Internal Revenue Service (IRS)

The House Appropriations Committee today released the FY2019 Financial Services and General Government Appropriations bill, which provides annual funding for the Treasury Department, the Judiciary, the Small Business Administration, the Securities and Exchange Commission, and related agencies.

The bill provides $11.6 billion for the Internal Revenue Service, an increase of $186 million above the FY2018 enacted level. Of the funds, $77 million are earmarked to help the IRS with implementing the new tax code adopted in the Tax Cuts and Jobs Act of 2017. The bill provides IRS Taxpayer Services an additional $31 million above the FY2018 enacted level to support the agency’s customer service function (such as phone calls and correspondence) as well as funding for fraud prevention and cybersecurity.

The IRS has faced nearly a decade of declining appropriations, causing the agency to enact deep cuts in enforcement personnel and customer service activities, among other reductions. The FY2019 proposed appropriation of $11.6 billion is more than $2 billion less than the appropriated amount nine years ago, in FY2010. Further complicating matters, in FY2019 the IRS will be faced with continuing implementation of the most significant reform of the Internal Revenue Code in decades.

For more up-to-date coverage from Tax Controversy Sentinel, please subscribe by clicking here.

 

 

Today the Internal Revenue Service notified taxpayers that it will soon be issuing regulations addressing the deductibility of state and local tax payments for federal income tax purposes. The IRS also reminded taxpayers that federal law controls the characterization of payments for federal income tax purposes regardless of the characterization of the payments under state law. These forthcoming regulations are targeted at efforts by some states, including New York and New Jersey, to pass laws providing for mechanisms to work around the newly-enacted federal cap on state and local deductions. These “workarounds” typically allow taxpayers to make payments to specified entities in exchange for a tax credit against state and local taxes owed.

The federal Tax Cuts and Jobs Act (TCJA) limited the amount of state and local taxes an individual can deduct in a calendar year to $10,000. The IRS said that the regulations, to be issued in the near future, will help taxpayers understand the relationship between federal charitable contribution deductions and the new statutory limitation on the deduction of state and local taxes. The IRS also warned that it is continuing to monitor other legislative proposals being considered to ensure that federal law controls the characterization of deductions for federal income tax filings. The limitation imposed by the TCJA applies to taxable years beginning after December 31, 2017, and before January 1, 2026.

For more up-to-date coverage from Tax Controversy Sentinel, please subscribe by clicking here.

Yesterday the Internal Revenue Service’s Large Business and International Division announced that it was adding six more compliance campaigns to its previously-announced list of 29 such campaigns. The compliance campaigns signify LB&I’s move toward “issue-based examinations” premised upon pre-selected issues that present the greatest risk of non-compliance. According to LB&I, the stated goal of this effort is to “improve return selection, identify issues representing a risk of non-compliance, and make the greatest use of limited resources.”

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. In November 2017, LB&I announced the identification and selection of 11 additional compliance campaigns. At the time, LB&I stated that more campaigns would continue to be identified, approved, and launched in the coming months. On March 13, 2018, LB&I announced the addition of five more issues to the growing list of compliance campaigns.

In yesterday’s announcement, LB&I stated that is currently reviewing the tax reform legislation signed into law on December 22, 2017, “to determine which existing campaigns, if any, could be impacted as a result of a change in the controlling statutory framework.” LB&I further stated that “[i]nformation regarding any identified impact will be communicated after that analysis has been completed.”

According to LB&I, the six new campaigns were identified through data analysis and suggestions from IRS employees.  The six campaigns selected for this rollout, and a description of each, are as follows:

Interest Capitalization for Self-Constructed Assets

When a taxpayer engages in certain production activities they are required to capitalize interest expense under Internal Revenue Code (IRC) Section 263A. Interest capitalization applies to interest a taxpayer pays or incurs during the production period when producing property that meets the definition of designated property. Designated property under IRC Section 263A(f) is defined as (a) any real property, or (b) tangible personal property that has: (i) a long useful life (depreciable class life of 20 years or more), or (ii) an estimated production period exceeding two years, or (iii) an estimated production period exceeding one year and an estimated cost exceeding $1,000,000.

