Fox Rothschild attorneys Ryan T. Becker and Matthew D. Lee will be speaking next week at the annual White Collar Practice conference sponsored by the Pennsylvania Association of Criminal Defense Lawyers.  The conference will take place on November 21-22, 2019, in Philadelphia.

Ryan will be moderating a panel entitled “Internal Investigations:  Protecting Your Client While Placating the Government.”

Matt will be speaking on a panel entitled “What You Really Need to Know if You Are Taking on a Criminal Tax Case.”

Details about the conference are available here.

The Internal Revenue Service announced today a significant increase in enforcement actions for syndicated conservation easement transactions, a priority compliance area.  According to the announcement, coordinated audits are being conducted throughout various examination divisions of the IRS.  At the same time, the IRS Criminal Investigation division has criminal investigations underway in this area. These audits and investigations cover billions of dollars of potentially inflated deductions as well as hundreds of partnerships and thousands of investors. Syndicated conservation easements are included on the IRS’s “Dirty Dozen” list of tax scams to avoid in 2019.

Generally, a charitable contribution deduction is not allowed for a charitable gift of property consisting of less than the donor’s entire interest in that property. However, the law provides an exception for a “qualified conservation contribution” that meets certain criteria, including exclusive use for conservation purposes. If taxpayers meet the criteria in the tax code and regulations, they may claim charitable contribution deductions for the fair market value of conservation easements they donate to certain organizations. Some promoters are syndicating conservation easement transactions that purport to give investors the opportunity to obtain charitable contribution deductions and corresponding tax savings that significantly exceed the amount an investor invested.

Typically, promoters of these schemes identify a pass-through entity that owns real property or form a pass-through entity to acquire real property. The promoters syndicate ownership interests in the pass-through entity or tiered entities that own the real property, suggesting to prospective investors that they may be entitled to a share of a charitable contribution deduction that greatly exceeds the amount of an investor’s investment. The promoters obtain an inflated appraisal of the conservation easement based on unreasonable factual assumptions and conclusions about the development potential of the real property.

In December 2016, the IRS issued Notice 2017-10, which designated certain syndicated conservation easements as listed transactions. Specifically, the Notice listed transactions where investors in pass-through entities receive promotional material offering the possibility of a charitable contribution deduction worth at least two and half times their investment. In many transactions, the deduction taken is significantly higher than 250 percent of the investment. In September 2018, the IRS Large Business & International announced that one of its new compliance campaigns was focused entirely on syndicated conservations easements.

“We will not stop in our pursuit of everyone involved in the creation, marketing, promotion and wrongful acquisition of artificial, highly inflated deductions based on these aggressive transactions. Every available enforcement option will be considered, including civil penalties and, where appropriate, criminal investigations that could lead to a criminal prosecution,” said IRS Commissioner Chuck Rettig. “Our innovation labs are continually developing new, more extensive enforcement tools that employ advanced techniques. If you engaged in any questionable syndicated conservation easement transaction, you should immediately consult an independent, competent tax advisor to consider your best available options. It is always worthwhile to take advantage of various methods of getting back into compliance by correcting your tax returns before you hear from the IRS. Our continued use of ever-changing technologies would suggest that waiting is not a viable option for most taxpayers.”

The IRS announced that taxpayers may avoid the imposition of penalties relating to improper contribution deductions if they fully remove the improper contribution and related tax benefits from their returns by timely filing a qualified amended return or timely administrative adjustment request. The IRS’s comprehensive compliance efforts are focused on the abusive syndicated conservation easement transactions described in Notice 2017-10, recognizing that there are many legitimate conservation easement transactions.

The IRS is fully committed to putting an end to abusive syndicated conservation easement transactions, and holding accountable the individuals and entities who promoted, assisted with or participated in these schemes. The IRS is committing significant examination and investigative resources to vigorously audit the entities and individuals involved in this scheme, including those who failed to properly disclose their participation as required. Additionally, the IRS is also litigating cases where necessary, with more than 80 currently docketed cases in the Tax Court.

