IRS Practice & Procedure
March 23, 2012
TEI Florida Chapter IRS Liaison Meeting
Deerfield Beach, Florida
Tax Controversy &
Dispute Resolution
PwC
Agenda
Part I• Uncertain Tax Position Statement: Background and Recent Developments • Foreign Bank Account Report (FBAR): Technical Aspects for Consideration • Understanding the Basics and Issues Surrounding EIN Assignment and
"Check the Box" Entity Classification
Part II
• Foreign Tax: Election to Deduct or Credit
• IRS Implementation of Unique Reference Identification Number Requirement • Form 1139: Utilizing Losses and Credits to Successfully Obtain a Quick Refund • Statute of Limitations: Nuts and Bolts
• Protective Claims
Part III
• Quality Examination Process (QEP)
• TEFRA Partnerships: Background, Penalty Application & Audit Procedures
2 2012
Part I
Devin W. Blackburn
PwC
Uncertain Tax Position Statement:
Background and Recent Developments
Uncertain Tax Positions
Development of Schedule UTP
• Need for increased transparency
- Currently, the IRS spends as much as 25% of audit time searching for issues rather than actually auditing issues
- Primary goal of the IRS is to reduce time spent searching for issues, and enhance focus on completing examinations
• Reasons IRS released Schedule UTP - Political environment
- Economic factors
- Challenges sustaining tax base
• Final Schedule UTP released on September 24, 2010
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Uncertain Tax Positions
Key Elements of Reporting
• Who Must File?
- Corporate taxpayers who file: ◦ Form 1120
◦ Form 1120-F ◦ Form 1120-L ◦ Form 1120-PC • Phased Effective Date
- Calendar year 2010 for corporate taxpayers with total assets ≥ $100 Million - Calendar year 2012 for corporate taxpayers with total assets ≥ $50 Million - Calendar year 2014 for corporate taxpayers with total assets ≥ $10 Million
6 2012
Uncertain Tax Positions
Key Elements of Reporting
• Disclosure on Schedule UTP is required if two criteria are met:
1. Corporation has taken a tax position on its U.S. Federal income tax return for the current tax year or a prior tax year;
and
2. Either the corporation or a related party has recorded a reserve with respect to that tax position for U.S. Federal income tax in audited financial statements, or did not record a reserve for that tax position because the corporation or related party
―expects to litigate‖ the position.
• The initial recording of a reserve will trigger reporting of a tax position taken on a return. However, subsequent reserve increases or decreases with respect to the tax position will not.
• Transition Rule – A corporation is not required to report a UTP for a tax position taken in a tax year beginning before January 1, 2010
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Uncertain Tax Positions
Key Elements of Reporting
• Taxpayers must provide a concise description for each tax position listed on Schedule UTP, including:
- A description of the relevant facts affecting the tax treatment of the position; and - Information that can reasonably be expected to apprise the IRS of the identity and
nature of the tax position.
• The concise description should not include: - Assessment of the hazards of a tax position;
- Analysis of the support for or against the tax position; or - Any privileged information.
8 2012
Uncertain Tax Positions
IRS Implementation & Guidance
• IRS will not assert waiver of privilege during examinations solely because taxpayer has provided the document to their independent auditor
(Announcement 2010-76)
- Does not apply if taxpayer has waived privilege
- Does not apply to requests for tax accrual workpapers with respect to the taxpayer’s involvement in listed transactions and unusual circumstances
• IRS has established a centralized repository to process all Schedule UTPs shortly after the filing of the return
• Schedule UTP is provided to examination teams to review in conjunction with the CAP program
- CAP Account Coordinators may request copies from taxpayers to expedite review - Examiners may consult with taxpayers to confirm intent of disclosures
- Examiners may not ask taxpayers about the make-up of reserves
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Uncertain Tax Positions
Planning for Schedule UTP
• Develop an effective and efficient UTP reporting process beginning with the initial calendar tax year of reporting
- Identify positions to be reported given changes in reserves
- Develop or modify existing processes and operational controls to capture necessary information to comply with reporting requirements
• Strategically address IRS examination issues
• Reduce or eliminate uncertainty prior to the release of the year-end financial statements and/or prior to the filing of the initial Schedule UTP
10 2012
Uncertain Tax Positions
Compliance and Management of Schedule UTP
2012
Now Initial Disclosure Ongoing
Assess the process – consider the impact on resources, controls and procedures
Consider solutions for compliance or technology issues
Communicate UTP and other tax risk matters to the Board
Determine additional
information needed during provision cycle
Improve infrastructure and processes
Evaluate and document UTPs as transactions occur
Mitigate uncertainty Streamline and enhance the use of financial data
Develop a strategy to manage all disclosures Prepare descriptions Determine IRS examination
strategy
Monitor legislative and judicial changes that impact Schedule UTP
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Foreign Bank Account Report (FBAR):
Technical Aspects for Consideration
Foreign Bank Account Reporting (FBAR)
What to File
Form TD F90-22.1
• Part I and Part V for consolidated report
• Part IV for individuals with signature authority only and no financial interest
When to File
By June 30th of the year following the year in which the account is maintained
• No process for requesting an extension available
• Mailbox Rule does not apply
Other Rules
• Under the simplified reporting rules, a US entity may file a consolidated FBAR report on behalf of itself and entities in which it owns a greater than 50% interest by vote or value • If reporting signature authority of 25+ accounts, limited information regarding such foreign accounts is required
• FBAR is filed separately from an income tax return, but must be disclosed on returns
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Foreign Bank Account Reporting (FBAR)
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Specifics of reporting requirements
U.S. Person
• U.S. citizen or resident
• Any entity formed under laws of U.S. (corporations, partnerships, LLCs, estates, trusts)
• Beginning with 2010 filing, persons in and doing business in US on regular and continuous basis
Financial Interest or Signature Authority
• Owner of record or legal title
• Authority of an individual to control the disposition of money, funds, assets held in financial account by direct communication to person maintaining account
• Test – Whether financial institution will act upon direct
