IRS Audits Archives - Page 17 of 28

IRS Audits

IRS Releases Practice Unit on Allocation of Interest Expense

by Jeffrey M. Glassman and McDermott Will & Emery | Mar 21, 2016 | IRS Audits, IRS Guidance, Uncategorized

On February 19, 2016, the Internal Revenue Service (IRS) released a 30-plus-page practice unit regarding interest expense of a foreign corporation engaged in a U.S. trade or business. As is the case with all practice units, the IRS cautions that practice units are not official pronouncements of law or directives and cannot be used, cited or relied upon as such. Even so, the IRS generally acknowledges that practice units provide a general discussion of a concept, process or transaction. This can be helpful from a taxpayer’s perspective. This is especially true for interest expense allocation calculations under Treasury Regulation § 1.882-5, one of the more complicated calculations for taxpayers to make.

The practice unit begins with a graph that illustrates possible circumstances where the interest expense allocation process described in the practice unit can apply. The practice unit then breaks down the four steps for determining interest expense allocations. The four steps are:

Determine the amount of U.S. assets.
Determine the amount of U.S. booked liabilities.
Determine what elections the taxpayer has made to compute the interest expense deduction.
Calculate the allocable interest expense to the U.S. trade or business.

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Preparing for a Tsunami of International Tax Disputes

by McDermott Will & Emery and McDermott Will & Emery | Mar 14, 2016 | Alternative Dispute Resolution, IRS Audits, Transfer Pricing Resource, Uncategorized

Recently, we published a Special Report in Tax Notes International, “Preparing for a Tsunami of International Tax Disputes.” The article can be accessed here. While there is near-universal agreement that the number of tax disputes is going to increase, existing international tax dispute resolution processes remain in serious need of improvement. A global consensus must be reached on a process for resolving worldwide tax disputes that appeals to all stakeholders. This article focuses on recent attempts by the Organisation for Economic Development (OECD), United Nations (UN) and international tax community to achieve such a consensus.

In short, the predictability of tax base results is a serious concern for countries and multi-national enterprises alike. The only realistic solution is to design a dependable and independent treaty-based dispute resolution process that accommodates the needs of all stakeholders. A foundation for this process has been provided by the inclusion of arbitration in both the OECD and UN model income tax treaties and its successful implementation in a few countries. Arbitration and alternative dispute resolution (ADR) have already evolved successfully in nontax government and commercial contexts. As with any such evolution, there have been both positive and negative experiences for countries and private parties. In the realm of international taxation, the development of these processes is in the early stages. It is important for all stakeholders in the tax arena to explore ways of using experiences from non-tax contexts to develop processes that can relieve emerging pressures relating to international taxation. To distinguish the international tax context from others, the new dispute resolution process could be referred to as the International Taxation Dispute Resolution Process (ITDRP), as suggested in the UN Secretariat Paper on Alternative Dispute Resolution in Taxation released on October 8, 2015.

While the development of a successful ITDRP will inevitably take time and will no doubt be contentious, significant advancements have been made in the past few months that suggest it could soon be on the horizon. These include the initial Base Erosion and Profit Shifting (BEPS) paper on dispute resolution, the January 2015 Dispute Resolution Conference in Vienna, the OECD Action 14 Final Report (released in October 2015) and the UN Secretariat ADR Paper.

Almost all stakeholders in the international taxation community agree that: (i) the number of disputes will increase; (ii) existing dispute resolution processes are in serious need of improvement; and (iii) a global consensus must be achieved so that global tax disputes can be resolved in a way that serves the interests of all stakeholders. In this regard, it may be fortunate for the tax community that it is arriving late to the ADR processes that have evolved in other areas over the past century. As the OECD and UN processes continue to evolve, it is hoped that lessons from these other areas can be drawn upon to develop an ITDRP that serves the interests of all parties.

IRS Updates LB&I Examination Process Guide

by McDermott Will & Emery | Mar 4, 2016 | IRS Audits, IRS Guidance, Tax Refunds, Uncategorized

Effective May 1, 2016, the Internal Revenue Service (IRS) will begin applying previously announced changes to the Large Business & International (LB&I) Division’s examination process. Publication 5125 begins by setting forth expectations for the LB&I exam team and the taxpayer or its representatives. It then addresses IRS expectations regarding refund claims. Finally, the publication discusses the three stages of the LB&I examination process—planning, execution and resolution—and how the IRS and taxpayers should conduct themselves during each stage.

