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McDermott’s Real-Time Tax Disputes Insights
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To Agree or Not to Agree, That Is the Question

by and | May 17, 2017 | , ,

The last few years have seen significant changes in audit procedures employed by the Internal Revenue Service (IRS). These changes range from the new Information Document Request (IDR) procedures to substantial changes at the IRS Appeals level. This post focuses on the IRS’s attempt to develop an agreed set of facts before a case is submitted to IRS Appeals.

As taxpayers and practitioners are aware, IDRs are the most-used tool by IRS revenue agents to obtain information and develop the factual record (other common tools include interviews and site visits). Revenue agents use IDRs in several ways, including to request documents, understand taxpayer positions and identify key personnel involved. The end result of this information gathering is a notice of proposed adjustment, which then forms the basis for the revenue agent’s report in an unagreed case. (more…)



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ABA Section of Taxation Response to Recent Changes to IRS Appeals

by and | May 10, 2017 | ,

We have covered on several occasions the changes in the past year to the IRS Appeals process. See here, here, here, here and here. The reactions from taxpayers and practitioners to the recent changes has, for the most part, been negative.

On May 9, 2017, the American Bar Association Section of Taxation provided comments to the Commissioner of the Internal Revenue Service regarding the recent changes at IRS Appeals (Comments). The comments, which can be found here, can be summarized as follows:

  • First, we recommend that Appeals reinstate the long-standing Internal Revenue Manual (Manual) provision regarding limited circumstances for attendance by representatives of the Service’s Examination divisions (Compliance) and the IRS Office of Chief Counsel (Counsel) at settlement conferences.
  • Second, we recommend that Appeals return the option for face-to-face settlement conferences to taxpayers.
  • Third, we recommend that Appeals publicly reaffirm that independent Appeals Technical Employees may, in all cases, evaluate the hazards of litigation on positions taken by Counsel.
  • Fourth, we offer some observations and suggestions regarding informal issue coordination in Appeals.
  • Fifth, we support the recent reaffirmation of Appeals Team Case Leader (ATCL) unilateral settlement authority.
  • Finally, we reiterate our recent comments with respect to docketed cases in Appeals’ jurisdiction.

Practice Point: We are observing many of the same changes in practices that are discussed in the Comments. Taxpayers and their advisors need to understand and be prepared for the different procedures and approaches being employed at IRS Appeals. These changes appear to be leading down a road where settlements may be more difficult to accomplish and, as a result, we may see an increase in tax litigation.



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The IRS’s Assault on Section 199 (Computer Software) Doesn’t Compute

by , and | Apr 24, 2017 | , , , , ,

Internal Revenue Code Section 199 permits taxpayers to claim a 9 percent deduction related to the costs to develop software within the U.S. The relevant regulations and their interpretation, however, place substantial restrictions on claiming the benefit.

Moreover, the regulations and the government’s position haven’t kept up with the technological advances in computer software.

Before claiming the deduction on your return, consider that the Internal Revenue Service has this issue within its sights, and perhaps it will be the subject of one of their new “campaigns.”

In 2004, Congress enacted I.R.C. Section 199 to tip the scales of global competitiveness more in favor of American business. The main motivation of the statute was to create jobs by encouraging businesses to manufacture and produce their products in the U.S. The tax benefit, however, isn’t available for services, a theme that pervades many of the provisions in the statute and regulations.

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Originally published in Bloomberg BNA Daily Tax Report – April 24, 2017 – Number 77



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Taxpayer Advocate Questions IRS CID’s Narrow Reading of the Taxpayer Bill of Rights

by | Apr 6, 2017 | , ,

On March 30, 2017, the US Treasury Inspector General for Tax Administration (TIGTA) published a report identifying numerous violations of taxpayer rights from 2012 to 2014 by the Internal Revenue Service Criminal Investigation Division (IRS CID) in structuring cases. TIGTA examined over 300 investigations for structuring in this time period and identified 21 cases in which taxpayer rights had been compromised.