communication
Financial Account
• Bank or securities accounts, insurance and annuity policies with a cash value, mutual funds or similar pooled funds
Exceptions:
• Bonds, notes, stock certificates
• Hedge funds (currently, but see FATCA)
Foreign Country
• Any geographic area outside of the US
• Situs of the account, not the situs of the institution controls
• Account with a foreign bank at a branch in US is not a foreign account
• Account with a US bank at a branch outside of US is a foreign account
If these requirements are met, FBAR must be filed if the aggregate balance of foreign accounts is greater than $10,000
FBAR — Compliance
Entity’s Consolidated FBAR Filing
• Collect data necessary to identify foreign financial accounts owned by the consolidated filer and all entities in which the consolidated filer has a greater than 50% interest • Prepare and file FBARs by June 30
Officers and Employees with Signature or Other Authority
• Identify US citizens and residents with signature or other authority over foreign financial accounts
• Determine to the extent possible application of FBAR exceptions
• Communicate information about FBAR reporting and account information to affected employees
- Employees need the information in time to complete Line 7 of Schedule B of the Form 1040
• Decide what FBAR compliance assistance to provide to employees
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Foreign Bank Account Reporting (FBAR)
Signature Authority Exceptions
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Foreign Parent Publicly traded on a US exchange (ADR) §1010.350(f)(2)(iv)
U.S. Parent Publicly traded on a US exchange
§1010.350(f)(2)(iv)
SEC Act § 12(g) filer (not publicly traded on US exchange) §1010.350(f)(2)(v)
Regulated banks and financial institutions registered with SEC or CFTC
§1010.350(f)(2)(i) & (ii)
RIC Authorized Service Provider registered and examined by SEC §1010.350(f)(2)(iii)
Employee of the Entity
Covered by (iv) exception and account owned by the entity
Covered by (iv) exception and account owned by the subsidiary Covered and account owned by the subsidiary by (v) exception
Covered by (ii) exception and account owned by the subsidiary
Covered by (iii) exception and account owned by the subsidiary
Employee of a Foreign Sub
Not covered by the exception
Not covered by the exception
Not covered by the exception
Not covered by the exception
Not covered by the exception
Employee of a U.S. Sub
Not covered by the exception; no consolidated report
Covered if account included in the consolidated FBAR filed for parent and subsidiary and account owned by the subsidiary
Not covered by the exception
Not covered by the exception
Not covered by the exception
Employee employed within the group, but not by the owner of the account
Not covered by the exception
Not covered by the exception
Not covered by the exception
Not covered by the exception
Not covered by the exception
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Example 1
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Foreign Bank Accounts (employee has
signature authority, but no financial interest) U.S. Parent (public company) U.S. parent employee (U.S. person) No employee filing requirement 2012
Example 2
Foreign Bank Accounts (employee has
signature authority, but no financial interest) Employee required to file U.S. Parent (public company) U.S. parent employee (U.S. person) Foreign sub 2012
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Example 3
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Foreign Bank Accounts (employee has
signature authority, but no financial interest) Employee required to file U.S. Parent (public company) Foreign sub employee (U.S. person) Foreign sub 2012
Example 4
Foreign Bank Accounts (employee has
signature authority, but no financial interest) Employee required to file U.S. Parent (public company) U.S. employee seconded to foreign sub (U.S. person)
Foreign sub
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Example 5
22
Foreign Bank Accounts (employee has
signature authority, but no financial interest) Employee required to file U.S. Parent (public company) U.S. employee seconded to foreign sub (U.S. person)
Foreign sub
Example 6
Foreign Bank Accounts (employee has
signature authority, but no financial interest) Employee required to file U.S. Parent (public company) Foreign sub employee (U.S. person) Foreign sub (disregarded entity) 2012
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Example 7
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Foreign Bank Accounts (employee has
signature authority, but no financial interest) No employee filing requirement U.S. Parent (public company) Foreign branch employee (U.S. person)
Foreign branch (not a legal entity in the foreign country)
Example 8
Foreign Bank Accounts (employee has
signature authority, but no financial interest) Employee required to file U.S. Parent (private company*) U.S. parent employee (U.S. person)
* Not a SEC 12(g) filer (generally more than $10 million in assets and more than 500 or more shareholders)
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Example 9
26
Foreign Bank Accounts (employee has
signature authority, but no financial interest) No employee filing requirement Foreign Parent (public company ADRs on NYSE) Foreign parent employee (U.S. person) 2012
Example 10
Foreign Bank Accounts (employee has
signature authority, but no financial interest) Employee required to file Foreign Parent (public company ADRs on NYSE) U.S. sub employee (U.S. person) U.S. sub 2012
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FBAR — Decision Tree to Identify Required Filers
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1. Identify foreign accounts
Bank Accounts Securities Accounts Other Financial Accounts
On an account by account basis, perform the following step:
2. Identify officers and employees with signature or other authority
Continue to Step 3
FBAR — Individuals with signature or other authority
3. Is the individual a citizen or resident of the US or a US territory or possession?
4. Is the individual an officer or employee of the entity that owns the account? STOP – No filing requirement with respect to this account No Yes No Yes
5. Identify type of entity that owns or maintains the account
(or provides services in the case of an authorized service provider)
Continue to Step 6
FBAR must be filed by the employee with respect to this account
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FBAR — Entity that owns or maintains the account
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6. Is the entity (foreign or domestic) publicly traded on a US exchange, an SEC §12(g) filer ($10 million in assets and 500 or more shareholders), a covered regulated bank or financial institution, or a regulated RIC Authorized Service Provider?
7. Is the account owned by a US subsidiary that is greater than 50% owned by a US parent AND the account is included in the US parent’s consolidated FBAR filing?
