TIGTA recently released a report discusses their audit of the IRS’s estate and gift tax examination procedures.  TIGTA made eight recommendations of changes to the estate and gift tax examination process.  The bulk of TIGTA’s recommendations address the informal processes, lack of consistency, and unknown effectiveness of the estate and gift tax examination procedures.

One of the more significant findings of the report is that while the examination division proposed over $577 million of estate and gift tax deficiencies for FY 2016, only $98 million of those deficiencies were sustained after cases were considered by IRS Appeals.  The Examination division attributed this statistic to the fact that the Examination division proposes alternative deficiencies in order to prevent being whipsawed.  However, the Examination division could not separately identify the amount of deficiencies that were attributable to these alternative positions.  TIGTA highlighted that the Government could be subject to suits for attorneys’ fees pursuant to Section 7430 if the positions set forth in the notices of deficiency were not substantially justified.  TIGTA recommended that Examination division develop written guidance “on the circumstances in which it is advisable to propose and issue notices of deficiency in estate and gift tax examinations that contain alternative positions.”

Other highlights from the report include:

  • there is one gatekeeper who decides whether or not to route a case for examination and how to prioritize cases;
  • there is no quality review process;
  • unlike the process for selecting income tax returns for examination, the process of selecting estate and gift tax examinations for examination is based minimal written guidance and involves almost no objective procedures, but instead relies on human involvement and judgment; and
  • procedures for documenting case selection, examination documentation and managerial review either did not exist or if they did exist were not followed as closely as they should be.

TIGTA’s report can be accessed here.

As many readers know, the Bipartisan Budget Act of 2015 (“BBA”) repeals the long standing TEFRA procedures governing IRS examinations of partnerships.  As a result, beginning January 1, 2018, partnerships are subject to a centralized partnership audit regime.  However, partnerships are permitted to make an election to have the BBA rules apply to partnership returns filed for tax periods beginning after November 2, 2015 and before January 1, 2018.  For most partnerships, this will apply to the 2016 and 2017 tax years.

Early Election Procedures under Section 1101(g)(4) of the BBA

Partnerships who receive written notification that a partnership return for an eligible year has been selected for examination have 30 days after the date of such notification to file an election to be subject to the BBA centralized partnership regime for that year.  The election can be made on Form 7036,  or by preparing a statement that complies with the regulations.  The election statement requires the partnership representative to represent that the partnership (1) is not insolvent and does not reasonably anticipate becoming insolvent before resolution of any adjustment for the partnership taxable year for which the election is being made; (2) is not currently and does not reasonably anticipate become subject to the bankruptcy petition under Title 11; and (3) has sufficient assets, and reasonably anticipates having sufficient assets, to pay a potential imputed underpayment.

IRS Guidance

On June 29, 2017, the Commissioners of the LB&I division and the SB/SE division issued a memo addressing procedures initial contacts with taxpayers eligible to make the early election.  The memo educates managers and examiners on which partnerships are eligible to make the election, how and when the election is made, the proper content of the election statement, and related correspondence procedures.  The memo requires the issuance of a new Initial Contact Letter, Letter 2205-D, at the beginning of a partnership examination.  If the partnership responds by making an early election, the process outlined below is followed.  If an early election is not made, examiners are instructed to follow existing TEFRA or NonTEFRA procedures.

The memo instructs examiners who receive elections to verify that no amended returns or administrative adjustment requests have been filed as this would disqualify the partnership from making the early election.  The memo also instructs examiners to ensure that Form 7036 is properly completed or that an election not on Form 7036 meets the requirements of Treas. Reg. section 301.9100-22T, request any missing information from the taxpayer if the 30-day election window is still open, and determine whether the election is valid.  The memo further instructs the examiner to wait 30 days after the valid election is received before issuing a notice of administrative proceeding.  The reason for the 30-day waiting period is to allow the partnership to file any administrative adjustment requests as permitted under Section 6227 as amended by the BBA.  During this 30-day period, examiners are instructed to perform a “cursory check” to determine whether the partnership representative’s name, address, identification number and phone number are correct.  Examiners are not permitted to issue a notice of administrative proceeding until the 30-day period expires.

We expect to see continued guidance from the IRS on BBA centralized partnership examination procedures as the rules become effective.