The Bank Secrecy Act of 1970 (BSA) requires US financial institutions to file reports of currency transactions exceeding $10,000. A provision of the BSA, 31 U.S.C. § 5324(a), prohibits structuring, that is, setting up a transaction for the purpose of evading this reporting requirement. Violations of the law can result in fines, imprisonment and asset forfeiture. This law is administered by the US Department of the Treasury, and one of its major goals is to monitor traffic in illegal-source funds (i.e., funds used in drug transactions or to support terrorism). (more…)



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Acting IRS Chief Counsel appoints new Deputy Chief Counsel (Operations)

by | Mar 30, 2017 | , , , ,

The Acting Chief Counsel announced that effective April 1, 2017, Drita Tonuzi will serve as the Deputy Chief Counsel (Operations), in Washington DC.  In this position, Ms. Tonuzi will provide legal guidance and litigation support to the Internal Revenue Service (IRS) and the Departments of Treasury and Justice in all matters pertaining to the administration and enforcement of the Internal Revenue laws.  This includes responsibility for all litigation in the United States Tax Court as well as the management of personnel in fifty field offices nationwide and in headquarters operations in Washington, DC. She will directly supervises nine Divisions including Large Business and International (LB&I), Small Business/Self Employed (SB/SE), Tax Exempt and Governmental Entities (TEGEDC), Wage and Investment (W&I), General Legal Services (GLS), Criminal Tax (CT), Procedure and Administration (P&A), Finance and Management (F&M) and Counsel to the National Taxpayer Advocate (CNTA).

Ms. Tonuzi began her career with the Office of Chief Counsel in 1987 in the Manhattan Office, where she litigated cases before the United States Tax Court. She served as the Securities & Financial Services Firms Industry Counsel and managed a group of attorneys, Deputy Division Counsel for the Large Business & International Division (formerly LMSB), where she was responsible for the operation and litigation of the organization and most recently she served as Associate Chief Counsel Practice and Administration.

With Ms. Tonuzi’s promotion, Kathryn Zuba has been appointed as the Acting Associate Chief Counsel, Procedure and Administration. Ms. Zuba will head an office of more than 150 professionals, who provide legal services to the IRS, other components of the Chief Counsel’s Office, other government agencies, and the public in the areas of federal tax procedure and administration. The responsibilities of this office include matters relating to the reporting and payment of taxes; assessment and collection of taxes; the abatement, credit or refund of over-assessments or overpayments of taxes; the filing of information returns; bankruptcy; disclosure; FOIA; privacy law; litigation sanctions; judicial doctrines; ethics; and liaison with the courts.



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Fast Track Settlement Now For SB/SE Taxpayers

by and | Mar 20, 2017 | , , , , ,

Today, the Internal Revenue Service (IRS) released Revenue Procedure 2017-25 extending the Fast Track Settlement (FTS) program to Small Business / Self Employed (SB/SE) taxpayers.  The IRS’s SB/SE group serves individuals filing Form 1040 (US Individual Income Tax Return), Schedules C, E, F or Form 2106 (Employee Business Expenses), and businesses with assets under $10 million.

FTS offers a customer-driven approach to resolving tax disputes at the earliest possible stage in the examination process. The program provides an independent IRS Appeals review of the dispute.  Under this approach, the IRS Appeals Officer acts as the mediator and has settlement authority.

The purpose of the program is to reduce the time to resolve cases and to provide the IRS Exam Team with the authority to settle cases based on hazards of litigation (which is generally reserved for IRS Appeals Officers).  FTS has been considered a great success by the IRS and many taxpayers.  The expansion of this successful alternative dispute resolution makes sense in light of the ever-shrinking resources of the IRS.



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IRS Issues IPU on Summons of Foreign Owned US Businesses

by and | Feb 2, 2017 | , , , , ,

On January 30, 2017, the Internal Revenue Service (IRS) released an International Practice Unit (IPU) on the use of a summons under IRC Section 6038A (IRC Section 6038A Summons) when a US corporation is 25-percent owned by a foreign shareholder.  See IPU here. The IPU describes the steps that the IRS should take when issuing an IRC Section 6038A Summons, and what to do when the US corporation does not substantially comply with the summons.

In general, IRC Section 6038A imposes reporting and recordkeeping requirements (together with certain procedural compliance requirements) on domestic corporations that are 25-percent foreign-owned, which the regulations refer to as a domestic reporting corporation (DRC).  Among other requirements, a DRC is required to keep permanent books of account or records per IRC Section 6001 that are sufficient to establish the correctness of the federal income tax return of the DRC, including information, documents, or records to the extent they may be relevant to determine the correct US tax treatment of transactions with related parties. See Treas. Reg. Section 1.6038A-3.