STOP – No filing requirement with respect to this account
Yes No
No Yes
FBAR must be filed by the employee with respect to this account
STOP – No filing requirement with respect to this account
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Foreign Bank Account Reporting (FBAR)
Risks of Non-Compliance
• Six year statute of limitations from the FBAR due date
- June 30, 2013 – Extended filing deadline for individuals with Signature Authority • Failure to File Penalties
- Willful Violation – Greater of $100,000 or 50% of highest balance in accounts - Non-Willful Violation - $10,000 per unreported account
32 2012
Foreign Bank Account Reporting (FBAR)
Illustration of potential penalties
Assume a taxpayer has the following amounts in a foreign account over a period of years, and willfully fails to file complete and correct FBARs
Year Amount on Deposit Interest Income Account Balance Penalties
2006 $1,000,000 $50,000 $1,050,000 $525,000 2007 $50,000 $1,100,000 $550,000 2008 $50,000 $1,150,000 $575,000 2009 $50,000 $1,200,000 $600,000 2010 $50,000 $1,250,000 $625,000 Total Penalties $2,875,000 2012
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Foreign Bank Account Reporting (FBAR)
2012 OVDI
• Offshore Voluntary Disclosure Initiative - No Set Deadline
- Maximum Penalty – 27.5% of highest aggregate balance in foreign accounts during tax years within the OVDI period
- Lowered Penalty – 12.5% or 5%, but must qualify
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Foreign Bank Account Reporting (FBAR)
Next Steps
• Appoint someone in your company to be responsible for FBAR matters
• Consult stakeholders and external advisors regarding FBAR requirements and how they impact your business
• Create procedures to gather and process information
• Consider available technology assistance for more efficient FBAR compliance • Document FBAR procedures and management/employee communications,
set timetable
• Prepare FBARs for entities required to file
• Participate in 2012 OVDI to take advantage of reduced penalties
• Consider whether to prepare FBARs for employees who are required to report company accounts
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Understanding the Basics and Issues
Surrounding EIN Assignment and
"Check the Box" Entity Classification
Default and Elective Classifications of Domestic Entities
• Default Classification Rules of Business Entities
- Corporation – Organized under a Federal or State Statute, if the statute refers to the entity as incorporated or as a corporation, corporate body
- Other Business Entity– Unless otherwise elected, it is: ◦ A partnership if it has two or more members;
◦ Disregarded as an entity separate from its owner if it has a single owner.
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Default and Elective Classifications of Foreign Entities
• What is a foreign entity?
- An entity organized under laws other than a U.S. State or a Federal Statute
• Foreign entities classified as per-se corporations for federal tax purposes are not eligible to make an entity classification election
(See Treas. Reg. § 301.7701-2(b)(8) for a list of such per se corporations per country)
• Default Classification Rules
- Foreign Eligible Entities – Unless otherwise elected, it is:
◦ A partnership if it has two or more members and at least one member does not have limited liability;
◦ An association if all members have limited liability; or
◦ Disregarded as an entity separate from its owner if it has a single owner that does not have limited liability.
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Form 8832 – Entity Classification Election
• Due Date
- Within 75 days following the desired effective date of the election; or
- No more than 12 months prior to the desired effective date. • Late Election Relief
- Rev. Proc. 2009-41 – Electing entity must demonstrate that:
◦ Entity has not filed federal income tax or information return for the first year in which its election was intended; or entity timely filed all required federal tax returns and information returns consistent with its requested classification; ◦ Entity has reasonable cause for its failure to timely make the election;
◦ 3 years and 75 days from the requested effective date of the election has not passed.
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Form 8832 – Entity Classification Election
• What to watch for:
- Obtain EIN for foreign entity prior to filing Form 8832
- Ensure that the Form is signed by each member of the electing entity who is an owner at the time the election is filed
- Ownership change during lookback period – Each person who was an owner between the date the election is effective and the date the election is filed, but not at the time of the filing must also sign the election
- Attach a copy of Form 8832 to the entity’s U.S. federal income tax return for the year in which the election is effective
- If Form 8832 is filed to change an entity’s federal tax classification, such entity
may not file another Form 8832 to change its classification again for 60 months.
Exception: If there has been a 50% ownership change
40 2012
Issues Surrounding EIN Assignment
• Dormant Entities
Example:
- In the midst of a reorganization in Year 1, Profit Corporation organizes multiple LLCs for which it obtains EINs and elects to have each taxed as a corporation. After the reorganization the LLCs do not have any activity, but continue to exist. In Year 4, each LLC receives IRS notices regarding Form 1120 filing requirements. • Erroneous or Multiple EINs
Example:
- In Year 1, ACME Corporation is formed and a representative obtains an EIN. In Year 3, it changes its name to ABC Corporation and a representative erroneously applies for an EIN. In Years 3 and 4, ABC Corporation files Form 1120 under the second erroneously EIN. However, in Year 5, Form 1120 is somehow filed under the originally issued EIN. The IRS return processor realizes that the EIN does not match the entity name, and assigns a third EIN.
Part II
Janice Flood
Foreign Tax:
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10 Year Statute to Elect Foreign Tax Deduction – Maybe Not
• In recent CCA 201136021 and 201204008, the IRS determined that the filing of an amended return to claim a refund based on a change from a foreign tax credit to a
foreign tax deduction is not timely under I.R.C. § 6511(d)(3)(A).
• The IRS states that the 10 year period of limitations provided by I.R.C. § 6511(d)(3) only applies if the claim for refund or credit relates to an overpayment attributable to any taxes paid or accrued for which credit, and only a credit, is allowed against U.S. income tax under I.R.C. § 901.
- The 10 year period is not applicable if the claim for refund or credit results from a deduction of foreign income taxes paid.
44 2012
10 Year Statute to Elect Foreign Tax Deduction – Maybe Not
• CCA 201204008 states that pursuant to the plain language of I.R.C. § 6511(d)(3)(A), the 10 year period of limitations only applies if the claim for refund or credit related to an overpayment attributable to any taxes paid or accrued for which credit is allowed
against U.S. income tax under I.R.C. § 901 (emphasis in CCA).
- The CCA emphasizes ―allowed‖ credit in the section, instead of the usage of
―allowable‖ credit; the distinction between these two words is an ―important one‖ according to the CCA.
- Citing the Random House Dictionary, the CCA states that ―allowable‖ is defined as ―that which may be allowed, legitimate, permissible.‖ In seeming contrast,
according to the CCA, ―allowed‖ is defined as that which is permitted.
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Deduction vs. Credit – IRS Position
• The CCA attempts to apply its distinction of allowed and allowable to the application of I.R.C. § 6511(d)(3). It first establishes that I.R.C. § 164(a)(3) provides that a deduction is allowed for the taxable year within which foreign income, war profits, and excess
profits taxes are paid or accrued.
