On March 13, 2018, the Large Business and International (LB&I) Division of the Internal Revenue Service (IRS) announced five new compliance campaigns. The announcement of these new campaigns reiterates LB&I’s efforts to focus its resources and efforts on issues-based examinations rather than focusing on specific industries and taxpayers. Ideally, the campaign process will enable the IRS to better utilize its dwindling resources and examine issues that present the greatest risk to the government.
These five new campaigns were identified through LB&I data analysis and recommendations from IRS compliance employees. As the announcement indicates, “the campaigns are the culmination of an extensive effort to redefine large business compliance work and build a supportive infrastructure inside LB&I.”
The new campaigns supplement the initial list of 13 campaigns announced by the IRS on January 31, 2017, and the 11 campaigns that were added on November 3, 2017. For further information on these earlier announcements, Eversheds Sutherland released a general alert discussing the initial campaigns and a follow-up alert on the expansion of the campaign process with the 11 new campaigns announced last fall. Like the earlier campaigns, this third iteration addresses a range of substantive areas of federal tax law.
Not unlike the two previous campaign lists, this third iteration addresses a range of substantive areas of federal tax law. The IRS has focused its attention on one aspect of the tangible property regulations implemented by numerous taxpayers—the partial disposition election for buildings—addressed in Treas. Reg. § 1.168(i)-8. These rules permit taxpayers to claim a loss on the partial disposition of a building’s structural components. Partial disposition treatment is available without identifying the component as an asset prior to the disposition. This new campaign focuses on ensuring that the taxpayer accurately recognized the related gain or loss on the partial disposition of such building property. For more information about this campaign, see our Legal Alert: “Repair” of tangible property examinations.
LB&I also appears to be focusing on certain tax-free distributions under section 355. In these spin-offs, split-offs, and split-ups, companies invariably incur significant transaction costs, including costs that are incurred specifically to facilitate the transaction. These facilitative costs are required to be capitalized, and it appears that LB&I is concerned with whether taxpayers are properly capitalizing, rather than deducting, these costs. In light of the frequent and growing use of these transactions by taxpayers, LB&I has identified these transactions as another new compliance campaign. For more information about this campaign, see our Legal Alert: Corporate transaction cost campaign.
The three remaining campaigns in this latest update all address pass-through entities. Specifically, these three campaigns focus on ensuring that partners properly report flow-through income as earnings from self-employment and pay the applicable Self-Employment Contributions Act (SECA) tax; that partnerships that have stopped filing tax returns still report certain economic transactions to their partners; and that partners correctly report the sale of a partnership interest and the corresponding gain or loss on their returns.
The campaigns and their descriptions shown below are taken from the press release.
1. Costs that Facilitate an IRC Section 355 Transaction
Costs to facilitate a tax-free corporate distribution under IRC Section 355, such as a spin-off, split-off or split-up, must be capitalized and are not currently deductible. Some taxpayers may execute a corporate distribution and improperly deduct the costs that facilitated the transaction in the year the distribution was completed. The goal of this campaign is to ensure taxpayer compliance with the requirement to capitalize, not deduct, the facilitative costs when the distribution is completed. The treatment stream for this campaign is issue-based examinations.
2. SECA Tax
Partners report income passed through from their partnerships. If the partner is an individual who renders services, the partner’s distributive share of income is subject to self-employment tax under the Self-Employment Contributions Act (SECA). Some limited partners and limited liability company (LLC) members who render services to clients on behalf of the partnership or LLC do not report flow-through income as earnings from self-employment and do not pay SECA tax. The Service’s goal in this campaign is to increase compliance with the law as supported by several recent court decisions. The treatment streams for this campaign will be issue-based examinations and outreach to practitioners, professional service provider associations, and software vendors.
3. Partnership Stop Filer
Partners report income, losses, and other items passed through from their partnership. Some partnerships stop filing tax returns for various reasons yet still have economic transactions that are not being reported to their partners. That activity is likely not being reported by the partners. The treatment streams for this campaign include issue-based examinations, soft letters encouraging voluntary self-correction, and stakeholder outreach.
4. Sale of Partnership Interest
A partner must report the sale of a partnership interest on their tax return. This campaign will address taxpayers who do not report the sale or report the gain or loss incorrectly. Incorrect reporting includes the amount and character of the gain or loss. Taxpayers may report the entire gain as long-term capital gain (usually 15 percent) when a portion of the gain may be ordinary gain or subject to the 25 percent or 28 percent long-term capital gain rates. A variety of treatment streams will address noncompliance, including, but not limited to, examinations and soft letters.
5. Partial Disposition Election for Buildings
IRC Section168 disposition regulations (Treas. Reg. Section 1.168(i)-8), issued August 2014, provide rules for recognizing gain or loss on the disposition of MACRS property and allow taxpayers to elect to recognize partial dispositions of property.
To comply with the Section168 disposition regulations and make a partial disposition election, a taxpayer must be able to substantiate that it:
- disposed of a portion of a MACRS asset owned by the taxpayer;
- identified the asset that was partially disposed;
- determined the placed-in-service date of the partially disposed asset;
- determined the adjusted basis of the disposed portion; and
- reduced the adjusted basis of the asset by the disposed portion.
The goal of this campaign is to ensure taxpayers accurately recognize the gain or loss on the partial disposition of a building, including its structural components. The treatment stream for this campaign is issue-based examinations and potential changes to IRS forms and the supporting instructions and publications.