In addition to grossly overstating the value of the easement that is purportedly donated to charity, these transactions often fail to comply with the basic requirements for claiming a charitable deduction for a donated easement. The IRS has prevailed in many cases involving these basic requirements and has now established a body of law that the IRS believes supports disallowance of the deduction in a significant number of pending conservation easement cases. Where it has not done so already, the IRS announced that it will soon be moving the Tax Court to invalidate the claimed deductions in all cases where the transactions fail to comply with the basic requirements, leaving only the final penalty amount to be determined.

In addition to auditing participants, the IRS is pursuing investigations of promoters, appraisers, tax return preparers and others. Further, the IRS is evaluating numerous referrals of practitioners to the IRS Office of Professional Responsibility. The IRS stated that it will develop and assert all appropriate penalties, including penalties for participants (40 percent accuracy-related penalty), appraisers (penalty for substantial and gross valuation misstatements attributable to incorrect appraisals), promoters, material advisors, and accommodating entities (penalty for promoting abusive tax shelters and penalty for aiding and abetting understatement of tax liability), as well as return preparers (penalty for understatement of taxpayer’s liability by a tax return preparer).

In December 2018, the Department of Justice filed a complaint seeking to stop several individuals and an entity from organizing, promoting or selling allegedly abusive syndicated conservation easement transactions. The IRS continues to work with the Department of Justice in this area and in its announcement reminds taxpayers that continued disclosure of syndicated conservation easement transactions is required under Notice 2017-10.

For more up-to-date coverage from Tax Controversy and Financial Crimes Report, please subscribe by clicking here.

The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) announced today that it has launched a new Global Investigations Division (GID), which will be responsible for implementing targeted investigation strategies to combat illicit finance threats and related crimes, both domestically and internationally. Matthew Stiglitz, a former Principal Deputy Chief in the Department of Justice’s Criminal Division, will lead GID.

GID will build upon FinCEN’s existing authorities under the Bank Secrecy Act, including Section 311 of the USA PATRIOT Act, to investigate and target terrorist finance and money laundering threats. GID will work closely with foreign counterparts to coordinate actions against such threats when appropriate.

According to FinCEN, the foundation of GID is the agency’s former Office of Special Measures (OSM), which was previously a part of FinCEN’s Enforcement Division. FinCEN’s strategic use of its Section 311 authority as well as its other information collection authorities, such as the geographic targeting order and foreign financial agency regulation authorities, have greatly expanded in recent years. FinCEN will now have one dedicated division focused on utilizing these authorities to maximum effect, building upon OSM’s prior work.

GID will employ FinCEN’s authorities to detect and deter a wide range of potential threats to our national security and financial system, including those that have a nexus to the proliferation of weapons of mass destruction, rogue state actors, transnational organized crime, international narcotics trafficking, and terrorism.

For more up-to-date coverage from Tax Controversy and Financial Crimes Report, please subscribe by clicking here.

The Internal Revenue Service announced today that it has begun mailing what it calls “educational letters” to taxpayers with cryptocurrency transactions who potentially failed to report income and pay the resulting tax from such transactions, or did not report their transactions properly. The IRS started sending these letters to taxpayers last week. By the end of August, more than 10,000 taxpayers will receive these letters. The IRS said it obtained the names of these taxpayers through “various ongoing IRS compliance efforts,” but did not specifically identify such efforts.

The unnamed “compliance efforts” referred to in today’s IRS announcement no doubt include the well-publicized “John Doe” summons served on Coinbase by the IRS. In late 2016, a federal judge authorized the IRS to serve a “John Doe” summons on Coinbase, the largest U.S.-based cryptocurrency exchange, based upon the IRS’s belief that numerous taxpayers were evading taxes by investing in Bitcoin and other cryptocurrencies. After the parties engaged in a year of contentious litigation challenging the summons, a federal judge ultimately ruled in the IRS’s favor, and ordered Coinbase to turn over the names of approximately 13,000 of its customers to the IRS.