• The CCA then provides: Under I.R.C. § 275(a)(4) and the regulations under IRS I.R.C. §§ 164 and 901, a deduction for foreign taxes paid or accrued is allowable unless and until the foreign tax credit has been claimed with respect to the such taxes [emphasis added]. Once a credit is taken, such deduction is not allowed; similarly a foreign tax credit is allowable for such taxes unless and until a deduction has been claimed…at which point the credit is not allowed.
• The IRS pairs the term ―allowed‖ with a requirement that the foreign tax credit actually and finally be claimed and produce a tax benefit for the taxpayer in order to be ―allowed.‖ Therefore, in reading § 6511(d)(3), an ―allowed‖ credit, to which the special 10 year period of limitations applies, can only refer to the foreign tax credit, and not the ―allowable‖ foreign tax deduction.
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Deduction vs. Credit
Allow or Allowable that is the Question
• ―Allow‖ versus ―Allowable‖
- These two terms cannot be given static definitions that carry through every Code section. The definition of each word is more appropriately determined section by section based on the Congressional purpose and intent of the particular section. • Distinctions between the Code's usage and definition of ―allow‖ and ―allowable‖ cannot
simply be made by referencing a single English dictionary as the IRS has done in the CCA.
- Dictionaries have multiple and different definitions of ―allowed‖ and ―allowable.‖ - Example: The Oxford English Dictionary defines
◦ ―allowed‖ among other things as ―not prevent the occurrence of; not prevent a person from doing something; permit;‖ and
◦ ―allowable‖ as "appropriate, satisfactory, permissible, tolerable, legitimate."
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Code Usage of ―Allow‖ and ―Allowable‖
The usage of the terms ―allow‖ and ―allowable‖ in the Code are too great and varied to equate one particular definition to each word for each particular Code section the words are used in.
• Usage in Code - "allow" – 44 - "allowed" – 517 - "allowable" – 312 - "allowance" – 517 - "shall be allowed―– 345 - "may be allowed" – 10
• In other words, ―allow‖ in one Code section could have a different denotation and connotation than in another Code section based on the Congressional intent for that section; the same can be said for the term ―allowable.‖
48 2012
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Supreme Court Interpretation
• Thus, to say that ―allow‖ always means X, and ―allowable‖ always means Y in every Code section, would be taking an overly simplified, and unreasonable, position. Therefore, there is no plain or dictionary definition of the terms that can be derived from the term ―allowed‖ in section 6511(d)(3)(A).
• In United States v. Hemme, 476 U.S. 558 (1986) the Supreme Court held that ―allowed‖ as used in the Code does not have a standard definition but must be interpreted by context and Congressional Intent
- Addresses whether there is a distinction in meaning between "allowed" and "allowable."
- "The term 'allowed' is a familiar denizen of the Tax Code. In some sections it appears unqualified, while in others, Congress has clearly embellished the term with the 'tax benefit" qualification..."
- In Hemme, the Government argued that "allowed" simply meant "allowable" or provided by the Code, and did not require any actual claim or benefit to the taxpayer.
- The Supreme Court held that the term "allowed" has no fixed meaning in the Code, but the context of the term needs to be examined to determine its meaning in a given case.
49 2012
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Foreign Tax: Deduction vs. Credit
I.R.C. § 901 and Treasury Regulations
• The IRS concludes that the statute of limitations for claims of refunds where the overpayment is related to a choice of a deduction is three years. However, it is clear that under I.R.C. § 901 and its regulations, the period is 10 years. While the CCA recognizes the election under I.R.C. § 901, it does not recognize that its interpretation conflicts with those provisions.
- I.R.C. § 901(a) provides, in pertinent part, that:
Such choice [of credit or deduction] for any taxable year may be made or changed at any time before the expiration of the period prescribed for making a claim for credit or refund of the tax imposed by this chapter for such taxable year.
• Treas. Reg. §1.901-1(d) provides the times prescribed for making the credit/deduction choice, and hence the period of limitations for claims resulting from that choice:
(d) Period during which election can be made or changed. — The taxpayer may, for a particular taxable year, claim the benefits of section 901 (or claim a deduction in lieu of a foreign tax credit) at any time before the expiration of the period
prescribed by section 6511(d)(3)(A) (or section 6511(c) if the period is extended by agreement).[emphasis added]
50 2012
Foreign Tax: Deduction vs. Credit
Treasury Regulation Not Considered by CCA
• Thus, in the context of the equating by I.R.C. § 901(a) of conterminous periods for
making the election and the refund period of limitations, this regulation clearly states that the period of limitations for refunds attribution to foreign tax deductions is the 10 year period (the only period prescribed by section 6511(d)(3)(A)).
• In its current position, the CCA fails to recognize that the above regulation in the
context of the statute specifies that a taxpayer may claim a foreign tax credit under I.R.C. § 901 or claim a deduction in lieu of a foreign tax credit, and obtain a refund at any point during the 10 year period of limitations.
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URI:
IRS Implements Unique Reference Identification
Number Requirement
URI Number
Little known requirement
• Beginning with U.S. federal tax return filed for the 2012 tax year, taxpayers who file certain forms will be required to provide a Unique Reference Identification Number (URI) or Employer Identification Number (EIN) for all foreign entities reported on the following forms:
1. Form 5471 (Information Return of US Persons With Respect To CFCs) 2. Form 8858 (Information Return of US Disregarded Entities)
3. Form 8865 (Return of US Persons With Respect to Certain Foreign Partnerships)
• A URI is a alpha numeric number limited to 50 characters or less that is selected by the taxpayer. The taxpayer need not apply nor have approved by the IRS.
• Once a URI is selected by a taxpayer it must remain the same for the foreign entity to which it is assigned. If a liquidation or disposition of the entity occurs the URI may not be transferred or used with a different entity.
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URI Number
• The IRS website suggests that where multiple taxpayer each have an independent filing requirement with respect to a single foreign entity, a URI will be established separately by each taxpayer.
