rate changes.  Each economic model cited in the Report offers a different elasticity, meaning that each economic model produced a different result as to how much a one percent change in the corporate tax rate affects workers’ wages.  This is because each model used slightly different variables.  The Report uses results from these different economic models to conclude that for every one percent increase in U.S. corporate tax, workers’ wages decrease by about 0.3 percent.  Using these figures, the Report concludes that these various economic models suggest that decreasing the current corporate tax rate by fifteen percent will raise the average household income annually by, conservatively, $4,000, and up to $9,000, using the higher range of the figures.

Lastly, the Report states that data from the Bureau of Economic Analysis shows that increasing the U.S. corporate tax rate by one percent results in 2.25 percent higher corporate profit shifting to lower tax jurisdictions.  The Report suggests that reducing the U.S. corporate tax rate by fifteen percent would reduce corporate profit shifting to lower tax jurisdictions and result in $140 billion of repatriated profit, based on the figures from 2016.

Review of Sources Cited

A review of the sources cited to in the Report highlight that the disagreement among economic theorists depends on the variables used in the economic model.  First, an economic model can be based on either a closed or open economy.  In a closed economy model, the supply of capital and labor are restricted to that country’s economy.  A closed economy model results in the owners of the capital bearing the burden of the corporate tax.  See Harberger, A.C., The Incidence of the Corporate Income Tax, Journal of Political Economy (1962).  The closed economy model is found more often in older economic literature, as the modern U.S. economy is more global.  In an open economy model, the capital is mobile, meaning that the supply of capital can move to different countries, but the labor remains immobile.  The open economy model shifts the corporate tax burden onto workers’ wages.  Although the Report ultimately uses figures from open economy models to reach its conclusion, this consistency among economic models does not necessarily decrease the variability in results.

Even among economic models that use an open economy, there is drastic variability in results.  Sophisticated economic models based on an open economy can take many forms, such as analyzing data across countries or restricting the model to data from only one country.  For example, the Report used a combination of results from economic models that analyzed data across countries and from economic models that analyzed data across states within the U.S. to calculate the figure for elasticity of wages.

Each open economy model can also account for a different rate of openness, or capital mobility.  The economic models that found that workers’ wages bear a lower percentage of the burden of corporate tax used moderate estimates of capital flow overseas.  On the other hand, economic models that found that workers’ wages bear a high percentage of the burden of corporate tax used figures to account for a free flow of capital abroad.  The differences in percentages cited in the Report show the drastic effect on results when an economic model adjusts figures for just one variable: openness.

Within these sophisticated economic models, there are assumptions and variables that are manipulated.  For example, two sources cited in the Report note the differences in outcomes when an open economic model does not assume that domestic and foreign products are perfect substitutes.  See Felix, R.A. Passing the Burden: Corporate Tax Incidence in Open Economies, LIS Working Paper Series (2007; see also Gravelle, Jane and Smetters, Kent, Does the Open Economy Assumption Really Mean that Labor Bears the Burden of Capital Income Tax?, B.E. Journal of Economic Analysis & Policy, (2006).  This variability is also seen in the conclusions drawn in the Report, as it notes that the estimated $4,000 annual increase to the average household income was calculated based on economic models that used countries and time periods that have less foreign corporate profit activity than the U.S. and less corporate profits held abroad.

Conclusion

Overall, the Report offers a conclusion that is supported by modern economic theorists and empirical data; a sophisticated economic model using an open economy can show that workers’ wages bear most of the burden of corporate tax, and a decrease in corporate tax may increase workers’ wages.  Importantly, the Report’s estimated effects of lowering the corporate tax rate in the U.S. suffer the same uncertainty as the results from any sophisticated economic model.  Adjustments to even one variable can create significantly different results.  Although sophisticated economic models offer valuable insight, it is crucial to investigate the information used in order to gain a clear picture of the basis of economic predictions, which in turn become the basis of major tax reform.

 

BitcoinIn its recently-published 2017 National Drug Threat Assessment (NDTA), the Drug Enforcement Administration reports that drug trafficking organizations are turning to Bitcoin and other virtual currencies to enable easy transfer of illicit funds internationally. The NDTA is a comprehensive strategic assessment of the threat posed to the United States by domestic and international drug trafficking and the abuse of illicit drugs. The report combines a wide variety of law enforcement reporting and other data to determine which substances and criminal organizations represent the greatest threat to the United States.

The NDTA notes that in order to avoid law enforcement detection and banking regulations, transnational criminal organizations (TCOs) employ various strategies to move and launder drug proceeds into, within, and out of the United States. Preferred methods to move and launder illicit proceeds – such as bulk cash smuggling, money value transfer systems, trade-based money laundering, and through the formal banking sector – remain the same as in past years. Emerging as a new money laundering threat, however, are Bitcoin and other virtual currencies because of their “anonymizing nature and ease of use.” Bitcoin is the most common form of payment for drug sales on dark net marketplaces and is emerging as a desirable method to transfer illicit drug proceeds internationally. Bitcoin is the most widely used virtual currency due to its longevity and growing acceptance at legitimate businesses and institutions worldwide.

The NDTA notes that Bitcoin’s widespread popularity in China has now spread to trade-based money launderers operating in that country. Many trade-based money laundering schemes are China-based, and have historically consisted of the purchase by TCOs of large shipments of “made-in-China” goods via wire transfer or bulk cash carrying from the United States to China. The “made-in-China” goods are then shipped to business owners in Mexico and South America, who in turn reimburse the drug trafficking organizations in local currency. Now, many China-based firms manufacturing goods used in such schemes prefer to accept Bitcoin for payment.

The use of Bitcoin in this type of trade-based money laundering scheme no doubt facilitates the money laundering process for TCOs, which currently face scrutiny from U.S. banks whenever they wire money to Chinese manufacturers. In contrast, the NTDA notes that a TCO purchasing Bitcoin through a licensed money service business without raising red flags will face no further scrutiny when transferring the Bitcoin to China. Many TCOs can also buy Bitcoin from individuals selling Bitcoin on the Internet without any MSB license. Many TCOs will thus be able to convert their cash drug proceeds to Bitcoin and buy Chinese goods with no fear of oversight from a formal financial institution.

The NDTA also notes that Bitcoin is increasingly being used by Over-the-Counter (OTC) Bitcoin brokers who conduct high-risk Bitcoin trading consistent with Chinese capital flight and money laundering. These brokers likely use foreign Bitcoin wallet-hosting services and exchanges that do not properly conduct “know your customer” or anti-money laundering monitoring on Bitcoin purchases. OTC Bitcoin brokers primarily attract two types of clients: those who want to use Bitcoin to move their money out of China and those who want to convert large quantities of cash into Bitcoin. Chinese underground banking systems money brokers sell Bitcoin to drug traffickers for cash earned from drug sales in the United States, Australia, and Europe. This drug cash is then sold to Chinese nationals in exchange for Bitcoin the Chinese nationals use to transfer the value of their assets outside of China. The NTDA concludes that the increasing use of OTC Bitcoin brokers, who are capable of transferring millions of dollars in Bitcoin across international borders as part of a capital flight scheme, is expected to continue to intertwine criminal money laundering networks with capital flight.