In testimony before the Senate Finance Committee on June 13, IRS Commissioner Mark Everson outlined specific IRS enforcement priorities for large corporate taxpayers. In remarks notable for their specificity, the Commissioner identified a host of “compliance issues” for LMSB attention. He also shed light on the IRS plan of attack for these and future issues. The Commissioner’s remarks suggest that the IRS may employ here the same issue management techniques refined in its response to alleged tax shelters and “listed” transactions. Taxpayers need to remain aware of the Commissioner’s agenda as they structure transactions and claim tax benefits.

Compliance Issues

The following transactions and claimed tax benefits are suspect or may otherwise draw IRS scrutiny, according to the Commissioner:

• Refund claims for research credits that are marketed for contingent fees and that are based on indefensible amounts, non-qualified expenditures, or undocumented estimates (section 41);
   
• Telecommunications carriers claiming Federal and state subsidies for universal service and treating the subsidies as capital contributions to avoid reporting income (section 118);
   
• Refund claims under the new domestic manufacturing deduction, especially mass-marketed claims or claims for which the promoter charges a contingent fee (section 199);
   
• Utilities changing their accounting methods to recharacterize certain assets in order to recover the costs of these assets more swiftly (section 263A);
   
• High-tech and pharmaceutical companies transferring valuable intangibles to related offshore entities for inadequate consideration, e.g., through cost-sharing agreements (section 482);
   
• Transactions to generate foreign tax credits, e.g., by (1) acquiring assets with a built-in gain subject to foreign but not U.S. tax, (2) employing hybrid or other structures treated differently for foreign and U.S. tax purposes, (3) machinating to secure credits before related foreign income is subject to U.S. tax, or (4) arranging for a domestic entity to loan to (or borrow from) a foreign entity to shift the latter’s foreign tax liability to the domestic entity (or to allow the domestic entity to pay creditable foreign taxes instead of interest) (section 901); and
   
• Companies transferring U.S. intangibles from Puerto Rico to other low-tax jurisdictions following the expiration of the possessions tax credit (section 936).

While the following tax benefits are not necessarily suspect, the Commissioner indicated that taxpayers claiming these benefits must ensure that they satisfy all applicable requirements:

• Service providers excluding deferred amounts from income under a nonqualified deferred compensation plan (section 409A); and
   
• Repatriation of foreign earnings at a discount (section 965).

IRS Plan of Attack

The Commissioner described a multi-faceted approach that the IRS is employing to discourage disfavored transactions and claims for tax benefits.

• Successfully used against tax shelters, Issue Management Teams will oversee many of the compliance issues above.
   
• The IRS hopes to identify issues through the specific book-tax differences on the new Schedule M-3 and through mandatory electronic return filing by large corporations.
   
• A pilot Compliance Assurance Program, broader use of Pre-Filing Agreements, and new guidance from LMSB should facilitate accurate reporting and issue resolution prior to filing.

Click here for the Commissioner’s Testimony

For more information, please contact:

Kevin Kenworthy, kkenworthy@milchev.com, 202-626-5848

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