• Change of ownership of the foreign entity may result in the need to correlate the URIs
- Example 1
In the case of a merger or acquisition, Form 5471 must correlate a new URI
assigned to the foreign corporation by the acquired entity with the previous URI used by the target.
- Example 2
If Form 8832 is filed to change a foreign entity’s classification to be disregarded, then the URI previously used on Form 5471 must be correlated to the new URI used on Form 8858.
• 2011 Forms 5471, 8858 and 8865 have been updated to include a line for reporting of the URI. Although the instructions to these forms state the URI is mandatory for years beginning in 2012, the IRS website states that a penalty may be assessed for failure to provide the URI.
54 2012
URI Number
• In brief, it appears that the implementation of URIs is part of the IRS’s continued enforcement efforts in the international area. The use of URIs will allow the IRS the ability to identify taxpayers’ foreign entities and follow their activities more closely. • The IRS has been working with software providers to ensure they are prepared to
handle the URI implementation. However, the IRS has said little to taxpayers about the new requirement and therefore taxpayers should take the time this year to ensure their system will comply with the new requirements.
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Form 1139:
Utilizing Losses and Credits to
Successfully Obtain a Quick Refund
Utilizing Losses & Credits to Obtain a Quick Refund via Form 1139
• Form 1139, Corporation Application for Tentative Refund
- Carry back NOLs, net capital losses and business credits ◦ NOLs – 2 years
◦ Capital Losses – 3 years ◦ Business Credits – 1 year - Timing
◦ Must be filed within 12 months after the end of the tax year in which the loss or credit was generated; but
◦ May not be filed before the filing of Form 1120 for the year in which the loss or credit was generated (Exception: Barebones Return)
• Barebones Return
- Ability to obtain refund before the filing of Form 1120 for the year in which the loss or credit was generated
› First – File Barebones Return for Form 1120 › Second – File Form 1139
› Last – File Superseding Return for Form 1120 by extended due date
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Utilizing Losses & Credits to Obtain a Quick Refund via Form 1139
Form 1139
Form 1120X
Tentative adjustment of tax liability Formal claim for refund or adjustment
Taxpayer receives refund before IRS audits the return
May be subject to an IRS examination before it is paid
No matter the amount, refunds are not subject to pre-refund review
However, amounts in excess of $2M will be subject to post-refund review
Refunds in excess of $2M are subject to review by the Joint Committee on Taxation
IRS must act within 90 days of filing, and typically pays refund within 45 days
Refund may take up to two years to be received
Statute of Limitations:
Nuts and Bolts
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Statute of Limitations
Overview
• The periods of limitation establish the period in which the IRS can assess additional tax, and the period in which the taxpayer may recover a refund of taxes already paid • The two periods of limitation that are most significant:
1. I.R.C. §6501 – Statute of Limitations on Assessments
2. I.R.C. § 6511 – Statute of Limitations on Claiming a Refund
• There are separate periods of limitation that may apply to overpayment interest and collection matters
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Limitation on Adjustments
• Generally, there is no limitation on the making of adjustments in any year, to the extent that the adjustment, applying the normal carryover or carryback provisions of the Code, would affect another year for which the period of limitations for assessment or refund remains open
• Other procedural issues, i.e., elections, estoppel, and methods of accounting
principles, however, may provide restrictions on adjustments after a period of time
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Assessments
• I.R.C. §6501(a) provides that the amount of tax must be assessed within 3 years after the original return was filed. "Filed" means received by the IRS. Original return also includes a "superseding" return which is a later return which is nevertheless received by the due date.
- An original return filed before the last day prescribed by law or by regulations for filing the return is deemed filed on the last day prescribed by such law or
regulations but this rule applies only to original due dates, not extended due dates - Returns mailed before the due date of the return (including extensions), but
received by the IRS after the due date are deemed to be ―filed‖ on the date the envelope is postmarked
• Effect of Amended Returns
- Amended return reporting additional tax - IRC § 6501(c)(7) - Amended returns claiming refunds have no effect on limitations
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Assessments
• Common exceptions to 3-year Statute of Limitations period - False or fraudulent return
- No return filed
- Extension by agreement - Substantial omissions
- Net operating losses or capital loss carrybacks - Credit carrybacks under IRC section 39
- Tentative carryback adjustments
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Exceptions to 3 Year Statute
• Listed Transactions
- Current guidance on the extended period of limitations for undisclosed listed transactions exists in Rev. Proc. 2005-26
- Recent proposed regulations were issued
- Under I.R.C. § 6501(c)(10), where a taxpayer fails to disclose participation in a listed transaction the period of limitations for those taxable years to which the failure to disclose relates, will not expire before the earlier of:
◦ One year after the date on which the taxpayer makes a disclosure as described in the regulations; or
◦ One year after the date on which a material advisor makes a section 6112 disclosure
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Exceptions to 3 Year Statute
• During the extended limitations period, any tax ―with respect to the listed transaction‖ may be assessed including:
- The tax consequences of the transaction, interest and penalties;
- Items affected by the listed transaction even if those items are unrelated (e.g., as the result of a change to AGI)
• The proposed regulations operate to extend the general limitations period for assessment of tax; however, the limitations period is never shortened
• The rules of Treas. Reg. § 301.6501(c)-1(g) apply on a taxpayer-by-taxpayer basis - Even if a partnership complies with disclosure provisions with respect to a listed
transaction, the extended period of limitations will still apply to the partners if they do not
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• Foreign Tax Credit
- I.R.C. § 905(c) provides that adjustments are made in two instances:
1. When accrued taxes, when paid, differ from the amounts claimed as credits; or
2. If any taxes paid are refunded by the foreign jurisdiction.
Note: The taxpayer is required to notify the IRS when this occurs
- When the adjustment causes a deficiency in the domestic tax liability, there is no period of limitations
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Exceptions to 3 Year Statute
• Foreign Tax Credit (continued)
- Not every change in FTC will give rise to an exception to the 3-year period of limitations.
