Monthly Tax Roundup (Volume 2, Issue 7)
In this month's Tax Roundup, we cover developments relating to congressional action on Internal Revenue Service (IRS) funding, White House review of tax regulations, recently released guidance from Treasury and the IRS relating to direct pay and transferable credits, accounting methods, and listed transactions, IRS enforcement priorities, and an update on current litigation. We'll be taking a break from publication in August and will be back after Labor Day – happy summer!
Tax fact: Three presidents have chaired the tax-writing House Ways and Means Committee: James Polk, Millard Fillmore, and William McKinley. Ways and Means is the oldest standing committee in Congress.
"To facilitate to them the performance of their duty, it is essential that you should practically bear in mind that towards the payment of debts there must be revenue; that to have revenue there must be taxes; that no taxes can be devised which are not more or less inconvenient and unpleasant...." –George Washington in his 1796 farewell address
Congress Claws Back Part of IRS Additional Funding
As previously reported, on August 16, 2022, President Biden signed the Inflation Reduction Act (IRA) that included $80 billion in additional funding for the IRS, $45.6 billion of which was earmarked for enforcement. On April 5, 2023, the IRS issued its long-awaited Strategic Operating Plan (Plan) for implementing the IRA and a comprehensive overhaul of IRS technology, customer service, and enforcement.
Many taxpayers and tax practitioners welcomed this infusion of funds as a reversal of a decade-long decline in IRS resources. Despite this, this additional funding became a lightning rod of political controversy, particularly among the Republican majority in the House. As a result, when Congress considered legislation raising the debt ceiling, a clawback of some or all the $80 billion was among the issues raised in negotiations between the Biden administration and the House majority.
On June 3, 2023, Congress enacted legislation raising the debt ceiling, including a $1 billion clawback of the additional IRS funding. In addition, a "handshake deal" between President Biden and Speaker Kevin McCarthy (R-CA) would claw back another $20 billion of the IRA funding in future years. Those additional clawbacks, the amount of which could be more or less, will be decided by a future legislation.
It is unclear at this point which function at the IRS will be impacted by the clawbacks, but it is likely that enforcement will bear the brunt of the reduction. IRS executives have indicated that the clawback will not affect implementation of the Plan in the near term. Nonetheless, not all the proposed enforcement strategies in the Plan may see the light of day. Even if the entire amount is clawed back from enforcement, the IRS still has $25 billion in new dedicated enforcement funding at its disposal. The IRS's stated goal of using those funds to target large corporations, substantial partnerships, and high net worth families has not changed. Those taxpayers should continue to prepare for additional scrutiny no matter what the ultimate outcome of the clawback provisions may be.
Tax Rulemaking (Again) Exempt from OIRA Review
The U.S. Department of the Treasury (Treasury) and the Office of Management and Budget (OMB) recently agreed to reverse a Trump-era rule subjecting significant tax regulations to centralized review by the Office of Information and Regulatory Affairs (OIRA) within OMB. Under a memorandum of agreement (MOA) effective June 9, 2023, substantive tax guidance is no longer subject to centralized review by OIRA under Executive Order (E.O.) 12866. This change promises to streamline and expedite the issuance of tax regulations.
E.O. 12866 was issued in 1993 with the aim of reforming the regulatory process throughout the Executive branch. Among other things, E.O. 12866 requires that for any significant regulatory action, the responsible agency must provide OIRA with a draft of the proposed rule along with a mandatory cost-benefit analysis. However, tax regulations were generally exempt from OIRA review under an MOA between Treasury and OMB pre-dating E.O. 12866 and reconfirmed thereafter. But by E.O. 13789, issued in April 2017, President Trump ordered a reconsideration of this traditional exemption, and the next year Treasury and OMB agreed to revoke the prior agreements and subject tax regulatory action to OIRA review, albeit on an expedited basis. The latest MOA restores the historic exemption for tax rulemaking.
