On July 2, 2018 the IRS Large Business and International (“LB&I”) division announced its approval and introduction of five additional compliance campaigns. The announced campaigns are: (1) restoration of sequestered alternative minimum tax (“AMT”) credit carryforward; (2) S corporation dividends; (3) virtual currency; (4) repatriation via foreign triangular reorganizations; and (5) section 956 transition tax.
LB&I Compliance Campaign Program
In 2016, LB&I unveiled a revised division structure–shifting away from a domestic/international divide, moving towards IRS employee specialization, and focusing compliance efforts on specified high-risk audit issues through an approach known as “campaigns.” The goal of the compliance campaign approach was to publicly identify specific areas of non-compliance, set preferred compliance outcomes, provide tailored resources, and suggest “treatment streams” for compliance personnel to achieve the stated outcomes.
The move towards compliance campaigns also reflected the reality of a shifting audit landscape for large business and international taxpayers. The expansion of multinational corporations increased the need for LB&I examination teams to utilize specialists (industry experts, economists, engineers, etc.) during a period of a shrinking IRS compliance budget. Moreover, the average LB&I audit increasingly presented a combination of domestic, international, and transfer pricing issues, raising the risk of conflicts among IRS employees over issues such as audit control, resolution authority, the issue escalation process, and responsibility for timing delays. The compliance campaign structure presented an opportunity to focus training, audit issue ownership, and a risk-based approach.
On January 31, 2017, LB&I announced the initial set of thirteen campaigns. Since that announcement, LB&I has issued a total of 22 supplemental campaign topics. As the list of compliance campaigns grows, LB&I asserts that it continues to review legislation, including the 2017 Tax Cuts and Jobs Act (P.L. 115-97), to determine if any existing campaigns have been impacted, but that analysis has yet to be completed.
New LB&I Compliance Campaigns
The July 2, 2018 announcement included campaigns topics ranging from repatriation issues before and after U.S. federal tax reform (triangular reorganizations and section 965 transition tax issues) to the more headlinegrabbing new frontiers of tax compliance (virtual currency). As with previous campaigns, LB&I stated that the five additional campaigns were selected through analysis of internal data and suggestions from IRS employees.
The first campaign addresses situations where a taxpayer improperly (in LB&I’s view) restores a sequestered AMT credit in a subsequent tax year though section 168(k)(4). While section 168(k)(4) was repealed under the 2017 Tax Cuts and Jobs Act, LB&I will be issuing letters to taxpayers that it has identified as having improperly restored sequestered credits. LB&I will also focus educating taxpayers on the proper treatment of sequestered AMT credits in an effort to have taxpayers self-correct the issue.
The second campaign addresses multiple compliance issues LB&I identified related to S corporation distributions. The announcement highlights three issues in particular: failure to report gain upon distributions of appreciated property, failure to appropriately characterize S corporation distributions as taxable dividends, and failure by S corporation shareholders to report distributions in excess of basis as subject to taxation. The campaign announcement states that LB&I will address these issues through issue-based examinations, suggesting revisions to relevant tax forms, and taxpayer outreach.
The third campaign addresses the new frontier of virtual currency. On March 25, 2014, Treasury issued Notice 2014-21 to clarify the status and characterization of virtual currency for federal income tax purposes and certain implications of convertible virtual currency transactions. Notice 2014-21 provided guidance through a series of frequently asked questions covering issues including, but not limited to, determination of currency fair market value upon acquisition, income characterization upon sale or exchange, and employment tax considerations. The virtual currency compliance campaign will address non-compliance with the principles outlined in Notice 2014-21 and provide additional educational opportunities for taxpayers.
In the July 2, 2018 campaign announcement, the IRS encouraged taxpayers with unreported virtual currency transactions to amend their returns as soon as possible. Notably, the announcement explicitly states that the IRS is not contemplating a virtual currency-specific voluntary disclosure program to address taxpayers currently in non-compliance. Put differently, the IRS is putting taxpayers on notice that they should not expect a better deal by delaying their compliance efforts.
The fourth and fifth campaigns highlight LB&I’s focus on repatriation issues. The fourth campaign, repatriation via foreign triangular reorganizations, focuses on taxpayer’s attempts to repatriate untaxed CFC earnings through the use of triangular reorganization transactions, following up on Notice 2016-73 issued in December 2016. Notice 2016-73 addressed certain triangular reorganizations involving foreign corporations where a subsidiary acquires stock in its parent and uses that stock to acquire a target corporation. LB&I’s stated goal of this campaign is “to identify and challenge these transactions.” It is not clear whether this statement was intended to leave LB&I room to expand its audit focus to triangular repatriations beyond those described in Notice 2016-73.
The fifth campaign focuses on issues arising in connection with the section 965 deemed repatriation and transition tax. Section 965, overhauled under the 2017 Tax Cuts and Jobs Act, requires United States shareholders to pay a transition tax on the untaxed foreign earnings of foreign corporations as if those earnings had been repatriated to the United States. Under section 965, taxpayers may affirmatively elect to pay the tax in installments over an eight-year period. The IRS has previously provided guidance on the mechanics of revised section 965 in Notices 2018-07, 2018-13, 2018-26 and an online FAQ. LB&I announced this compliance campaign early relative to other issues from an audit perspective, as the transition tax would be imposed, in whole or in part, in connection with a calendar-year taxpayer’s 2017 return at the earliest (i.e., for a taxable year that closed on Dec. 31, 2017).
Implications of New Campaigns
The announcement of the five additional compliance campaigns is not surprising. Nor is it surprising that the announcement does not provide significant detail on the campaigns, beyond a short summary, the relevant practice area, and the IRS employee assigned to lead each campaign. Practically, taxpayers should expect these issues to receive increased scrutiny in upcoming audits cycles, especially as LB&I further develops issue-focused training materials to assist exam teams with identifying and evaluating these issues. Additionally, the compliance campaign expansion increases the risk of audit delay by incentivizing LB&I examination teams to request assistance from centralized issue experts, often unfamiliar with the taxpayer-specific facts obtained over the course of the audit.