◦ Must have an actual redetermination by the foreign jurisdiction
◦ Does not include adjustments that are caused by factors knowable within the normal period of limitations
◦ Does not include adjustments that are computational (as opposed to those that result from substantive judgment of the foreign jurisdiction)
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Exception to 3 Year Period
• Carrybacks – NOLs, Capital Loss, Credits
- Statute of Limitations period runs from the date of the loss or credit return year, not to the year to which carried
- May impact other years if carryback dislodges items of carryback year which must now be carried to a different year
• Tentative Carryback Adjustments
- Statute of Limitations period for assessment runs from the date the return is filed for the year of NOL, capital loss, or credit giving rise to carryback
- Tentative carryback claim must be filed within one year of close of loss year on either Form 1139 or 1045
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Other Exceptions to 3 Year Statute
2012
• I.R.C. § 6503(h) – Bankruptcy Stay
• I.R.C. § 6672(b)(3)(A) – After Protest of Preliminary Notice of 100% Liability – expires not before 90 days after notice
• I.R.C. § 7508(a)(1)(G) – Service in Combat Zone
• I.R.C. § 7508A – Presidentially Declared Disaster Areas
• Tax Treaties – Many treaties waive periods of limitations for competent authority actions
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Exception to 3 Year Statute
Refunds
• Unlike the statute of limitations period for assessments, two separate periods must be examined for refunds
1. There is the period of limitations for which a claim for the refund must be filed 2. There are separate but somewhat coordinated rules which provide, given the
claim filed at a particular time, the extent of the refund that can be recovered • Timeliness General Rule – A claim for credit or refund of any tax with respect to which
a taxpayer is required to file a return must be filed within 3 years from the time the return was filed or 2 years from the time the tax was paid
• Look-back General Rule – As a general rule, the amount recoverable is the amount paid within three years of the time the claim was filed (if filed under three-year rule),
or two years before the claim was filed (if the claim was filed under two-year rule)
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Exception to 3 Year Statute
Refunds
• Amount of credit or refund limitation • Voluntary extensions
• NOL or capital loss carrybacks • Foreign Tax Credit
• I.R.C. § 39 – General Business Credits
• I.R.C. § 6511(h) – ―Financially Disabled‖ Individuals • Protective Refund Claims
Barred Years:
• IRS may adjust deductions/credits in closed year if the carryforward of those adjustments affects tax due in an open year
• IRS may not assess additional tax or authorize refund in a closed year • But, look for mitigation
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Protective Claims
Concept of Protective Claim
• A protective claim for refund is well-established, even though the term does not appear in the Code or regulations
- Commonly filed when a taxpayer's right to a refund is contingent on future events that will not be resolved until after the statute of limitations has expired
- In these circumstances, a timely and proper protective claim will preserve the taxpayer's right to obtain a refund.
• Conditioned on the timely filing and compliance with the procedural requirements of Treas. Reg. § 301.6402-2, protective claims will constitute valid refund claims
pursuant to which the IRS may issue refunds (or credit overpayments against other liabilities of the taxpayer)
• Upon resolution of the future event, protective claims may (and should) be ―perfected‖ by filing complete Forms 1120X
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When to File a Protective Claim
• General Counsel Memorandum 38786 describes various circumstances in which filing a protective claim would be appropriate when the expiration of the refund SOL is imminent:
- Pending Litigation - Competent Authority
- Change in statutory or regulatory law
- SOL imminent but supporting documentation not currently available
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Disallowance of Protective Claim
• There have been instances in which the IRS has formally disallowed protective refund claims when the taxpayer specifically described the grounds on which it believed it was entitled to a refund (e.g., entitled to a larger Sec. 41 research credit), but was unable to quantify precisely the overpayment amount because of an incomplete research credit study
• Service Center Advice Memorandum 199941039
IRS sought to distinguish protective refund claims from what it calls ―incomplete
claims.‖ However, the memorandum does not discuss GCM 38786, which includes the most comprehensive discussion of protective refund claims. Some support for the
incomplete claim concept can be found in Treas. Reg. § 301.6402-3(a)(5), which
provides ―[a] return or Amended Return shall constitute a claim for refund or credit if it contains a statement setting forth the amount determined as an overpayment....‖
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Action to Take Upon Disallowance of Claim
• If the IRS disallows a protective claim, the taxpayer might be forced to file a refund suit because the 2-year statute of limitations for doing so runs from the date the claim is disallowed. In reality, the Service has great discretion in the way it handles refund claims.
• The IRS has set forth a current procedure to alert taxpayers on a yearly basis of their protective claim and procedures set forth to perfect if the contingent aspect has been resolved.
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Part III
Bill Laverty,
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Quality Examination Process (QEP)
Quality Exam Process (QEP)
Background
• A decade has passed since the implementation of the Joint Audit Planning Process which was jointly developed with Tax Executives Institute
• Agents found the process useful but it needed streamlining, additional flexibility, and more opportunities for taxpayer involvement
• Taxpayers and their advisors observed inconsistent use of the process; some very involved and others not at all
• The new Quality Examination Process replaces the Joint Audit Planning Process • While Joint Audit Planning was a set of suggested best practices, the new QEP
contains ―requirements‖ for the Service and encourages taxpayer participation which cannot be mandated
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Quality Exam Process (QEP)
Background
• Joint Audit Planning Process ended for examinations started after May 30, 2010. Quality Exam Process took place of Joint Audit Planning Process for all examinations initiated after June1, 2010.
• The Joint Audit Planning check sheet eliminated. • The QEP is incorporated in the IRM.
• QEP focuses on three elements or PER - Planning
- Examination - Resolution
• For revenue agents the ―shoulds‖ of Joint Audit Planning are now ―wills‖ – QEP is required. The QEP process brochure must be shared with taxpayer at beginning of audit.
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Quality Exam Process (QEP)
Collaborative audit process ―Rules of the road‖
• Educate both parties
• Reach agreements regarding procedures to obtain related party returns, claims, affirmative issues and third party contacts
• Obtain basic data needed to prepare exam plan
• Clarify use/role of specialists, Counsel, and Technical Advisors • Discussion of potential issues/risk analysis
• Discussion of the Information Document Request (IDR) process • Develop and agree on schedule for periodic meetings
• Issue Resolution Process including early submission of Technical Advice Requests, Industry Issue Resolution program, etc.