The IRS had previously released draft publication 5125 in November 2014, which concerned some taxpayers, particularly with respect to the statement that informal refund claims would only be accepted within 30 days of the opening conference. Final Publication 5125 retains the 30-day period for making informal refund claims, but provides that LB&I will not require a formal claim after the 30-day period if an issue has been identified for examination (unless IRS published guidance specifically requires a formal claim). Exceptions may also be granted by LB&I senior management.

Publication 5125 also made changes to the examination process based on the recent shift to an issue-based audit approach. The case manager will have overall responsibility for the case, which may be beneficial to taxpayers involved in recent audits where domestic and international personnel appeared to share responsibility for the conduct of the audit. Factual and issue development are also heavily stressed, with an emphasis on the information document request (IDR) process and a focused and useful examination plan. The publication also states that IRS team members are expected to seek the taxpayer’s acknowledgment of the facts and to resolve any disputes prior to the issuance of Form 5701, Notice of Proposed Adjustment.

Taxpayers should review Publication 5125 to familiarize themselves with the current audit process and to ensure that IRS team members are following the guidance. To the extent an IRS team member is not following the guidance, taxpayers should not hesitate to discuss the matter with the team manager.

Generic IRS Publication Fails to Satisfy the Advance Notice Requirement for Third Party Contacts

by Robin L. Greenhouse | Feb 15, 2016 | IRS Audits, Uncategorized

In Baxter v. United States, No. 4:15-cv-04764 (ND Cal. 2016), the Internal Revenue Service (IRS) issued a third-party summons for the petitioner’s 2011 tax year to the California Supreme Court seeking documents relating to payments made to the petitioner for his legal representation of capital defendants. The petitioner brought a timely petition to quash the 2011 third-party summons in federal district court. The court granted the petition to quash the 2011 third-party summons because the IRS failed to provide advance notice to the petitioner pursuant to Internal Revenue Code (IRC) section 7602(c)(1), which requires advance notice by the IRS of third party contacts. Importantly, the court rejected the government’s contention that the advance notice requirement could be satisfied by providing a taxpayer with the generic notice in IRS Publication 1, which states that the IRS will “sometimes talk with other persons if [they] need information that [the taxpayer] have been unable to provide.”

To enforce a summons or dismiss a petition to quash a summons, the government must first establish a prima facie case of good faith by making a showing that: (1) the underlying investigation is for a legitimate purpose, (2) the inquiry requested is relevant to that purpose, (3) the information sought is not already in the government’s possession and (4) the administrative steps required by the IRC has been followed.

The district court found that the government has met its burden as to the first three requirements, but it failed to establish that the administrative steps required by the IRC had been followed. The government admitted that the IRS did not provide advance notice to the petitioner of its intent to make a contact with the California Supreme Court, but instead contended that the IRS satisfied the advance notice requirement in IRC section 7602(c)(1) by transmitting a publication about the audit process generally. In finding this argument unpersuasive, the court reasoned that the implementing regulations (301.7602-2(f)(1)(i)(B)) contemplate notice for each contact either orally or in writing.

Having quashed the summons, the court went one step further (and perhaps beyond its jurisdiction) and ordered that any new summons issued by the IRS to the California Supreme Court seeking information regarding payments made to petitioner “shall direct the California Supreme Court to first deliver the summonsed documents to the Court for an in camera review to determine whether the documents contain any privileged attorney-client communications.”

Practice Note: At the beginning of the IRS examination, the taxpayer or his representative should request that the IRS agent provide in writing the names of each person that the agent intends to contact.

LB&I Practice Units: Know Your EOI Programs

by McDermott Will & Emery | Feb 10, 2016 | Court Procedure Matters, IRS Audits, IRS Guidance, Transfer Pricing Resource, Uncategorized

On January 20, 2016, the Large Business and International (LB&I) Division released a Practice Unit entitled Overview of Exchange Information Programs and Types of EOI Exchanges, defining and describing the Internal Revenue Service (IRS) Exchange of Information (EOI) programs. These EOI Practice Units specify what types of exchanges are covered by EOI programs and what types of information the IRS can seek through each type of EOI exchange.