The goal of this campaign is to ensure taxpayer compliance by verifying that interest is properly capitalized for designated property and the computation to capitalize that interest is accurate. The treatment stream for this campaign is issue-based examinations, education soft letters, and educating taxpayers and practitioners to encourage voluntary compliance

Forms 3520/3520-A Non-Compliance and Campus Assessed Penalties

This campaign will take a multifaceted approach to improving compliance with respect to the timely and accurate filing of information returns reporting ownership of and transactions with foreign trusts. The Service will address noncompliance through a variety of treatment streams including, but not limited to, examinations and penalties assessed by the campus when the forms are received late or are incomplete.

Forms 1042/1042-S Compliance

Taxpayers who make payments of certain U.S.-source income to foreign persons must comply with the related withholding, deposit, and reporting requirements. This campaign addresses Withholding Agents who make such payments but do not meet all their compliance duties. The Internal Revenue Service will address noncompliance and errors through a variety of treatment streams, including examination.

Nonresident Alien Tax Treaty Exemptions

This campaign is intended to increase compliance in nonresident alien (NRA) individual tax treaty exemption claims related to both effectively connected income and Fixed, Determinable, Annual Periodical income. Some NRA taxpayers may either misunderstand or misinterpret applicable treaty articles, provide incorrect or incomplete forms to the withholding agents or rely on incorrect information returns provided by U.S. payors to improperly claim treaty benefits and exempt U.S. source income from taxation. This campaign will address noncompliance through a variety of treatment streams including outreach/education and traditional examinations.

Nonresident Alien Schedule A and Other Deductions

This campaign is intended to increase compliance in the proper deduction of eligible expenses by nonresident alien (NRA) individuals on Form 1040NR Schedule A. NRA taxpayers may either misunderstand or misinterpret the rules for allowable deductions under the previous and new Internal Revenue Code provisions, do not meet all the qualifications for claiming the deduction and/or do not maintain proper records to substantiate the expenses claimed. The campaign will address noncompliance through a variety of treatment streams including outreach/education and traditional examinations.

NRA Tax Credits

This campaign is intended to increase compliance in nonresident alien individual (NRA) tax credits. NRAs who either have no qualifying earned income, do not provide substantiation/proper documentation, or do not have qualifying dependents may erroneously claim certain dependent related tax credits. In addition, some NRA taxpayers may also claim education credits (which are only available to U.S. persons) by improperly filing Form 1040 tax returns. This campaign will address noncompliance through a variety of treatment streams including outreach/education and traditional examinations.

For more up-to-date coverage from Tax Controversy Sentinel, please subscribe by clicking here.

Attorneys representing cannabis businesses are often faced with questions about what happens when the cannabis business has not paid its taxes and the IRS is proceeding with collection actions.  No one thinks the IRS will seize and sell cannabis to satisfy tax liabilities, because in doing so the IRS would engage in criminal violations of the Controlled Substances Act.  However, recently, IRS Chief Counsel issued advice addressing questions posed by the field about whether an IRS sale of equipment used in a cannabis business would result in a violation of criminal laws.

In CCA 2018042616201420, Chief Counsel determined that Gas Chromatographer Mass Spectrometers (GCMS) and Liquid Chromatographer Mass Spectrometers (LCMS) used by taxpayers involved in the marijuana industry to measure the amount of cannabinoids in marijuana were not drug paraphernalia under the Drug Paraphernalia Statute, 21 U.S.C. § 863.  The conclusion was that because the equipment, which is used to measure organize material, can be used for purposes other than measuring cannabinoids, such as in fire investigations, explosive investigations, and even the identification of foreign material collected from outer space, the equipment was not drug paraphernalia.