• Statute Extensions understandings
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Quality Exam Process (QEP)
Audit scope and issue priority
The exam team and taxpayer discuss:
• Limited scope audits include LIFE exams, follow-up on issues raised in preceding cycle and repeat examinations where unabsorbed claimed credits (e.g., foreign tax credits) are so large as to preclude a productive full scope audit
• Prior audit results
• Claims and affirmative issues
• Mandatory issues – including Tiered issues, Coordinated issues and compliance checks
• Permanent or timing issues; accounting or non-accounting issues
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Quality Exam Process (QEP)
Audit scope and issue priority
Materiality: • Total dollars
• Dollars to income
• Dollar value of deductions to total deductions • Tax benefit to total tax
• Credit to tax
• Compare to gross receipts and/or gross assets
• Materiality was used for financial statements and tax return • Absence of an item
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Quality Exam Process (QEP)
The exam plan: Audit scope and issue priority
Ongoing Risk Analysis – But must be conducted during initial planning, and when 50% of time applied, or significant event occurs
• Level of compliance
• Adjustment potential/expected result of examination • Future impact
• Industry trends, practices, issues • Financial state of entity
• Compliance • Prior experience
• Cost benefit – resources/time
• Taxpayer systems and internal controls • Appeals and litigation considerations
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Quality Exam Process (QEP)
The exam plan: Audit scope and issue prioritization
• All of the factors used to determine scope and issue prioritization should be shared and discussed with taxpayer during planning discussions/meetings and in the
exam plan
• The Exam Team will explain to the taxpayer why the issue was selected
• Taxpayers should also discuss the audit team’s proposed examination techniques to determine that the most effective and efficient methods are employed
• The Exam Team solicits the taxpayer’s input on best approaches for examining the issue/transaction
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Quality Exam Process (QEP)
The exam plan: Establishing timelines
Teams will establish mutually agreeable timelines including: • Start and completion dates
• Risk Analysis review, completed, and shared • Last date for IDRs to be issued
• Last date for claims to be filed • Last date for F5071(s) to be issued • RAR target date
• Specialist work timeline
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Quality Exam Process (QEP)
Information document request process
• Establish contact points for both parties for IDRs to go to/from
• Before issuing an IDR the team will discuss and agree on the records necessary to address the examiner’s issues/concerns, what sources for obtaining information are available, alternative records, and the purpose/intent of request
• Should be specific, clear, and concise
• Will specify timeframes for taxpayer to respond after discussion
• Will specify timeframes for IRS to notify taxpayer that response is complete or what else is needed
• Will agree on process to elevate concerns or address delays quickly
• Note: The IDR management process should be documented and become a part of the Exam Plan.
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Quality Exam Process (QEP)
The exam plan: Overview
• Part I: Taxpayer Information Section includes overall plan of examination and the taxpayer is asked to sign off
• Part II: Service Management Information Section is the team manager’s instructions to the audit team members
• Part III: Examination Procedures Section contains each team member’s assignment and the procedures to be used to accomplish that assignment; includes planned start and completion dates, estimate of time by issues, description of exam
technique/sampling, prioritization of issues
• ALL parts of the plan should be shared with the taxpayer (unless Law Enforcement Criteria or Official Use Only)
• Representatives for the IRS and the taxpayer sign the examination plan acknowledging understanding and commitment
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Quality Exam Process (QEP)
Establish issue resolution process
• Generally, before issuing a Form 5701 - Notice of Proposed Adjustment (NOPA), the taxpayer and exam team will discuss the issue associated with the proposed
adjustment. NOPAs should not be a surprise. The taxpayer will, at a minimum, confirm the facts of the issue in question and clarify their position.
• Taxpayers should provide additional facts and/or supporting evidence to validate facts presented during issue discussion.
• The exam team may engage specialists, technical advisors, Counsel, and other experts in issue discussions.
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TEFRA Partnerships
Course objectives
At the end of this session you will be able to:
• Understand why Congress enacted the TEFRA partnership provisions • Identify the entities to which the rules apply
• Define partnership items, non-partnership items and affected items • How penalties apply in to TEFRA partners
• Understand the different statute rules when TEFRA applies • How to amend a TEFRA partnership return
• How the IRS TEFRA audit procedures differ from general audit procedures • Identify the important roles and responsibilities of the Tax Matters Partner.
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Agenda
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Session Time
Introduction & Objectives 5 min
Background of TEFRA and IRC Structure 5 min
TEFRA entities defined 5 min
Partnership Items, non-partnership items, & affected items 10 min
Penalties application for TEFRA partners 5 min
Statute of limitations applicable to TEFRA partners 5 min
Amending a TEFRA partnership return 10 min
Different Audit procedures for TEFRA partnerships 10 min
Roles and responsibilities of the TMP 5 min
Total 60 mins
Background of TEFRA and IRC Structure
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Background of TEFRA and IRC Structure
• Prior to the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), any partnership examination was performed at the partner level
• The Service was required to audit each partner's return separately and its
determination as to the treatment of a partnership item applied only to that partner
• Previously, a form 1065 was simply an information return:
• it was not binding on the partners in any way
• the IRS was required to individually examine and adjust the items of each partner
• each partner's period for assessment and refund depended entirely upon the partner's unique circumstance and no "extension" could be obtained from the partnership for all partners
• Individual partners also filed claims on their own and no "amended" partnership return was required
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Background of TEFRA and IRC Structure
• With the Tax Equity and Fiscal Responsibility Act of 1982 Congress enacted I.R.C.§§ 6221 through 6233 which created two different partnership types for procedural purposes:
• TEFRA" partnerships, governed by special procedures, and
• other partnerships (now called small partnerships" or non-TEFRA partnerships) which remain governed by the pre-TEFRA -the old rules still apply
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Background of TEFRA and IRC Structure
TEFRA rules are significantly different than the old rules:
• All adjustments to partnership items are determined in a single proceeding at the partnership level
• Each partner must either report his partnership items consistently with the partnership return or notify the Service that he is not doing so -
• Failure to do so permits the IRS to adjust the partner return, by "computational adjustment" to be consistent with the filed partnership
• The Service must audit the partnership under TEFRA proceeding to make changes in the return with respect to partnership items
• When the partnership is audited, the Service will generally deal with one partner--the Tax Matters Partner,
• but other partners are entitled to participate fully in the audit, and in appeals conferences and litigation.