Today’s IRS announcement included a stern warning from Commissioner Chuck Rettig. “Taxpayers should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest and penalties,” said IRS Commissioner Chuck Rettig. “The IRS is expanding our efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers fully understand and meet their obligations.”

For taxpayers receiving an educational letter, there are three variations: Letter 6173, Letter 6174, or Letter 6174-A. According to the IRS, all three versions strive to help taxpayers understand their tax and filing obligations and how to correct past errors, and advise such taxpayers to file amended returns and pay back taxes.

The IRS also reminded taxpayers that last year it announced the creation of a Virtual Currency Compliance campaign to focus on tax noncompliance related to the use of cryptocurrency. At the time, the IRS stated that it would address noncompliance in this area through outreach and audits, and further stated that “[t]axpayers with unreported virtual currency transactions are urged to correct their returns as soon as practical.”

According to today’s announcement, the IRS will be issuing additional legal guidance on the tax treatment of cryptocurrency transactions in the near future. To date, the IRS has issued only a single guidance document on cryptocurrency. IRS Notice 2014-21 states that cryptocurrency is property for federal tax purposes and provides guidance on how general federal tax principles apply to cryptocurrency transactions.

The IRS concluded today’s announcement by stating that it will remain actively engaged in addressing noncompliance related to virtual currency transactions through a variety of efforts, ranging from taxpayer education to audits to criminal investigations. In addition, the IRS warned that cryptocurrency is an ongoing focus area for IRS Criminal Investigation, and that taxpayers who do not properly report the income tax consequences of virtual currency transactions are, when appropriate, liable for tax, penalties and interest, and in some cases could be subject to criminal prosecution.

Individuals who receive one of these “educational letters” from the IRS should proceed cautiously, as such letter may be a precursor to enforcement activity, such as an audit or even a criminal investigation. Fox Rothschild’s tax controversy and white collar criminal defense attorneys have significant experience dealing with IRS audits and criminal investigations. Please contact Matthew D. Lee if you receive correspondence from the IRS or have questions regarding the tax treatment of cryptocurrency.

For more up-to-date coverage from Tax Controversy and Financial Crimes Report, please subscribe by clicking here.

 

 

Earlier this week, the Internal Revenue Service’s Large Business & International Division announced six more compliance campaigns, bringing the total number of campaigns announced to date to a whopping 59. These campaigns reflect LB&I’s movement toward issue-based examinations and a compliance process in which LB&I decides which tax issues that present risk require a response in the form of one or multiple treatment streams to achieve compliance objectives. This approach is intended to make the best use of the IRS’s knowledge and to deploy the right resources to address these issues. The campaigns are the culmination of an extensive effort to redefine large business compliance work and build a supportive infrastructure inside LB&I. The overall goal is to improve return selection, identify issues representing a risk of non-compliance, and make the greatest use of limited resources.

A complete list of all 59 campaigns is available here.

LB&I’s description of each new campaign follows:

S Corporations Built in Gains Tax

C corporations that convert to S corporations are subjected to the Built-in Gains tax (BIG) if they have a net unrealized built-in gain and sell assets within 5 years after the conversion. This tax is assessed to the S corporation. LB&I has found that S corporations are not always paying this tax when they sell the C corporation assets after the conversion. LB&I has developed comprehensive technical content for this campaign that will aid revenue agents as they examine the issue. The goal of this campaign is to increase awareness and compliance with the law as supported by several court decisions. Treatment streams for this campaign will be issue-based examinations, soft letters, and outreach to practitioners.

Post-OVDP Compliance

U.S. persons are subject to tax on worldwide income. This campaign addresses tax noncompliance related to former Offshore Voluntary Disclosure Program (OVDP) taxpayers’ failure to remain compliant with their foreign income and asset reporting requirements. The IRS will address tax noncompliance through soft letters and examinations.