The IRS may issue an IRC 6038A Summons when:  (i) the taxpayer under exam is a DRC; (ii) there was a transaction between the DRC and the 25 percent foreign shareholder or any foreign person related to the DRC or to such 25 percent foreign shareholder; and (iii) the DRC is appointed to act as a limited agent with respect to any request by the IRS to examine its records or produce testimony that may be relevant to the tax treatment of any transaction between the DRC and a foreign related party.  If the DRC does not substantially comply in a timely manner with the IRC 6038A Summons, the IRS has sole discretion to determine the amount of the DRC’s deductions related to transactions with, and the cost of property purchased from (or transferred to), the foreign related party.

The IPU is particularly relevant in light of final regulations published in the Federal Register on December 13, 2016 (TD 9796) which treat a domestic disregarded entity wholly owned by a foreign person as a domestic corporation for purposes of the reporting, record maintenance and associated compliance requirements under IRC Section 6038A.  The regulations are effective for tax years beginning after December 31, 2016, and ending on or after December 13, 2017.  The IPU refers to these regulations in describing the criteria which must be met before the IRS issues an IRC Section 6038A Summons.

Practice Point:  For US entities that are owned by foreign entities and file US tax returns, it is crucial to have all of the relevant information for the entity in the US. US taxpayers are required to support all of the positions claimed on a return.  For example, if there are expenditures of the US entity that are paid for by the foreign affiliate, there should be adequate documentation in the US to support those payments.



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National Taxpayer Advocate 2016 Report – Penalties

by | Jan 26, 2017 | , , , ,

Every year, the Taxpayer Advocate Service’s (TAS) Annual Report to Congress provides a unique perspective regarding the workings of the Internal Revenue Service (IRS) and how the IRS relates to the vast majority of taxpayers. That insight is particularly valuable when the IRS chooses to assert penalties—one of the most policy-driven decisions that the IRS can make. In its 2016 report, the TAS makes a number of important observations and recommendations related to three of the most commonly asserted types of penalties—accuracy-related penalties, failure-to-file and failure-to-pay penalties, and the Trust Fund Recovery Penalty.

Accuracy-Related Penalties

The TAS identified 122 cases litigated between June 1, 2015, and May 31, 2016 (the reporting period), involving accuracy-related penalties.  Of those cases, the IRS prevailed in full in 86 cases (70 percent), taxpayers prevailed in full in 20 cases (16 percent), and 16 cases were split decisions (13 percent) (percentages were rounded down in the original report). Unusual this year were the number of split decisions and the number of taxpayer wins in pro se cases. Many cases involving the negligence penalty turned upon the taxpayer’s failure to maintain adequate books and records related to the adjustments at issue.

In 2013, the TAS issued a study noting that the IRS’s imposition of accuracy-related penalties, subsequently abated after an assessment and a successful taxpayer appeal (among other fact patterns), could lead to a perception of unfairness among taxpayers regarding the IRS’s manner of assertion of these penalties. The TAS cited this study in its 2016 report, and noted again that this conduct could be detrimental to voluntary taxpayer compliance and could undermine the purpose of accuracy-related penalties.

In fact, a main priority of the Annual Report overall is to improve voluntary compliance, a fundamental element of our tax system. The TAS notes that “unnecessary coercion” by the IRS—whether through unsustained penalties or otherwise—could have the effect of reducing voluntary compliance.

Failure-to-File / Failure-to-Pay Penalties

The TAS identified 45 total decisions involving failure-to-file and failure-to-pay penalties in the reporting period.  Of these, 28 cases involved taxpayers representing themselves. The majority of cases involved full or partial taxpayer losses.

The TAS noted, consistent with our experience, that the IRS frequently relies upon selection of failure-to-file and failure-to-pay cases through its Reasonable Cause Assistant software, which makes the initial decision to impose the relevant penalties in most cases without significant human involvement.  Personal review of the penalty decision does not generally occur until after the taxpayer files an administrative appeal.  The TAS advocated for heightened personal review of these penalties and heightened consideration of relevant facts and circumstances potentially supporting abatement.

Trust Fund Recovery Penalties

The TAS noted that several Trust Fund Recovery Penalty cases this year had successfully challenged whether the penalty was properly noticed and assessed. United States v. Appelbaum, 117 A.F.T.R.2d 2016-633 (W.D.N.C.); Romano-Murphy v. United States, 816 F.3d 707 (11th Cir. 2016).

