On January 31, 2017, the Large Business & International Division of the IRS (LB&I) released the subjects of its first 13 campaigns. Each campaign addresses a specific area that the IRS has identified as a substantial non-compliance risk. Various high-level officials within LB&I have publicly explained that campaigns generally will be LB&I’s primary focus in the coming years, though the level of resources dedicated to these first campaigns may initially account for a relatively small percentage of the division’s total activities. Campaigns are an important step in the reorganization of LB&I that began in early 2016.
The LB&I Reorganization
In September 2015, the LB&I division announced that it would make substantial changes to both its organization and its approach to taxpayer examinations. The overarching theme of the restructuring was “One LB&I.” Its purpose was to use LB&I’s limited resources as efficiently as possible to address tax non-compliance. The structural changes were implemented in early 2016.
The structural changes unify and centralize authority within LB&I’s leadership. The distinction between the domestic and international arms of LB&I was eliminated. The Commissioner of LB&I is now supported by a single deputy. Below the Deputy Commissioner, LB&I has replaced its industry-based subdivisions with nine practice areas: five based on categories of tax issues and four based on geographic regions.
To complement these structural changes, LB&I is shifting its attention to specific tax issues and away from specific taxpayers, marking a significant change to the way that it approaches taxpayer examinations. While some of the largest taxpayers will still face continuous audits, the new structure indicates that the bulk of LB&I’s resources will be dedicated to identifying and addressing the tax issues that present the greatest risk of non-compliance in the coming years. The campaigns will be central to this effort.
Eversheds Sutherland Observation: These structural changes are a major part of LB&I’s effort to consolidate decision-making authority in order to thoroughly address a relatively small number of tax issues, meaning that the discretion of general field audit teams may be diminished. To fully engage within this new structure, taxpayers must understand the dynamics of the LB&I division as a whole and prepare for deep, complex investigations of specific parts of their tax arrangements.
The Campaigns – Overview
When LB&I identifies an issue area with significant non-compliance risk, it may create a campaign aimed at reducing non-compliance. Each campaign will attempt to accomplish its goal using a flexible range of methods. Some campaigns may not initially involve examinations at all; instead, LB&I may begin by issuing guidance or voluntary compliance “soft” letters to taxpayers.
When LB&I does use audits to address an issue, the examiners may have far less discretion in structuring and conducting the examination than they did before the reorganization. Instead, IRS leadership may provide more rigid procedures for auditors to follow, with the intention to focus on the specific issue targeted by the campaign.
At the same time, LB&I is attempting to create processes that foster collaboration between examiners, taxpayers, and LB&I’s central leadership. Each campaign will have a public “executive lead” who can be contacted by taxpayers and practitioners. Each campaign will be conducted using a “feedback loop” that encourages both taxpayers and examiners to provide information about and critiques of the exam process and the campaign generally to the executive lead throughout the process. In turn, LB&I intends to use this feedback to update their approach midstream to more effectively deal with the issue addressed by each campaign. This collaborative approach may provide taxpayers and practitioners with a valuable opportunity to help steer LB&I’s efforts going forward.
Eversheds Sutherland Observation: The campaign approach creates substantial opportunities for taxpayers both in planning their affairs and in participating in examinations. Taxpayers can proactively review their arrangements in the areas addressed by LB&I campaigns to minimize the risk and cost of an audit. Although many questions remain, including how campaigns will fit into current audit plans, LB&I’s decision to publish the campaigns suggests it is making an effort to be transparent, which may portend future guidance.
On Tuesday, January 31, the LB&I Division announced its first 13 campaigns. It is a diverse group that we believe was chosen to demonstrate a breadth of subjectmatter coverage as well as the different approaches that LB&I may take in a campaign. LB&I’s descriptions of the campaigns follow, and the full release. For your convenience, we have reproduced the campaigns and their descriptions in full below.
1. IRC 48C Energy Credits
- This campaign ensures that only those taxpayers whose advanced energy projects were approved by the Department of Energy, and who have been allocated a credit by the IRS, are claiming the credit. These credits must be pre-approved through extensive application to the DOE. The treatment stream for this campaign will be soft letters and issue-focused examinations.
2. Offshore Voluntary Disclosure Program (OVDP) Declines-Withdrawals
- The Offshore Voluntary Disclosure Program (OVDP) allows U.S. taxpayers to voluntarily resolve past non-compliance related to unreported offshore income and failure to file foreign information returns. This campaign addresses OVDP applicants who applied for pre-clearance into the program but were either denied access to OVDP or withdrew from the program of their own accord. Taxpayers, who have yet to resolve their non-compliance and who meet the eligibility criteria, are encouraged to consider entering one of the offshore programs currently available. The IRS will address continued noncompliance through a variety of treatment streams including examination.
3. Domestic Production Activities Deduction, Multi-Channel Video Program Distributors (MVPDs) and TV Broadcasters
- Multi-channel Video Programming Distributors (MVPDs) and TV Broadcasters often claim that “groups” of channels or programs are a qualified film eligible for the IRC Section 199 deduction. Taxpayers are asserting that they are the producers of a qualified film when distributing channels and subscriptions packages that often include third-party produced content. Additionally, MVPD taxpayers maintain that they provide online access to computer software for the customers’ direct use (incident to taxpayers’ transmission activities, including customers’ use of the set-top boxes). LB&I has developed a strategy to identify taxpayers impacted by these issues and will develop training to aid revenue agents in examining them. The treatment streams for this campaign include the development of an externally published practice unit, potential published guidance, and issue based exams, when warranted.