IRS Releases Proposed Guidance on Direct Pay and Transferability, Advanced Manufacturing Investment Credit
On June 14, 2023, the Department of Treasury (Treasury) and the IRS released proposed regulations under section 6417, relating to the direct pay of certain green energy credits available under the IRA to applicable entities, and under section 6418, relating to the ability of other entities to sell those credits for cash to other taxpayers. The guidance has been much anticipated, as the elections for direct pay and transferring are to be made with returns filed for the tax year ending in 2023. Both sets of proposed regulations are not yet effective, but taxpayers may rely on them if they do so consistently.
Treasury and the IRS released these regulations concurrently with proposed regulations under section 48D, relating to the direct pay of the Advanced Manufacturing Investment Credit enacted as part of the Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act. Certain portions of the proposed regulations under section 6417 and 48D that address registration requirements were also released as temporary regulations.
Section 6417 Proposed Regulations
The section 6417 proposed regulations provide guidance on the nuts and bolts of an applicable entity's direct pay election. First, the applicable entity must register with the IRS and provide information electronically relating to eligibility for the credits for which an election is being claimed (applicable credits). The proposed regulations provide that the applicable credit election is made on a facility-by-facility basis and the taxpayer will therefore receive a unique registration number for each facility.
Generally, an applicable entity must be a tax-exempt, governmental, or similar entity. However, for three credits (the section 45Q carbon sequestration credit, the section 45V clean hydrogen credit, and the section 45X advanced manufacturing credit), taxpayers that are not otherwise applicable entities can elect to be treated as such. The proposed regulations clarify that this election may be made for a single five-year period with respect to each facility.
Mechanically, the proposed regulations provide a complex waterfall for determining the elective payment amount. Essentially, taxpayers must:
- Compute their federal income tax liability without regard to any section 38 general business credit (GBC)
- Compute their GBC carry forwards and current year GBCs, including any GBCs for which the taxpayer has elected direct pay and apply them to the liability
- Identify any excess or unused GBCs and carry them forward or back as appropriate
- Reduce the applicable credit by the amount of that credit allowed as GBC, with the balance being treated as a payment against tax (which may result in an overpayment)
There is some ambiguity in the proposed regulations about the impact of this deemed payment against tax on the computation of the estimated tax penalty under sections 6654 (individuals) and 6655 (corporations). Prop. Treas. Reg. § 1.6417-3(e)(3) provides that "The full amount of the applicable credits for which an elective payment election is made is deemed to have been allowed for all other purposes of the Code, including, but not limited to, the basis reduction and recapture rules imposed by section 50 and calculation of any underpayment of estimated tax under sections 6654 and 6655 of the Code." However, in one of the examples, Prop. Treas. Reg. § 1.6417-2(e)(4), ex. 5, the taxpayer "did not owe tax after applying the elective payment amount against its net tax liability." The example stated that taxpayer nonetheless "may be subject to the section 6655 penalty for failure to pay the estimated income tax. The net elective payment election is not an estimated tax installment, rather, it is treated as a payment made at the filing of the return." In the example, the taxpayer had filed a timely extension, although the relevance of this fact is unclear.
Section 6418 Proposed Regulations
The section 6418 proposed regulations provide guidance on the transfer of eligible credits for both the eligible taxpayer and the transferee. As with the section 6417 proposed regulations, an eligible taxpayer must first register with the IRS and provide information relating to each eligible credit property for which the eligible taxpayer intends to transfer a specified credit portion, with each eligible credit property receiving a unique registration number. The proposed regulations offer a list of eligible credit properties as it relates to each of the eleven eligible credits.
The eligible taxpayer and the transferee must both make an election on an original return and include an election statement. The election statement must include:
- The identities of the transferee(s) and the eligible taxpayer
- A description of the eligible credit
- The taxable year of the eligible taxpayer and the first taxable year the credit will be used by the transferee
- The amount(s) and dates of payments
- The registration number
The eligible taxpayer may elect to transfer multiple portions of an eligible credit to different transferees, but to the extent of the eligible credit. The specified credit portions must be made proportionately to the total amount of the credit, including any eligible bonuses (i.e., a bonus alone may not be transferred).
Unlike the proposed regulations under section 6417, the proposed regulations under section 6418 are clear that a transferee taxpayer may account for the transferred credit for purposes of computing its estimated tax obligations.