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Background of TEFRA and IRC Structure
TEFRA rules are significantly different than the old rules, (contd):
• The Service can settle separately with one or more partners,
• but must allow any partner to enter into a settlement consistent with that offered to another partner, if requested by a partner
• All partners have the right to participate in litigation; however, only the Tax Matters Partner or a ―notice partner‖ may commence such litigation
• The statute of limitations for assessing tax to the partners from a change in the treatment of a partnership item is generally controlled at the partnership level
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What entities are subject to the TEFRA rules?
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What entities are subject to the TEFRA rules?
• The TEFRA rules apply to all partnerships required to file a return under § 6031(a),
except, for Small Partnerships that have not otherwise elected the TEFRA procedures • The Small Partnership exception includes partnerships if:
- It has 10 or fewer partners
◦ tested by number or partners at any time during the year) ◦ A husband and wife and estates count as one
- All partners are natural persons, C corps or estates at all times during the year ◦ If any partner is a passthrough entity at any time during the year, the
partnership is disqualified from the Small Partnership exception
• An entity which has properly elected classification of a partnership (for instance LLC or LLP), or which defaults to a partnership, is treated as a partnership which may be subject to TEFRA
• Therefore an entity may be subject to TEFRA audit procedures even though it may be treated differently under local business law or state tax law
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What entities are subject to the TEFRA rules?
Uncertain Status Based on Partnership Return
• IRC § 6231(g) provides that the TEFRA non-TEFRA determination should be made by the IRS from the partnership return alone
• The IRS can determine (a) the number of partners,
(b) the nature of the partners, and
(c) whether the partnership has elected out of the small partnership exception all from the partnership return itself without further inquiry and can apply that
information to determine TEFRA qualification and status -
-generally, the number and nature of the partner can be determined by examining form K-1's since Part II, line I requires that the type of entity of the partner be stated
-In addition, see Schedule B, item 2 which asks if any partner is a passthrough
• If, based on the return, the IRS reasonably determines that TEFRA applies, it applies
• If, based on the return the IRS reasonably determines that TEFRA does not apply, it does not apply
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What entities are subject to the TEFRA rules?
Nature of Partners
• Generally, a partner is whatever classification it gets under Treas. Reg. § 301.7701-3
• Thus, an LLC can be either a partnership, corporation, or disregarded entity depending on the number of members and its election
- A tax-exempt organization is considered to be a C corporation. Rev. Rul. 2003-69 - A foreign corporation is also considered to be a C corporation. Rev. Rul. 2003-69
• However, a foreign individual is not an eligible partner for the small partnership exception
- Thus, if an alien individual wishes to hold a partnership interest and it desires non-TEFRA procedures, it should hold the interest through an entity regarded as a corporation for US purposes under §301.7701-3 (regardless of its treatment for foreign purposes).
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What entities are subject to the TEFRA rules?
Nature of Partners
• For classification of partners, a disregarded entity is not disregarded but is rather
considered a "pass-through" entity, rather than the partner having the classification of the DE's owner.
- Therefore, if a disregarded entity of a corporation holds an interest in a partnership, the interest is treated as being held by a flow-through entity and therefore the
partnership is a TEFRA Partnership, not eligible for the small partnership exception. Rev. Rul. 2004-88.
- See Primco Management Co., T.C. Memo. 1997-332, which held that the fact that a grantor trust which was ignored as an entity separate from its owner for federal tax purposes, was nevertheless a flow-through partner for the TEFRA rules and
disqualified the partnership from the small partnership exception.
• While disregard entities (including grantor trusts) may disqualify an otherwise
qualifying small partnership, if the DE and its owner are the only partners, the entity is not a partnership. Rev. Rul. 2004-77. See also CCA 200250012
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What entities are subject to the TEFRA rules?
Electing Out of Small Partnership Exception
• Even if a partnership meets the small partnership exception criteria, it may elect out of the exception and back into the TEFRA procedures. §6231(a)(l)(B)(ii).
• Form 8893 is designed for the election and must be signed by all partners
• See also Schedule B, item 5 of the Form 1065 which asks if the election was made. • Treas. Reg. 301.9100-2 will permit an automatic extension to 6 months after the
original due date of the partnership return. The return can be amended to make the election until that time.
• Once an election is made, it continues from year to year unless revoked with the consent of the Commissioner. Treas. Reg. § 301.6231 (a)(l )-1 (b)(3).
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Partnership Items, non-partnership
items, & affected items
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Partnership Items, non-partnership items, & affected items
Partnership Items – In General
A partnership item is any item more appropriately determined at the partnership level than at the partner level. 1.R.C § 6231 (a)(3).
1. Important because section 6221 states that the tax treatment of any partnership item is to be determined at the partnership level –which means that a TEFRA proceeding is necessary to resolve that item, it cannot be adjusted in a normal deficiency or refund proceeding.
2. The TEFRA audit rules apply only to "partnership items." Therefore, all other aspects of a partner's tax liability for a given year will continue to be subject to the general audit, deficiency and refund procedures, and cannot be part of the
TEFRA proceeding.
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Partnership Items, non-partnership items, & affected items
Partnership Items – The Regs
1. Treas. Reg. § 301.623 1(a)(3)-1 states that "partnership items" include the following:
a) the partnership aggregate and each partner's share of items of income, gain, loss, deduction, or credit of the partnership;
b) expenditures by the partnership that are not deductible in computing its taxable income, such as foreign taxes or charitable contributions;
c) any item that could be a tax preference item for any partner; d) exempt income;
e) the amount and type of any partnership liabilities (e.g., recourse or no recourse); f) guaranteed payments;
g) optional adjustments to the basis of partnership property pursuant to a section 754 election (including necessary preliminary determinations, such as the determination of a transferee partner's basis in a partnership interest); and
h) Other amounts determinable at the partnership level with respect to partnership assets, investments, transactions, and operations necessary to enable the partnership or the partners to determine the investment credit, recapture of the investment credit, and amounts at risk in the activity.
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