Interactions with the IRS, on any level, are notorious for eliciting nervous responses from taxpayers. The IRS Large Business and International (LB&I) Division is revamping its audit processes, which may help relieve those feelings of dread should the IRS come knocking.
LB&I focuses on tax issues of entities with assets greater than $10 million. The entities LB&I serves typically have numerous employees and face complex domestic and international tax issues. Earlier this year, LB&I announced the rollout of its initial campaigns that will make up the focus of the division’s audit efforts in the near term. These campaigns are part of LB&I’s broader reorganization plan in recent years. The need to focus the division’s limited resources in a more efficient manner prompted this reorganization. As part of the restructuring, the division is moving away from enterprise-focused examinations to a process geared more toward combating specific tax issues.
Historically, LB&I has conducted its examinations on an entity-by-entity basis, identifying target taxpayers and expanding the issues under examination from that point. Under the new regime, the division will focus more on specific “risk issues” and less on taxpayer characteristics when determining which entities to examine. This tactic is likely to catch a wider variety of taxpayers in the examiner’s net; however, once LB&I has selected a taxpayer for campaign-based treatment, the interaction with the IRS likely will be limited to that specific issue.
LB&I currently selected 24 campaigns based on its perceived ability to successfully execute and test the new process using current resources and various “treatment streams,” which can vary among the campaigns. The IRS website houses a complete listing of the initial 13 and subsequent 11 campaigns. Some of the campaign-based issues taxpayers should have on their radar include:
- Micro-Captive Insurance
- This campaign continues the increased IRS focus on micro-captive arrangements identified as Transactions of Interest under Notice 2016-66. The IRS is concerned certain arrangements aren’t truly insurance, but rather a means to reduce a taxpayer’s income through premium payments to a related captive insurance company that excludes the premium income under a special election available to small captives. See our prior BKD Thoughtware® alert for additional information. The treatment stream for this campaign will be issue-based examinations.
- Related-Party Transactions
- For this campaign, LB&I will embark on issue-based examinations to assess the compliance level of commonly controlled entity groups with sufficient means to unjustifiably transfer funds among group members.
- Land Developers – Completed Contract Method (CCM)
- Developers with average annual gross receipts exceeding $10 million only can use the CCM for home construction contracts. The IRS has identified several large land developers that use the CCM to improperly defer all gain on land development projects until the entire project is complete. The treatment stream for this campaign includes issuing soft letters, developing a dedicated practice unit and, if necessary, performing issue-based examinations.
- S Corporation Losses Claimed in Excess of Basis
- S corp shareholders must have sufficient stock or debt basis to claim losses and deductions on their personal income tax returns. LB&I has observed instances of shareholders over-reporting losses and plans to address this concern using soft letters, issue-based examinations and the creation of a new tax form to assist shareholders with basis computations.
- While various structures are in place to facilitate the tax-free repatriation of funds into the U.S., LB&I has found many entities omit taxable repatriation events when filing their tax returns. To address this campaign issue, LB&I plans to conduct issue-based examinations using more effective selection filters.
- Corporate Direct Foreign Tax Credit (FTC)
- LB&I intends for this campaign to be the first of several to address FTC issues. The corporate FTC campaign’s goal is to improve the selection filters used to identify domestic corporations in an excess limitation position that may be claiming an incorrect credit amount. LB&I will use issue-based examinations for this campaign.
- Individual FTC
- Using a variety of treatment streams, including issue-based examinations, LB&I will address the issues with computing the FTC for individuals. This campaign was selected due to the complexity of computing the FTC and challenges associated with third-party reporting information.
Because the compliance campaigns focus on identifying issues versus entities, taxpayers not previously subject to IRS attention may see a rise in contact from the agency. Taxpayers with situations falling under one of the campaigns should be especially prepared. If the IRS does make contact, consider the following best practices:
- Notify your tax advisor immediately upon the receipt of any correspondence from the IRS. Your advisor can help guide you through the process.
- Determine the purpose of the communication as soon as possible, asking directly if the contact relates to a specific campaign.
- Keep track of all correspondence with the IRS.
The IRS has created a webinar series to further educate taxpayers on the campaign process and structure of each campaign. LB&I intends for these 24 issues to be the beginning of several compliance campaign waves. Watch for future campaign waves and work directly with your tax advisor to determine the possible effect on your tax situation—especially if the IRS initiates contact.
For additional insight into dealing with the IRS, tune in to episode three of BKD’s Simply Tax Podcast, “Controversial Tax.”