The IRS breaks down the avenues for international information exchange into several categories:

Specific Requests involve requests for information pertaining to a specific taxpayer under examination or investigation for a specific period.
Spontaneous Exchanges involve the transmission of taxpayer information by one member of an EOI agreement that is deemed potentially of interest to a foreign partner even though no specific requests have been initiated by the foreign partner.
Automatic Exchanges involve the transmission of taxpayer information that foreign partners have agreed to exchange on a regular and systematic basis without individualized specific requests. The most common example includes information relating to dividends, interest, rents, royalties, salaries and annuities earned in one partner country by residents of the other partner country.
Industry-Wide Exchanges involve the sharing of trends, policies and operating practices in a particular industry or economic sector and do not implicate specific taxpayer information.
The Simultaneous Examination Program coordinates strategies and the development of technical issues between the United States and a foreign partner if it is determined a common interest exists between the respective taxing authorities. These discussions are intended to facilitate the exchange of relevant taxpayer information with the foreign partner in furtherance of the separate independent examinations of a taxpayer by each jurisdiction.
Joint Audits take place when the United States and one or more of its foreign partners collaborate to conduct a single examination of a taxpayer or a related taxpayer within their jurisdictions.
The Simultaneous Criminal Investigation Program operates through the EOI provisions of bilateral tax agreements and fosters the coordination of separate criminal investigations conducted concurrently by the United States and the foreign partner.
The Mutual Legal Assistance Program relates to an agreement that authorizes a partner country to secure evidence for use by the requesting country in criminal judicial proceedings of the taxpayer.
The Mutual Collection Assistance Request Program is intended to utilize the collection assistance provisions of tax treaties, enabling one partner state to collect taxes covered by the treaty on behalf of the other contracting state. These collection provisions appear in a limited number of current United States treaties.

The Practice Units provide a short general overview of each method and—of particular usefulness—describe what government office or department is responsible for executing requests in each category. Thus, the Practice Units may be a good “first line of defense” for information-gathering when you believe the IRS is pursuing or has received an international EOI request related to your client.

In future posts, we will discuss how these tools are utilized in practice, [...]

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Substantial Changes to Auditing Partnerships

by Kevin Spencer | Feb 2, 2016 | IRS Audits, IRS Guidance, Uncategorized

On November 2, 2015, the Bipartisan Budget Act of 2015 was signed into law, and which instituted significant changes to the rules governing the federal tax audits of partnerships for tax years after 2017. In the absence of affirmatively electing partner-level adjustment, the new rules impose entity-level tax liability for Internal Revenue Service (IRS) audit adjustments to partnerships. The new rules are a significant departure from what has historically been merely pass-through treatment of partnerships for US federal income tax issues.

There is a small partnership exception to elect out of the new audit rules. This election may apply to partnerships with 100 or fewer partners, each of which is an individual, a C corporation, an S corporation or an estate of a deceased partner. However, any tiered partnership – partnerships that have partnerships as partners – are ineligible for the exception.

The new rules determine IRS audit adjustments at the partnership level for items of partnership income, gain, loss, deduction or credit. The taxes owed on those adjustments are calculated at the maximum statutory tax rate, and assessed and collected from the partnership in the year that the audit or any judicial review is completed. Additionally, the partnership is liable for all associated penalties and interest.

Alternatively, the partnership can elect out of the entity-level tax, but must furnish to every partner for each year under examination a statement of the partner’s share of any tax adjustments. Under this election, each partner will be responsible for paying its taxes, penalties and interest related to the adjustment.

The new rules also change who speaks to the IRS on behalf of the partnership. Instead of the “tax matters partner,” the new rules provide for a “partnership representative.” The partnership representative, who no longer must be a partner, has sole power to act on behalf of the partnership during the audit. Moreover, the partnership representative can bind both the partnership and the partners with respect to the IRS examination and adjustments.

The new partnership audit regime applies to partnership returns filed for tax years beginning after December 31, 2017. Because the new rules make fundamental changes to the way that partnerships were audited in the past, we are hopeful that the delayed effective date will give taxpayers time to consider the potential effects of the new rules on their partnerships and operative agreements. The new rules leave open numerous issues, and we expect the IRS to issue substantial guidance in the future.