4. Micro-Captive Insurance
- This campaign addresses transactions described in Transactions of Interest Notice 2016-66, in which a taxpayer attempts to reduce aggregate taxable income using contracts treated as insurance contracts and a related company that the parties treat as a captive insurance company. Each entity that the parties treat as an insured entity under the contracts claims deductions for insurance premiums. The manner in which the contracts are interpreted, administered, and applied is inconsistent with arm’s length transactions and sound business practices. LB&I has developed a training strategy for this campaign. The treatment stream for this campaign will be issue-based examinations.
5. Related Party Transactions
- This campaign focuses on transactions between commonly controlled entities that provide taxpayers a means to transfer funds from the corporation to related pass through entities or shareholders. LB&I is allocating resources to this issue to determine the level of compliance in related party transactions of taxpayers in the mid-market segment. The treatment stream for this campaign is issue-based examinations.
6. Deferred Variable Annuity Reserves & Life Insurance Reserves Industry Issue Resolution (IIR)
- The IRS and Chief Counsel have agreed to accept the Deferred Variable Annuity Reserves and Life Insurance Reserves issues into the IIR program (pursuant to Rev. Proc. 2016-19) to develop guidance to address uncertainties on issues important to the Life Insurance Industry. The issues include amounts to be taken into account in determining tax reserves for both deferred variable annuities with Guaranteed Minimum Benefits, and Life Insurance contracts. The campaign’s objective is to collaborate with industry stakeholders, Chief Counsel and Treasury to develop published guidance that provides certainty to taxpayers regarding these related issues.
7. Basket Transactions
- This campaign addresses structured financial transactions described in Notices 2015-73 and 74, in which a taxpayer attempts to defer and treat ordinary income and short-term capital gain as long-term capital gain. The taxpayer treats the option or other derivative as open until a barrier event occurs, and, therefore, does not recognize or report current period gains. The gains are deferred until the contract terminates, at which time the overall net gain is reported as a Long Term Capital Gain. LB&I has developed a training strategy for this campaign. The treatment streams for this campaign will be issuebased examinations, soft letters to Material Advisors and practitioner outreach.
8. Land Developers – Completed Contract Method (CCM)
- Large land developers that construct in residential communities may be improperly using the Completed Contract Method (CCM) of accounting. A developer, whose average annual gross receipts exceed $10 million, may only use the CCM under a home construction contract. In some cases, developers are improperly deferring all gain until the entire development is completed. LB&I will provide training for revenue agents assigned to work this issue. The treatment stream includes development of a practice unit, issuance of soft letters, and follow-up with issue based examinations when warranted.
9. TEFRA Linkage Plan Strategy
- As partnerships have become larger and more complex, LB&I has regularly revised processes to assess tax on the terminal investors. Recent legal advice provides an opportunity to make significant changes to how we approach this process. This campaign focuses on developing new procedures and technology to work collaboratively with the revenue agent conducting the TEFRA partnership examination to identify, link and assess tax to the terminal investors that pose the most significant compliance risk.
10. S Corporation Losses Claimed in Excess of Basis
- S corporation shareholders report income, losses and other items passed through from their corporation. The law limits losses and deductions to their basis in the corporation. LB&I has found that shareholders claim losses and deductions to which they are not entitled because they do not have sufficient stock or debt basis to absorb these items. LB&I has developed technical content for this campaign that will aid revenue agents as they examine the issue. The treatment streams for this campaign will be issue-based examinations, soft letters encouraging voluntary self-correction, conducting stakeholder outreach, and creating a new form for shareholders to assist in properly computing their basis.
- LB&I is aware of different repatriation structures being used for purposes of tax free repatriation of funds into the U.S. in the midmarket population. It has also been determined that many of the taxpayers do not properly report repatriations as taxable events on their filed returns. The goal of this campaign is to simultaneously improve issue selection filters while conducting examinations on identified, high risk repatriation issues and thereby increase taxpayer compliance.
12. Form 1120-F Non-Filers
- Foreign companies doing business in the U.S. are often required to file Form 1120-F. LB&I has data suggesting that many of these companies are not meeting their filing obligations. In this campaign, LB&I will use various external data sources to identify these foreign companies and encourage them to file their required returns. The treatment stream for this campaign will involve soft letter outreach. If the companies do not take appropriate action, LB&I will conduct examinations to determine the correct tax liability. The goal is to increase voluntary compliance by foreign corporations with a U.S. business nexus.
13. Inbound Distributors
- U.S. distributors of goods sourced from foreign-related parties have incurred losses or small profits on U.S. returns, which are not commensurate with the functions performed and risks assumed. In many cases, the U.S. taxpayer would be entitled to higher returns in arms-length transactions. LB&I has developed a comprehensive training strategy for this campaign that will aid revenue agents as they examine this IRC Section 482 issue. The treatment stream for this campaign will be issue-based examinations.