On July 2, 2018, the Large Business and International (LB&I) Division of the Internal Revenue Service (IRS) announced five new compliance campaigns, including campaigns relating to virtual currency and the transition tax imposed by section 965 of the Internal Revenue Code of 1986, as amended (the Code), which was added by Public Law 115-97. These five new campaigns reiterate LB&I’s efforts to focus its resources on issue-based examinations rather than specific industries and taxpayers, and notably, for the first time, on tax reform items.
Taxpayers should be aware that IRS agents essentially use the campaigns as a roadmap to conduct their examinations and will likely be on the hunt for these issues when examining 2017 returns. Taxpayers should keep this in mind when evaluating and taking certain positions that would fall under one of the announced campaigns.
A brief summary of the new campaigns and Eversheds Sutherland observations are included below:
1. Virtual Currency
Previous guidance on virtual currency, Notice 2014-21
, classified virtual currency as property for tax purposes. This campaign targets taxpayers that engage in virtual currency transactions and do not comply with the general tax principles that apply to transactions in property.
Eversheds Sutherland Observation: The initial focus of this campaign may include audits of some of the 13,000 virtual currency customers notified in February 2018 that their identities and certain account information would be provided to the IRS in connection with a John Doe summons. Compliance with tax reporting requirements can be complex, especially with regard to initial coin offerings, which can have a myriad of tax consequences for both the issuers and the holders of the virtual currency. The IRS has announced that it is not contemplating a voluntary disclosure program in connection with non-compliance involving virtual currency, so affected taxpayers should take action promptly to correct their tax reporting.
2. Section 965 Transition Tax
This campaign focuses on taxpayer compliance with the transition tax imposed on unrepatriated foreign earnings by section 965 of the Code, including filing and payment obligations and the election to pay in installments. The IRS has noted that such obligations may apply to non-corporate US shareholders, including smaller businesses and individuals.
Eversheds Sutherland Observation: Given the highly technical and quantitative nature of section 965, it is not surprising that the IRS is making it a compliance focus. Taxpayers can expect the IRS to request detailed information necessary to calculate their section 965 inclusion amount. This campaign highlights the importance of maintaining records to support the calculations and updating the calculations to reflect the guidance that has been previewed in Notices and is expected to be addressed in future regulations. For example, given the position taken by the IRS with respect to accounting method changes and entity classification elections in Notice 2018-26, taxpayers should be particularly cautious and ensure that any method changes filed after November 2, 2017 that reduce or otherwise impact a taxpayer’s section 965 tax liability have been thoroughly evaluated and documented. This campaign reiterates the interest and willingness of the IRS to examine this activity. See the prior Eversheds Sutherland alerts on the transition rule.
3. Sequestered AMT Credit
This campaign targets taxpayers that are subject to sequestration with respect to the refundable portion of the Alternative Minimum Tax (AMT) credit. Sequestration does not affect the portion of the AMT credit that offsets tax due in the current year. To the extent the credit is refundable, however, sequestration reduces the refundable amount by a percentage, which is 6.6% for returns filed between October 1, 2017 and September 30, 2018. Some taxpayers subject to sequestration have taken the position that the amount not refunded due to sequestration can be added to the AMT credit carryover and potentially refunded in subsequent years. The IRS position is that the sequestered amount is permanently lost. The goal of the campaign is to educate taxpayers and to request that taxpayers self-correct.
Eversheds Sutherland Observation: A working group of taxpayers had requested Treasury to determine that the AMT credit represents a refund of tax paid in prior years, which would not be subject to sequestration. This campaign makes clear that the IRS takes the position that the refundable portion of the credit is subject to sequestration and that the sequestered amount is permanently lost. This is consistent with the IRS position with respect to the elective refundable AMT credit under section 168(k) prior to amendment. See Chief Counsel Memorandum 20163601F (June 7, 2016).
4. S Corporation Distributions
This campaign focuses on three issues relating to the tax consequences of distributions by S corporations to their shareholders. Specifically, the campaign targets S corporations that fail to report gain on the distribution of appreciated property to a shareholder, S corporations that fail to determine that a distribution is properly taxed as a dividend, and S corporations that fail to report non-dividend distributions in excess of their stock basis that are subject to taxation.
Eversheds Sutherland Observation: The second issue within this campaign is generally relevant to an S corporation that was formerly a C corporation or that acquires the stock or assets of a C corporation in a reorganization. Any accumulated earnings and profits that are attributable to the C corporation period may cause a distribution by the S corporation to its shareholders to be characterized for tax purposes as a dividend, which would be taxable to the shareholders as if the distribution were made by a C corporation.
5. Repatriation via Foreign Triangular Reorganizations
This campaign focuses on taxpayers that repatriate basis and untaxed controlled foreign corporation (CFC) earnings through triangular reorganizations involving foreign corporations, which were addressed by the IRS in Notice 2016-73
Eversheds Sutherland Observation: This campaign will be most relevant to pre-2018 transactions because the transition tax provisions will cause most pre-transition earnings to be considered previously taxed income and distributions of post-transition earnings that are not previously taxed income are generally exempt from taxation under section 245A, provided the ownership and holding period requirements are satisfied.
These five new campaigns supplement the 11 campaigns previously announced this year. See the prior Eversheds Sutherland legal alert on the five campaigns announced in March and a legal alert specific to the corporate transaction cost campaigns announced in March.