Section 48D Proposed Regulations
The proposed section 48D regulations addressing the section 48D(d) direct pay election largely mirror the proposed section 6417 regulations. A taxpayer must register each qualified investment in an advanced manufacturing facility it has made in the taxable year with the IRS. The taxpayer will make the election on its Form 3800 and certify under penalty of perjury that it is not a foreign entity of concern, has not made any transactions that would trigger recapture under section 50(a)(3), and will not claim a double benefit with respect to the credit.
The proposed section 48D regulations contain the same step-by-step computation for determining the taxpayer's direct credit payment portion as in the proposed section 6417 regulations. Similarly, there remains some ambiguity regarding how exactly a taxpayer should take its section 48D credit into account when determining estimated tax payments. What appears clear, in the context of section 48D(d), is that a taxpayer that makes the election is entitled, at a minimum, to account for the amount of GBCs to which it is entitled in the taxable year under section 38 for purposes of determining its estimated taxes.
See our coverage of additional proposed regulations on the Advanced Manufacturing Investment Credit here.
Relief for Estimated Tax Payments Relating to Corporate Alternative Minimum Tax
The IRS recently provided welcome relief to corporate taxpayers continuing to wrestle with the recently enacted corporate alternative minimum tax (CAMT). IRS Notice 2023-42, 2023-26 IRB 1085, provides that for taxable years beginning after 2022 and before 2024 (Covered CAMT Year), the IRS will waive the section 6655 addition to tax for corporate underpayments of estimated tax to the extent related to the corporation's CAMT liability. Thus, a corporation's quarterly estimated tax payments for a Covered CAMT Year need not include amounts attributable to the corporation's CAMT liability to avoid a section 6655 addition to tax. A corporation must still pay its CAMT liability for the Covered CAMT Year by the due date of the corporation's tax return for the Covered CAMT Year, determined without regard to extensions. Otherwise, the corporation could face a section 6651 addition to tax for failure to pay.
The Notice instructs corporations to complete Form 2220, Underpayment of Estimated Tax by Corporations, for the Covered CAMT Year without regard to the corporation's CAMT liability for the year and file the completed Form 2220 with the corporation's U.S. federal income tax return for the Covered CAMT Year. This instruction applies even if the completed form shows the corporation owes no section 6655 addition to tax for the Covered CAMT Year. The corporate taxpayer's U.S. federal income tax return for the Covered CAMT Year must also include an amount (even if zero) of section 6655 addition to tax, e.g., on Form 1120, Line 34. The Notice makes clear that "[f]ailure to follow these instructions could result in affected taxpayers receiving a penalty notice that will require an abatement request to apply the relief provided by this Notice."
The IRS released the Notice on June 7, just in time for corporate taxpayers facing the June 15 deadline for making a second quarter estimated tax payment. This timing was significant as large corporations can generally calculate first quarter estimated tax payments based on the preceding year's tax liability (which would not include CAMT) but must calculate second quarter estimated tax payments based on the current year's tax liability (which could include CAMT). While Treasury and the IRS have released preliminary CAMT guidance (read our coverage here and here), fundamental questions remain over which corporations are subject to CAMT and how such corporations must calculate their CAMT liability. Taxpayers and tax practitioners are eagerly awaiting further substantive guidance from Treasury on the IRS that is expected to address many of these unanswered questions.
*Hadden Martinez is a summer associate.
IRS Updates Consolidated List of Automatic Accounting Method Change
The IRS has released an updated consolidated list of accounting method changes that are eligible for the automatic change procedures. Rev. Proc. 2023-24 replaces Rev. Proc. 2022-14 — the prior automatic change list — and applies to Forms 3115 that a taxpayer files on or after June 15, 2023, for a year of change ending on or after October 31, 2022. The new revenue procedure includes the automatic accounting method changes the IRS has published since releasing Rev. Proc. 2022-14, e.g., for research and experimentation expenditures subject to Section 174 (Rev. Proc. 2023-11) and for adopting the Natural Gas Safe Harbor Method (Rev. Proc. 2023-15). The "Significant Changes" section of Rev. Proc. 2023-24 also identifies 29 noteworthy revisions to automatic accounting method changes previously included in Rev. Proc. 2022-14. Here are three revisions that are likely to be most relevant to our readers.