I was recently interviewed by the Wall Street Journal about the IRS LB&I audit campaigns discussed here.  An interesting part of the conversation included a discussion of why the IRS would tell taxpayers what issues they are targeting.  The bottom line is to increase compliance.  The IRS has identified issues it believes a significant number of taxpayers are non-compliant and is focused on those for one reason: to generate revenue and collections.  There are a few things to keep in mind as you evaluate how to respond to the IRS audit campaigns:

  • The use of “soft letters” indicates the IRS is encouraging taxpayers to self-correct.  It is always better to self-correct than to deal with an issue in audit.  Especially when that issue is something the IRS has highlighted publicly as an issue they are targeting.
  • Failure to self-correct may give the IRS a stronger position for asserting penalties.
  • The 13 IRS audit campaigns identified is not a finite list.  It is an initial list which we expect will evolve over time.

Due to budget constraints, it makes sense that the IRS is targeting significant issues and encouraging self-correction which allows the IRS to increase revenues without significant manpower.

You can read the Wall Street Journal article here.

In 2015, the IRS first included micro-captives, or small insurance companies which have elected under section 831(b) to exclude premiums from their income, on its annual dirty dozen list. At the end of 2015, Congress eliminated the use of micro-captives in estate planning but also expanded use of micro-captives by raising the threshold for tax exempt premiums for micro-captives from $1.2 million to $2.2 million, effective January 1, 2017.

For several years, the IRS has been examining hundreds of micro-captives as well as conducting promotor examinations of several captive managers. On November 2, 2016, the IRS took one more step in focusing on these transactions when it issued Notice 2016-66 which identified certain micro-captive transactions as transactions of interest. As a result, the IRS has added additional reporting and disclosure requirements for micro-captives which do not incur significant claims or which make loans to related entities, such as the insured. It appears the IRS is focused on finding taxpayers it has not already identified who have set up micro-captive structures.

Who Should Care?

  • Micro-captives with insured losses and expenses which, over a five-year period, are less than 70% of the premiums earned (reduced by policyholder dividends)
  • Micro-captives who loaned or transferred funds through some other means to the insured or any related parties
  • Promoters who market micro-captive transactions

What Must I Do?

  • Consult a tax advisor to determine whether you are required to file Form 8886, Reportable Transaction Disclosure Statement
  • For promoters, determine whether you are in compliance with material advisor rules under section 6111 and 6112

When Must I Act?

  • The deadline for filing Form 8886 if required for prior years is January 30, 2017
  • Deadlines for filing Form 8886 for 2016 tax years will depend on annual income tax return deadlines

Why Should I Care?

  • The minimum penalties for failure to file Form 8886 are $5,000 for individuals and $10,000 for entities per year
  • Promoter penalties for failing to comply with the material advisor rules start at $50,000

The notice is available here:  https://www.irs.gov/pub/irs-drop/n-16-66.pdf

 

Tax and accounting issues you should not ignore when setting up your cannabis business:

The Trouble With Cash-Based Businesses

  • Internal Controls – any cash-based business is closely scrutinized by the IRS and other taxing authorities. Having robust internal control procedures, in writing, which are strictly enforced, will go a long way in establishing credibility with taxing authorities.
  • Form 8300 requirements – educate yourself or hire an accountant who can work with you to comply with this filing requirement.
  • Bank Secrecy Act – take precautions to avoid violations

Find Good Help

  • Hiring reputable Certified Public Accountants (CPA) and legal counsel to assist you in operating your business is very important.
  • CPAs often do not have guidance from their licensing boards regarding representation of marijuana businesses and many are therefore reluctant to offer advice.
  • Many large law firms are still reluctant to assist marijuana businesses despite actions by numerous state bar associations to assure attorneys they will not be violating state ethics rules when representing businesses in the legalized marijuana industry.
  • However, sophisticated advisers are starting to work with the industry, both in-house and as external advisers.

Comply, Comply, Comply

  • Abide by Internal Revenue Code section 280E – this requires knowledgeable and diligent accounting advice.
  • Be ready for an audit and for dealing with very aggressive revenue agents. Even though federal law enforcement in many cases is easing up on enforcement under CSA, the IRS has not adopted that view – marijuana businesses have a huge target on their back and the IRS is holding marijuana businesses to a very high standard.
  • Be timely and fully pay your taxes – tax liens can create issues with licensing authorities.