Expatriation

U.S. citizens and long-term residents (lawful permanent residents in eight out of the last 15 taxable years) who expatriated on or after June 17, 2008, may not have met their filing requirements or tax obligations. The Internal Revenue Service will address noncompliance through a variety of treatment streams, including outreach, soft letters, and examination.

High Income Non-filer

U.S. citizens and resident aliens are subject to tax on worldwide income. This is true whether or not taxpayers receive a Form W-2 Wage and Tax Statement, a Form 1099 (Information Return) or its foreign equivalents. Through an examination treatment stream, this campaign will concentrate on bringing into compliance those taxpayers who have not filed tax returns.

U.S. Territories – Erroneous Refundable Credits

Some bona fide residents of U.S. territories are erroneously claiming refundable tax credits on Form 1040, U.S. Individual Income Tax Return. This campaign will address noncompliance through a variety of treatment streams including outreach and traditional examinations.

Section 457A Deferred Compensation Attributable to Services Performed before January 1, 2009

This campaign addresses compensation deferred from nonqualified entities attributable to services performed before January 1, 2009. In general, Internal Revenue Code (IRC) Section 457A requires that any compensation deferred under a nonqualified deferred compensation plan shall be includible in gross income when there is no substantial risk of forfeiture of the rights to such compensation. The campaign objective is to verify taxpayer compliance with the requirements of IRC Section 457A through issue-based examinations.

For more up-to-date coverage from Tax Controversy and Financial Crimes Report, please subscribe by clicking here.

Earlier this week, the Attorneys General of New Jersey, New York, and Connecticut sued the Treasury Department and the Internal Revenue Service challenging a new IRS rule that would preclude individuals in those states from claiming deductions for charitable contributions to local governments. This lawsuit is the latest chapter in the battle over the “SALT cap,” enacted as part of the 2017 tax reform legislation which imposes a $10,000 annual limitation on the deduction for state and local taxes.

Enacted in 2017, the Tax Cuts and Jobs Act was touted as the most significant tax reform legislation in three decades. Among its provisions is a $10,000 annual limitation on the deduction for state and local tax, which includes state and local income taxes, local real estate taxes and state sales taxes. Previously, there was no monetary limitation for an individual taxpayer’s SALT deduction. The new limitation is more detrimental to individuals in high tax states, such as California and New York. The average SALT deduction in California was around $18,500, while the average deduction in New York was around $22,000. The SALT limitation imposed by the TCJA applies to taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2026.

Some states have attempted to work around the SALT limitation using creative legislative solutions. Last year, New York Gov. Andrew Cuomo signed into law a new state-operated charitable contribution fund to accept donations for the purposes of improving health care and public education in New York state. Taxpayers who itemize deductions may claim these charitable contributions as deductions on their federal and state tax returns. Any taxpayer making a donation may also claim a state tax credit equal to 85 percent of the donation amount for the tax year after the donation is made. Taxpayers may also make qualified contributions to certain not-for-profit organizations for specified purposes. The law also authorizes local governments and school districts to establish charitable gift reserve funds and to offer real property tax credits to incentivize contributions to these new local charitable funds.

New Jersey soon followed suit, with Gov. Phil Murphy signing into law a measure allowing municipalities, counties and school districts to establish charitable funds where taxpayers can donate in return for a property tax credit. In return for donations, taxpayers would receive credits on their property tax bill of up to 90 percent of the donation. Taxpayers would then be able to claim their donation as a charitable deduction on their federal income tax return.

In Connecticut, the General Assembly passed legislation in 2018 that allowed municipalities to create “community supporting organizations” classified as charitable organizations. Taxpayers could make contributions to these organizations and most of that donation would be credited toward their local property tax liability.

In response to these state initiatives, the IRS issued a new rule aimed at nullifying the tax benefits these states were making available to charitable givers. The new rule – set to take effect on August 12, 2019 – requires taxpayers to subtract the value of any state and local tax credits they receive for charitable giving from their federal charitable contribution deduction.