First, the IRS has waived the prior five-year item change limitation for an additional year for taxpayers seeking to make certain accounting method changes relating to revenue recognition under section 451(b). This additional year is a welcome addition given how complex the revenue recognition regulations under section 451(b) are.
Second, the IRS made two changes to the automatic change for adopting the Natural Gas Safe Harbor Method from Rev. Proc. 2023-15. They added a requirement that taxpayers attach additional statements to their Form 3115 when making the change and provided that taxpayers must exclude amounts subject to a prior book capitalization election under Treas. Reg. § 1.263(a)-3(n) when calculating a Section 481(a) adjustment. The new statement requirement is consistent with other public utility tax accounting method changes that can implicate normalization issues, and it was surprising that the IRS didn't include the requirement in Rev. Proc. 2023-15 in the first place. The new provision regarding prior book capitalization elections prevents taxpayers from using the automatic method change to revoke such elections.
Third, the IRS clarified that the automatic accounting method change for transitioning to a permissible section 174 method for research expenditures includes moving from capitalizing these amounts to inventory for recovery as cost of goods sold to capitalizing these amounts and amortizing them. This appears to be the IRS sending a signal that taxpayers won't be able to avoid the new amortization requirement by capitalizing research expenditures to inventory and could be a preview of what's to come in expected proposed regulations under section 174.
Taxpayers should carefully review Rev. Proc. 2023-24 before filing a Form 3115 with the IRS to request consent to a proposed accounting method change. Taxpayers that last filed a Form 3115 before the end of 2022 should also note — and be sure to use — the revised Form 3115 and accompanying instructions that the IRS released in December 2022.
IRS Identifies Another Listed Transaction in Proposed Regulations
On June 7, 2023, the Treasury and the IRS issued proposed regulations under Code section 6011 designating certain transactions involving Malta personal retirement arrangements as listed transactions. The transactions at issue involve tax-favored individual savings arrangements where a U.S. taxpayer (1) transfers cash or other property to, or receives a distribution from, a personal retirement arrangement established under Malta's Retirement Pension Act of 2011, and (2) takes the position that income earned or gain realized under the Malta personal retirement arrangement is exempt from U.S. tax under the U.S.-Malta income tax treaty, or that distributions from the arrangement are exempt from U.S. tax by reason of the treaty. The proposed regulations reiterate the IRS's position that these personal retirement arrangements established under Malta's Retirement Pension Act of 2011 are not eligible for treaty benefits, as was previously announced in a December 2021 Competent Authority Agreement between the U.S. and Malta. Comments on the proposed regulations are due by August 7, 2023, and a hearing is scheduled for September 21, 2023.
The proposed regulations on the Malta arrangement are part of a broader trend where Treasury and the IRS are using regulations to identify reportable transactions. This is an effort to comply with the Administrative Procedure Act (APA) and a reaction to recent litigation where several courts have held that IRS notices designating arrangements as reportable transactions are invalid because the notices did not comply with APA notice-and-comment procedures. See Mann Construction, Inc. v. United States, 27 F.4th 1138 (6th Cir. 2022); CIC Servs., LLC v. I.R.S., 592 F. Supp. 3d 677 (E.D. Tenn. 2022); Green Valley Investors, LLC v. Comm'r, 159 T.C. No. 5 (2022); Green Rock, LLC v. I.R.S., No. 2:21-cv-01320, 2023 WL 1478444 (N.D. Ala. Feb. 2, 2023); GBX Assocs., LLC v. United States, No. 1:22-cv-401, 2022 WL 16923886 (N.D. Ohio Nov. 14, 2022). Other recently proposed regulations formalize prior notices designating arrangements as reportable transactions, such as arrangements involving syndicated conservation easements and section 831(b) captive insurance companies (which we covered here and here). We expect this trend to continue.
*Katherine Lewis is a summer associate.