The CCA also concluded that the existence of marijuana residue on the equipment did not prohibit the sale because, pursuant to 21 U.S.C. § 841(a), the existence of a residual amount of a controlled substance did not create the intent to distribute a controlled substance.

The CCA advised that the equipment should be subject to a “deep cleaning” prior to sale not only to avoid any possibility of a criminal violation but also to maximize the value of the equipment at auction.    The cost of this cleaning should be considered by Collections when determining collection potential of the property.

Recently, the written supervisory approval requirement of Section 6751(b) has been one of the primary issues in Tax Court litigation concerning penalties that the IRS has asserted against taxpayers. The focus of this litigation is the effect of Section 6751(b) and its interplay with the Commissioner’s burden of production as to penalties in court proceedings under Section 7491(c). In Dynamo Holdings v. Commissioner, 150 T.C. No. 10 (May 7, 2018), the Tax Court addressed these issues in a partnership-level proceeding.

Section 6751(b)(1) provides that “[n]o penalty under this title shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination…” (note that Section 6751(b)(2) provides certain exceptions to this general rule).

Section 7491(c) provides that the IRS “shall have the burden of production in any court proceeding with respect to the liability of any individual for any penalty, addition to tax, or additional amount imposed by this title.”

Until the Chai and Graev III opinions, there had been little litigation over the effect of Section 6751(b).

In Chai v. Commissioner, 851 F.3d 190 (2nd Cir. 2017), the taxpayer argued in his post-trial brief that compliance with the written-approval requirement in Section 6751(b)(1) is an element of the Commissioner’s claim for penalties and is therefore part of the Commissioner’s burden of production under Section 7491(c). The Second Circuit Court of Appeals agreed, holding that Section 6751(b)(1) requires written approval of the initial penalty determination no later than the date the IRS issues the notice of deficiency (or files an answer or amended answer) asserting such penalty. Chai held that Section 6751(b) is part of the Commissioner’s burden or production in a deficiency case in which a penalty is asserted.

In Graev v. Commissioner (Graev III), 149 T.C. No. 23 (Dec. 20, 2017), the Tax Court held that the Commissioner’s burden of production under Section 7491(c) includes establishing compliance with the written supervisory approval requirement of Section 6751(b). Thus, in a deficiency case in which a penalty is asserted, it is the IRS’s burden to introduce sufficient evidence establishing compliance with the supervisor approval requirement.

In Dynamo Holdings, the Tax Court addressed the interplay between the supervisor approval requirement and the IRS’s burden of production in a partnership-level proceeding. The Court held that the IRS does not bear the burden of production with respect to penalties under Section 7491(c) in a partnership-level proceeding. The Court reasoned that Section 7491(c) provides that the IRS has the burden of production “with respect to the liability of any individual for any penalty…” Because partnership-level proceedings do not determine liabilities and are not with respect to individuals, the IRS does not bear the burden of production as to penalties. In a similar vein, the IRS does not bear the burden of production with respect to penalties asserted against corporations.

The Court further held that where the IRS does not bear the burden of production as to penalties, the lack of supervisory approval of penalties may be raised as a defense to those penalties. However, taxpayers should note that they must affirmatively argue that the IRS failed to comply with the supervisory approval requirements of Section 6751. Failure to make such an argument can be costly, as the taxpayer will be deemed to have waived the defense.

United States v. Gerard, a recent case from the Northern District of Indiana, demonstrates how a tax lien, once attached, can stay with property even after the property is conveyed to someone other than the taxpayer.  In 1990, a husband and wife named Robert and Cynthia Gerard bought a residence as tenants by the entirety.  Although the Gerards bought the residence together, Robert paid at least 90% of the purchase price.  Between 2003 and 2008, Cynthia owned a business with outstanding employment and unemployment taxes.  The Gerards and the government generally agreed that the assessments for these tax liabilities attached to Cynthia’s interest in the property.  As time went on, Robert and Cynthia decided to convey the property solely to Robert.  The deed stated that the conveyance was “by way of gift and without any consideration other than for love and affection.”