The lawsuit filed this week by New Jersey, New York, and Connecticut contends that the new IRS rule is arbitrary and capricious, in violation of the federal Administrative Procedures Act. The complaint further alleges that the rule threatens economic harm to the states by discouraging charitable giving, and by depriving school districts, municipalities, and counties of important funding.

For more up-to-date coverage from Tax Controversy and Financial Crimes Report, please subscribe by clicking here.

 

The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) has announced new efforts to crack down on Business Email Compromise (BEC) schemes and those who profit from such scams.  BEC fraud schemes generally involve attempts to compromise the email accounts of victims to send fraudulent payment instructions to financial institutions or business associates in order to misappropriate funds or to assist in financial fraud.  Often, the unsuspecting victim is conned into thinking a legitimate email from a trusted person or entity is directing them to make a payment for a normal business activity.  Based upon Suspicious Activity Report (SAR) data, BEC scams generated more than $300 million in fraud proceeds each month during 2018, with a cumulative total exceeding billions of dollars stolen from businesses and individuals.

As part of its FinCEN Exchange forum, FinCEN convened a meeting this week in New York City to focus was on identifying and combatting BEC schemes.  Representatives from depository institutions, federal and state government agencies, a federal task force, money transmitters, third-party service providers, and technology companies attended the session.  The FinCEN Exchange is a voluntary program established in 2017 to convene law enforcement and financial institutions from across the country to share information.

FinCEN also issued an update to its “Advisory to Financial Institutions on E-mail Compromise Fraud Schemes,” first published in 2016.  The updated advisory offers updated operational definitions, provides information on the targeting of non-business entities and data by email compromise schemes, highlights general trends in BEC schemes targeting sectors and jurisdictions, and alerts financial institutions to risks associated with the targeting of vulnerable business processes.  The advisory also highlights the potential for financial institutions to share information about subjects and accounts affiliated with email compromise schemes in the interest of identifying risks of fraudulent transactions and money laundering.

FinCEN also released a Financial Trend Analysis of Bank Secrecy Act data that explores industries targeted and methodologies used by BEC scammers.  It notes that the number of SARs describing BEC incidents reported monthly has more than doubled, from averaging nearly 500 per month in 2016, to above 1,100 per month in 2018.  The total value of attempted BEC thefts reported in SARs has almost tripled, to an average of $301 million per month in 2018 from $110 million per month in 2016.  The use of fraudulent vendor or client invoices grew as a BEC methodology, from 30 percent of sampled 2017 incidents, to 39 percent in 2018, becoming the most common BEC method.  Impersonating a CEO or other high-ranking business officer as a methodology declined, accounting for 12 percent in 2018 from 33 percent of sampled incidents in 2017.  Impersonation of an outside entity was described in 20 percent of 2018 reports.  Manufacturing and construction businesses were the top targets for BEC fraud in 2017 and 2018.

In another ongoing effort, FinCEN’s Rapid Response Program, in collaboration with law enforcement, recently surpassed $500 million in recovered funds.  Under the program, when U.S. law enforcement receives a BEC complaint from a victim or a financial institution, the relevant information is forwarded to FinCEN, which moves quickly to track and recover the funds.  The program utilizes FinCEN’s ability to rapidly share information with counterpart Financial Intelligence Units (FIU) in more than 164 jurisdictions, and uses these relationships to encourage foreign authorities to intercede and hold funds or reverse wire transfers.

Finally, the Egmont Group of FIUs has issued a public bulletin to alert competent authorities and reporting entities of key typologies and money laundering risks associated with BEC fraud schemes.  This bulletin was the result of an initiative by FinCEN and the FIU of Luxembourg, in collaboration with nine other FIUs.  The Egmont Group is a united body of 164 FIUs that provides a platform for the secure exchange of expertise and financial intelligence to combat money laundering and terrorist financing.

For more up-to-date coverage from Tax Controversy and Financial Crimes Report, please subscribe by clicking here.