TIGTA Recommends LB&I Shifts Resources to Global High Wealth Audits
On May 25, 2023, the Treasury Inspector General for Tax Administration (TIGTA) released a report detailing its review of IRS's Large Business & International (LB&I) Division's use of resources in its audits of individual taxpayers. TIGTA undertook a review of LB&I's selection process, use of resources, and examination productivity for individual returns examined from fiscal years 2017 through 2021. Based on its review of IRS data, TIGTA determined that LB&I is not using its resources efficiently and recommends that LB&I shift resources to increase audits of higher risk and higher income individual taxpayers.
First, TIGTA found that LB&I was devoting too much of its resources allocated to individual audits to audits of lower-income individuals. It found that 90 percent of individual returns selected for audit had a total positive income (TPI) of less than $200,000. It also found that roughly 75 percent of the most experienced revenue agents were auditing lower-income and low-risk returns, while approximately 10 percent were auditing high-risk returns.
Second, TIGTA found that audits of high-income individuals yielded a significantly higher return than audits of lower-income individuals. From 2017 through 2021, audits of individuals with TPI of $200,000 or less was a fraction as productive as the average LB&I audit. TIGTA found that audits in the Global High Wealth (GHW) program, which is responsible for auditing businesses and enterprises controlled by individuals with assets in the tens of millions of dollars, while complex, were particularly productive.
Based on its findings, TIGTA recommended that LB&I shift resources to audits or higher-risk and higher-income individual taxpayers, specifically, that LB&I evaluate the composition of international individual cases to ensure that the most experienced and capable examiners are assigned to the cases with the highest compliance risk. LB&I management agreed to undertake a review of its case selection and assignment processes.
While this report may not, by itself, spur additional enforcement efforts or a renewed focus on GHW taxpayers, the Biden administration and Commissioner Werfel have made closing the tax gap a focus of their agenda. The TIGTA report also comes as Congress significantly increased funding for the IRS in the IRA (even after the debt ceiling clawback). The Plan signals that those additional resources will be devoted to more audits of GHW taxpayers as well as large corporations and large partnerships.
Liberty Global Case Heads Toward Summary Judgment on Economic Substance
The month of June brought significant developments in Liberty Global, Inc. v. United States, a closely watched case addressing the validity of temporary regulations issued under section 245A, as well the application of the economic substance doctrine.
As background, Liberty Global, Inc. (LGI) filed suit seeking a refund of income tax paid for its 2018 tax year as a result of temporary regulations under section 245A that reduced the dividends-received-deduction available under that section. In April 2022, the U.S. District Court for the District of Colorado ruled that such regulations were invalid for failure to comply with the APA. That ruling did not resolve whether the underlying transactions that implicated the temporary regulations otherwise complied with applicable tax laws, and pre-trial proceedings on that issue continued in that case.
The government filed a separate complaint in October 2022 seeking to recover additional tax from LGI for 2018, alleging that preparatory transactions undertaken by LGI in December 2018 lacked economic substance. The government asserts that, if the preparatory steps are disregarded, an additional $2.3 billion would have been taxable as capital gain, rather than as a dividend, significantly diminishing the relevance of the section 245A regulations to the outcome. In January 2023, LGI moved to dismiss the government's separate complaint, asserting that the government failed to provide a timely notice of deficiency.
On June 1, 2023, the district court denied LGI's motion to dismiss, concluding that the requirement to issue a notice of deficiency before an administrative assessment is not "logically relevant in the present context, a common-law suit on the debt." Then, on June 15, LGI filed its answer to the government's complaint. Concurrently, LGI and the government jointly requested permission to file cross-motions for summary judgment in the original refund suit, based on the belief that "the nature of LGI's admissions in this case, coupled with facts obtained during discovery which do not appear to be in dispute, likely eliminate the need for a trial." Shortly thereafter, the district court granted permission and set a summer briefing schedule, with oral argument on September 6, 2023.
The joint letter to the court suggests that the principal issue presented for summary judgment will be whether the economic substance doctrine is "relevant" to the transactions, a notoriously challenging issue. The codification of the economic substance doctrine in 2010 did not directly affect the determination of whether the doctrine is relevant to a transaction (see I.R.C. § 7701(o)(5)(C)) but was accompanied by legislative history analyzing existing law on relevance.
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