The government, however, still wished to enforce the liens.  Litigation ensued, and the government moved for summary judgment.  The key issue was whether the liens that were attached to Cynthia’s interest in the property survived the severance of the tenancy by the entirety.  Section 6323 provides that a lien is not valid against a purchaser until the IRS files proper notice.  Thus, according to the court, Robert would not be liable for Cynthia’s outstanding tax balance if Robert was a “purchaser.”  A “purchaser” is “[a] person who, for adequate and full consideration in money or monies worth, acquires an interest (other than a lien or security interest) in property which is valid under local law against a subsequent purchaser without actual notice.”  IRC § 6323(h)(6).  “Adequate and full consideration in money or money’s worth” is “a consideration in money or money’s worth having a reasonable relationship to the true value of the interest in property acquired.”  Treas. Reg. § 301.6323(h)-1(f)(3).

The Gerards argued that Robert was a purchaser because Cynthia used marital assets to pay her business’s expenses and then transferred her interest in the property in repayment of those debts.  The government, however, pointed out that the deed specifically stated that the transfer was made “by way of gift and without any consideration other than for love and affection,” and that any consideration would have been past consideration, which was insufficient.

The court was not concerned that the deed stated that the property was a gift.  It noted that “[i]t is a well-known fact that often a conveyance recites a nominal consideration whereas the true consideration is not nominal.  It is therefore never certain that the recited consideration is the true consideration.”  Clark v. CSX Transp., Inc., 737 N.E.2d 752, 759 (Ind. Ct. App. 2000).  The court was, however, concerned with the fact that the parties agreed that the use of marital assets to pay Cynthia’s business expenses was “past consideration.”  Under the regulations, “adequate and full consideration” includes past consideration only if, “under local law, past consideration is sufficient to support an agreement giving rise to a security interest. . .”  Treas. Reg. § 301.6323(h)-1(a)(3); (f)(3).  Accordingly, the court turned to Indiana law to determine whether past consideration could create a security interest.

The Gerards could not cite any Indiana authority indicating that past consideration gives rise to a security interest.  Also, other federal courts hold that past consideration does not make a party a “purchaser” under section 6323(a).  See, e.g., United States v. Register, 727 F. Supp. 2d 517, 526 (E.D. Va. 2010).  Thus, the court concluded that Robert was not a purchaser under section 6323(a) and that the liens attached to Cynthia’s interest in the property survived the conveyance.

The parties still disputed the extent to which the liens attached to the property.  The government argued that the liens remained attached to a one-half interest in the property.  The Gerards, however, argued that Cynthia’s actual interest was worth less than one-half of the property when it was conveyed, so the liens only attached to something less than a one-half interest.  Here again, the court found that Indiana law did not support the Gerards’ argument.  For example, in Radabaugh v. Radabaugh, the court held that the trial court erred by “conclud[ing] that appellee was the owner of less than an undivided one-half interest in the mortgage loan” for real estate owned by a husband and wife as tenant by the entirety.  35 N.E.2d 114, 115-16 (Ind. Ct. App. 1941).  Thus, the court concluded that the liens were still attached to one-half of Robert’s interest in the property, even after the conveyance.

 

The Internal Revenue Service announced today that it is providing taxpayers an additional day to file their tax returns following a computer problem that arose early in the morning on April 17, the tax filing deadline. Taxpayers will now have until midnight on Wednesday, April 18, to file their returns. No action is necessary in order for taxpayers to receive the benefit of an extra day.

“This is the busiest tax day of the year, and the IRS apologizes for the inconvenience this system issue caused for taxpayers,” said Acting IRS Commissioner David Kautter. “The IRS appreciates everyone’s patience during this period. The extra time will help taxpayers affected by this situation.”

A Washington Post article reported that “several senior government officials, speaking on the condition of anonymity, said the agency’s outdated technology failed amid the crush of last-minute filers.” The IRS has faced years of budget cuts from Congress, with its workforce steadily dwindling and its technology systems in dire need of upgrades.