By Kristina Burland and Matthew D. Lee

A precedent-setting criminal prosecution of two California executives under the Consumer Product Safety Act is sending a strong warning to corporate boardrooms that the reporting requirements of the CPSA must be taken seriously and that a company’s compliance program must be thoughtfully designed to ensure that reports are submitted promptly.

In an indictment handed up in March, a federal grand jury charged that Simon Chu and Charley Loh – executives of two California corporations that import and distribute dehumidifiers from China – had received multiple reports that the dehumidifiers were defective and could catch fire, but failed to notify the Consumer Products Safety Commission.

According to the indictment, Chu and Loh knew that they were required to report their knowledge of the defects, but waited at least six months before doing so and continued to sell the dehumidifiers to retailers.

Chu and Loh were charged with conspiracy to commit wire fraud, failure to furnish information under the CPSA, and defraud the CPSC, as well as one count of wire fraud. The indictment identifies a number of unnamed, unindicted co-conspirators, including the two corporations that Chu and Loh work for, referred to as “Unindicted Co-Conspirator Company A” and “Unindicted Co-Conspirator Company B” throughout the indictment. The case is being prosecuted in the Central District of California.

CPSA Reporting Requirements

Section 15 of the CPSA requires every manufacturer, distributor and retailer of a consumer product – as well as all directors, officers, and agents thereof – to “immediately” inform the CPSC of a product defect that could “create a substantial product hazard,” or “creates a substantial risk of injury to the public.”

Regulations clarify that the requirement for “immediate” reporting means “within 24 hours” of receiving information that the product “contains a defect which could create a substantial risk of injury to the public, or creates an unreasonable risk of serious injury or death.”

Chu’s and Loh’s Conduct

According to the indictment, Chu and Loh became aware of the defects associated with the dehumidifiers as early as July 2012, when they saw a video that depicted a burning dehumidifier resembling those imported, distributed, and sold by their companies. Soon after, Chu tested the plastic used in the Chinese dehumidifiers and confirmed that it would burn.

In September 2012, Loh allegedly informed a manager of one of the companies that the dehumidifiers could catch fire, and that the material used in them did not meet safety standards. But the indictment alleges that manager recommended that Chu and Loh “delay a recall … for six to nine months.” Later that month, Loh allegedly told high-ranking executives at one company that he believed the defects should be reported to the CPSC. However, neither Chu nor Loh submitted a report to the CPSC, and they continued to sell the defective dehumidifiers to retail companies in the United States from September 2012 to April 2013.

Approximately 2.2 million Chinese dehumidifiers, including those sold by the companies that employed Chu and Loh, were ultimately recalled in September 2013.

The indictment alleges that Chu and Loh “knowingly and willfully failed to immediately report,” and “willfully caused others” to fail to immediately report to the CPSC “upon receiving information that reasonably supported the conclusion that the Chinese dehumidifiers contained a defect that could create a substantial product hazard, and created an unreasonable risk of serious injury and death.”

The indictment also alleges that the executives “deliberately withheld” information about the dangers of the dehumidifiers from retailers who purchased the dehumidifiers for resale as well as the insurance companies who paid for damages associated with the defects.

Takeaways

The government has routinely brought civil actions against corporations for failure to report product defects pursuant to Section 15. Indeed, the prosecution of Chu and Loh is related to a civil CPSC administrative matter brought against Chinese company Gree Electric Appliances that was resolved in 2016. In that case, Gree and others agreed to pay a $15.5 million civil penalty for failures to report the defective dehumidifiers.

The indictment signals that the U.S. Department of Justice is now willing to prosecute both corporations and their executives for failing to comply with the reporting requirement set forth in Section 15. Criminal penalties for failure to report product defects can no longer be ruled out. As U.S. Attorney Nicola T. Hanna of the Central District of California cautioned, the indictment “sends a clear message: If you plan to profit from selling defective products, you should also plan to face justice.”