IRS Targets Big Business for Inbound Distributions, Basket Options, Captive Insurance and Asset Transfers

Almost a year ago (September 2015), the Internal Revenue Service announced the reorganization of its Large Business and International (LB&I) Division. Struggling to keep up with the nearly 300,000 taxpayers within its jurisdiction, and faced with significant declines in the IRS budget from the Congressional appropriation process, LB&I is moving to issue-focused examinations of taxpayer documents. Potential areas of noncompliance within an industry or industries will be identified and then corporate returns examined to see whether those issues are present.

A recent Forbes article identifies three areas of focus currently under the reorganized LB&I: inbound distributions, basket options and captive insurance. We’ve added our own fourth to the list for asset transfer pricing. Potential IRS whistleblowers with information about tax evasion through one of these methods should consult with a tax whistleblower attorney about the section 7623(b) program.

Inbound Distributions

Repatriation of foreign cash has been a huge issue as lower taxes overseas encourage companies to store cash from their international operations offshore. Although Congress has considered a tax holiday to encourage U.S.-based multinational corporations to repatriate a portion of their $2.1 trillion in cash holdings located overseas, no agreement has been reached yet. If a corporation uses overseas cash in the U.S. without paying the proper taxes on it to the IRS, there could be large tax bills due. The Medtronic acquisition and settlement comes to mind here.

Basket Options

Hedge funds for many years converted short term gains to long term gains by hiring investment banks to oversee a basket of securities and selling to them a long-term option linked to the success of the securities. The technique has been on the radar of the IRS and Congress since the 1990s.

In 2010, the IRS Office of Chief Counsel issued a Memorandum (Number AM2010-005) that set forth the IRS position that the taxpayer must recognize gains or losses on the short-term securities in the basket rather than solely the option contract. In July 2015, the IRS issued two notices on the technique, with one indicating that “option treatment is not warranted, and the income deferral and conversion to long-term capital gain is improper.”

Captive Insurance

The IRS has been seeking penalties against taxpayers for the improper operation of captive insurance companies. The core issue, according to media reports by tax experts, is whether the company and corresponding pool is legitimately engaged in insurance or solely created to save money. If there are excessive premiums paid to the captive or the captive is simply acting as a tax shelter through the insurance of remote risks, they may become the subject of an enforcement action to recover back taxes and penalties.

Asset Transfers

In other tax news, the IRS has sued Facebook for information concerning the 2010 asset transfer to Facebook Ireland of its intellectual property assets and worldwide business outside of Canada and the United States. Arrangements like this one have become common as companies seek to reduce tax payments by shifting revenue to jurisdictions with low corporate taxes. The companies then license back the assets to the U.S. entity, which can deduct the fees from its taxes.

The documents filed by the IRS reportedly seek information about whether Facebook and Ernst & Young, its accounting firm, understated the value of the intangible assets transferred by billions of dollars. Facebook is not the only company that the IRS is investigating – Microsoft is also on the list for its transfer pricing.

IRS Whistleblower Program

In the Tax Relief and Health Care Act of 2006, Congress authorized the IRS to pay rewards to individuals who provide information about tax noncompliance. If a tip qualifies under section 7623(b) and the individual is otherwise eligible, the IRS may pay a reward of up to 30 percent of the tax noncompliance and penalties recovered.

The IRS program has been regularly criticized for insufficient action based on tips and a lack of communication with whistleblowers concerning their tax investigations (acknowledging briefly here this is in part due to concerns about taxpayer privacy). However, the reorganized LB&I may allow it to focus its energy and bring substantial resources to bear when a tip involves information/evidence concerning one of its priority areas for investigation and enforcement.

If you have evidence of tax noncompliance by a corporation, please call 1-800-590-4116 to discuss it with one of our IRS whistleblower attorneys. There is no fee for our initial, confidential legal consultation.

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