For more up-to-date coverage from Tax Controversy Sentinel, please subscribe by clicking here.

Tomorrow is the annual deadline for the filing of individual income tax returns for calendar year 2017.  The Internal Revenue Service expects to receive approximately 32 million returns in the final days leading up to April 17.  In addition, the IRS expects to receive about 12 million last-minute requests for extensions of the April 17 filing deadline.  With millions of taxpayers scrambling to meet tomorrow’s deadline, we provide this recap of the IRS’s annual list of the “Dirty Dozen” tax scams for 2018 and a link to our prior blog posts addressing each one.

Compiled annually by the IRS, the “Dirty Dozen” lists a variety of common scams that taxpayers may encounter any time of the year, but many of these schemes peak during filing season as people prepare their tax returns or seek help from tax professionals. To help protect taxpayers, the IRS highlighted each of these scams on twelve consecutive days leading up to the filing deadline to help raise awareness.

1. “Phishing” scams: These schemes typically take the form of fake emails or websites looking to steal personal tax information and often increase in frequency during tax season.

2. Phone scams where criminals pose as IRS agents: In aggressive phone scams, criminals pose as IRS agents in hopes of stealing money. During filing season, the IRS generally sees a surge in scam phone calls threatening such things as arrest, deportation, and/or license revocation if the victim does not pay a phony tax bill. In a new variation, the IRS has observed that identity thieves are filing fraudulent tax returns with refunds going into the real taxpayer’s bank account, followed shortly thereafter by a threatening phone call trying to convince the taxpayer to send the money to the fraudster.

3. Identity theft: Even though instances of tax-related identity theft have declined markedly in recent years, the IRS warns that this practice is still widespread and remains serious enough to earn a spot on its annual list of tax scams. Tax-related identity theft occurs when someone uses a stolen Social Security number or Individual Taxpayer Identification Number (ITIN) to file a fraudulent tax return claiming a refund.

4. Tax return preparer fraud: With more than half of the nation’s taxpayers relying on someone else to prepare their tax return, the IRS reminds consumers today to be on the lookout for unscrupulous tax preparers looking to make a fast buck from honest people seeking tax assistance. The IRS recognizes that the majority of tax professionals provide honest, high-quality service. But there are some dishonest preparers who operate each filing season to perpetrate refund fraud, identity theft, and other scams that hurt honest taxpayers.

5. Fake charities: Scam groups masquerade as charitable organizations, luring people to make donations to groups or causes that don’t actually qualify for a tax deduction.

6. Falsely inflated refunds:  Scam artists frequently prey on older Americans, low-income taxpayers, and others with promises of big refunds.

7.  Improper claims for business credits:  Two common credits targeted for abuse include the research credit and the fuel tax credit. While both credits have legitimate uses, there are specific criteria that must be met in order to qualify for them.

8.  Falsely padding deductions:  Common areas targeted by unscrupulous tax preparers involve overstating deductions such as charitable contributions, padding business expenses, or improperly claiming credits such as the Earned Income Tax Credit or Child Tax Credit.

9.  Falsified income and fake Form 1099 scams:   A common tax scam the IRS sees each year involves falsifying income in order to claim refundable credits, such as the Earned Income Tax Credit. Another frequent scheme involves the filing of false Forms 1099 and/or bogus financial instruments such as bonds, bonded promissory notes, or worthless checks.

10.  Frivolous tax arguments:  Promoters of frivolous schemes encourage taxpayers to make unreasonable and outlandish legal claims to avoid paying their taxes. Such arguments have been repeatedly thrown out of court.

11.  Abusive tax shelters:  These sophisticated schemes, particularly those involving micro-captive insurance shelters, are peddled by promoters and others to avoid taxes.

12.  Offshore tax evasion: Offshore tax compliance has been a major focus for the IRS in recent years, and taxpayers who avoid taxes by hiding money or assets in unreported offshore accounts should remain wary given the continuing focus on such schemes by both the IRS and the Justice Department.