The TAS further discussed a number of unsuccessful taxpayer challenges to assessment of the Trust Fund Recovery Penalty on grounds of [...]

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National Taxpayer Advocate 2016 Report – IRS Appeals and Alternative Dispute Resolution

by and | Jan 24, 2017 | , , , ,

In its annual report to the US Congress, the Taxpayer Advocate Service (TAS) had a lot to say about IRS Appeals and the (lack of) use of other alternative dispute resolution (ADR) techniques. In this post, we will highlight what the TAS had to say in this area.

IRS Appeals

Undoubtedly, one of the Internal Revenue Service’s (IRS) most successful dispute resolution techniques has been IRS Appeals. Briefly, after the IRS’s Examination Division proposes a tax adjustment, taxpayers have the statutory right to seek an “appeal” of the decision. IRS Appeals is a separate and seemingly independent division of the IRS where one or more appeals officers review the redeterminations and adjustments made by the Examination Division, and attempt to settle the dispute directly with the taxpayer based upon a “hazards of litigation” analysis, much in the same manner as a judge would rule. The TAS acknowledged the success and utility of the IRS Appeals program and mission, but requested that Congress expand the program, giving the IRS the resources it needs to manifest the full intent of the program.

The TAS reported that funding for IRS Appeals has diminished sharply—by about 11 percent from 2013 to 2016, with staff reduced during the same period by 24 percent. In response to shrinking resources, but hobbled by the same duties and similar case load, IRS Appeals has been forced to implement procedures and policies that hamper its long-term mission of providing a fair and impartial review of the Examination Division’s adjustments. The TAS pointed out that these policies have resulted in (1) creating an inhospitable Appeals environment; (2) limiting in-person Appeals conferences; (3) reducing the Appeals officer’s ability to perform a quality substantive review; and (4) failing to protect the rights of taxpayers when conducting collection Appeals hearings. The TAS noted that there has been a large increase of cases docketed in the US Tax Court before seeking an IRS appeal. The TAS believes that docketing a case before it goes to Appeals has added inefficiency and unnecessarily increased the case load of the Tax Court.

The TAS suggested the following solutions:

  1. Expand the locations in which Appeals Officers hear matters. Presently, there are numerous states in which there are no IRS appeals officers. As a result, taxpayers who seek an appeal and request an in-person conference are forced to travel to the states in which an IRS appeals officer is located.
  2. Hold more in-person appeals conferences. The TAS report argues that in-person conferences facilitate the efficient and expeditious settlement of matters.
  3. Revise procedures and policies to allow IRS appeals officers additional discretion and time to undertake factual development and provide more substantive review of matters.

Practice point: We have recently reported about many of the issues facing taxpayers seeking review by IRS Appeals. The TAS confirms our critiques of the system. IRS Appeals is a very good and useful technique that has a high probability of settling cases. Generally, appeals [...]

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IRS Audits and IRS Appeals — A Year in Review

by | Jan 6, 2017 | , , ,

This year has been marked with substantial changes in the manner in which the Internal Revenue Service (IRS) operates. Shrinking resources and retiring IRS professionals have marred the IRS and its efficiency. The pervasive theme for 2016 was trying to do the job with fewer resources.  For example, IRS audits continue to devolve with standardized information document requests (IDRs), international practice unit guides and issue-focused examinations (mostly focused on international tax issues). We say “goodbye” to old friends [au revoir Compliance Assurance Process (CAP) Program] and hello to new rules (e.g., partnership entity audit rules and adjustments). And we have born witness to the slow evisceration of the independence of IRS Office of Appeals.

As we turn the corner to a new year, we expect the IRS’s war on taxpayers to manifest itself in “campaign” after “campaign,” reminiscent of the tiered issue system of days gone by. We expect coordination on a national level to reside with IRS “issue specialists” controlling and dictating audits and appeals, which will increasingly challenge the efficiency of pre-litigation resolution techniques. The end result of these contractions may very likely be an increase in tax litigation as frustration with the administrative process boils over. But the wild card, of course, is what changes will be ushered in by the new administration. Will it be business as usual, or will we see a complete overhaul of the system? Only time will tell, as we wait with bated breath for the ball to drop.  (more…)



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