For more up-to-date coverage from Tax Controversy Sentinel, please subscribe by clicking here.

BitcoinWith the April 17 deadline for filing individual tax returns just around the corner, individuals who engaged in cryptocurrency transactions during 2017 must take care to properly report them on their tax returns. As we have previously reported, the IRS is focusing significant attention on tax compliance with respect to cryptocurrency transactions. Last year, the IRS prevailed in its long-running litigation with Coinbase seeking the names of clients who engaged in cryptocurrency transactions during 2013-2015, and Coinbase recently announced that it was disclosing transaction data to the IRS for 13,000 of its customers. In addition, the IRS-Criminal Investigation Division is ramping up its scrutiny of cryptocurrency transactions by assembling a team of specialized investigators in this area. And most recently, on March 23, the IRS issued a very public “reminder” to taxpayers about reporting cryptocurrency transactions and threating audits, penalties, and even criminal prosecution for non-compliance.

Four years ago, the IRS issued its only guidance to date regarding its view of the tax treatment of cryptocurrency transactions. Despite the explosion of interest in cryptocurrencies (currently more than 1,500 such currencies exist) and the monumental increase in Bitcoin’s value last year (an uptick of more than 1,400 percent before year’s end), the IRS has not updated its views or issued further guidance to investors, thus leaving individuals scrambling to make sure that their 2017 tax returns are properly capturing cryptocurrency transactions. This is especially critical for investors who sold Bitcoin during its rocket-like trajectory last year.

The IRS considers cryptocurrency transactions taxable just like transactions in any other property, and general tax principles that apply to property transactions apply. As a consequence, the following rules apply:

– A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

– Payments using virtual currency made to independent contractors and other service providers are taxable, and self-employment tax rules generally apply.  Normally, payers must issue Form 1099-MISC.

– Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2 and are subject to federal income tax withholding and payroll taxes.

– Certain third parties who settle payments made in virtual currency on behalf of merchants that accept virtual currency from their customers are required to report payments to those merchants on Form 1099-K, Payment Card and Third Party Network Transactions.

– The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.

In an article published by Bloomberg today, Lily Katz and Lynnley Browning write that many investors, and even tax professionals, are struggling to properly report their cryptocurrency transactions on their 2017 tax returns, due to be filed in four days:

If you thought trading Bitcoin was wild, try figuring out how to pay taxes on it.

Cryptocurrency investors are wrestling with spotty records, tangled blockchain addresses and rudimentary guidelines issued back in the ancient days of 2014. After last year’s boom in values, many people are likely disclosing transactions for the first time, adding to confusion.

The Bloomberg article further reports that the IRS is advising individuals to look for tax guidance in analogous areas:

An IRS spokesman said that in addition to the agency’s 2014 guidance, taxpayers should look at other rules governing an exchange or transfer of property and find the “factual scenarios that most closely resemble their circumstances.”

Individuals who fail to properly report their cryptocurrency transactions can face harsh consequences, including civil audits, penalties, and even criminal prosecution, as the IRS warned in a recent press release reminding taxpayers to report such transactions:

Taxpayers who do not properly report the income tax consequences of virtual currency transactions can be audited for those transactions and, when appropriate, can be liable for penalties and interest.

In more extreme situations, taxpayers could be subject to criminal prosecution for failing to properly report the income tax consequences of virtual currency transactions. Criminal charges could include tax evasion and filing a false tax return. Anyone convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Anyone convicted of filing a false return is subject to a prison term of up to three years and a fine of up to $250,000.

Despite the lack of up-to-date IRS guidance, and the uncertainly surrounding the tax consequences of recent developments in this area (such as “hard forks”), cryptocurrency investors would be well-advised to exercise caution with their income tax returns due next week.

For more up-to-date coverage from Tax Controversy Sentinel, please subscribe by clicking here.