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Offshore Voluntary Compliance Initiative • Subsidizing Employee Meals • More on the IRS Office of Appeals • K-1 Matching Program
Editor:
Editor's note: Mr. Ely is the former chair of the AICPA Relations with the IRS Committee. Messrs. Brennan, Dolan, Dougherty and Rosenberg are members of the IRS Practice and Procedures Committee. Mr. Dougherty is chair of that committee.
Amnesty for Offshore Tax Evaders Effective Jan. 14, 2003, the IRS issued Rev. Proc. 2003-11, the Offshore Voluntary Compliance Initiative. This one-time amnesty program generally applies to taxpayers who underreported their 1999, 2000, 2001 and/or 2002 taxable income by using payment cards (e.g., debit, credit and charge cards) issued by foreign banks and offshore financial arrangements with foreign entities (e.g., foreign trusts, corporations, partnerships and financial institutions). The Initiative may be available for tax years ending before 1999 under certain circumstances. According to the Initiative, eligible taxpayers who apply by April 15, 2003 can possibly avoid criminal prosecution and some civil penalties; however, they must still pay back taxes, interest and, perhaps in appropriate circumstances, the delinquency penalty under Sec. 6651 and the accuracy-related penalty under Sec. 6662. In IR 2003-5, the Service indicated [e]ligible taxpayers who come forward will also avoid criminal prosecution based upon application of the revised voluntary disclosure practice. Further, filing for amnesty will not preclude the Service from auditing a taxpayers related return and/or proposing changes for items not resolved under the Initiative. The Initiative permits eligible taxpayers to file or amend their returns and pay back taxes. The amount and type of penalties will be based on several factors, including the number of years involved, the tax underpayment amount, whether a return was inaccurate and whether a return was filed at all.
Possible Penalties Avoided For eligible taxpayers who voluntarily come forward, the IRS will refrain from assessing:
The latter penalties result when a taxpayer fails to file Forms 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations; 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or Foreign Corporation Engaged in a U.S. Trade or Business; 926, Return by a U.S. Transferor of Property to a Foreign Corporation; 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts; 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner; and/or 8865, Return of U.S. Persons with Respect to Certain Foreign Partnerships. In addition, Treasurys Financial Crimes Enforcement Network will refrain from imposing civil penalties for failure to comply with 31 USC Section 5314 and 31 CFR Part 103.24. These rules require taxpayers to timely file Form TDF 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR), to report on foreign bank or financial accounts, if such accounts total over $10,000 at any time during the tax year. This information return is required for foreign accounts, held under any name, over which the U.S. taxpayer had actual control.
The IRSs Objective Under the initiative, the IRSs goal is to gather information from amnesty applicants, to help it pursue the individuals who promote offshore credit card accounts as a device to conceal assets and evade U.S. income taxes. Currently, the Service is investigating several thousand offshore accounts, and has referred a large number of these to its Criminal Investigation Division. This division, however, lacks the financial and human resources to pursue all of them. The IRS has been studying offshore accounts since October 2000, when the first Federal judge granted it the authority to issue a series of John Doe summonses to several financial and commercial businesses, to obtain records of U.S. residents who held offshore credit, debit and charge cards. MasterCard International, American Express and Visa International are just a few of the companies that have since provided information to the Service on cards issued by financial institutions in countries such as Antigua, Barbuda, the Bahamas and the Cayman Islands. In addition, the IRS has been obtaining data via U.S. bilateral treaties and agreements with a myriad of foreign countries. Because these investigations also tend to uncover nontax evasion schemes (e.g., concealing assets from divorcing spouses, creditors and bankruptcy proceedings), they are often conducted jointly with other law enforcement organizations. According to the IRS, holding an offshore card is not illegal if there is a legitimate need, but U.S. citizens are still required to pay Federal tax on their worldwide income. The abuse stems from U.S. taxpayers holding these cards solely to evade taxes, as such cards can provide easy access to offshore funds and accounts in bank-secrecy or tax-haven countries that allow income to be concealed from U.S. authorities. For example, corporate executives, professional athletes, entertainers, etc., may deposit unreported wages, gambling winnings or investment income in an offshore account titled in their own name or in a corporations name. They can then spend these funds anywhere with internationally accepted debit or charge cards drawn on these accounts; the IRS cannot trace the origin.
Participant Eligibility Taxpayers may participate in the amnesty program if they timely file their request in writing or by email by April 15, 2003. The IRS will not grant any extensions for the initial filing. Also, a practitioner may submit a request, on a clients behalf, using a properly executed Power of Attorney. Taxpayers who demonstrate that they cannot pay all of the tax liabilities can submit a request to the IRS to make other payment arrangements. There are several criteria for program eligibility: 1. A taxpayer cannot already be under civil or criminal investigation (or notified of an impending investigation). 2. The IRS cannot already possess information that specifically identifies that taxpayers lack of compliance. 3. A taxpayer cannot be involved in other illegal activity. 4. A promoter or solicitor of the offshore arrangement in question cannot apply. Participation requirements are detailed in the box below.
How to Use the Initiative IR 2003-5 illustrated how the Initiative affects taxpayers who apply and those who do not. For example, in applying for amnesty, a taxpayer who understated his or her income to avoid $100,000 in taxes for 1999 would pay a $20,000 accuracy-related penalty and approximately $29,319 interest, for a total of $149,319. However, if he or she does not voluntarily apply, and the IRS ultimately detects tax evasion, the taxpayer would owe an additional $75,000 civil fraud penalty, additional interest of $42,758 and probable additional civil penalties for failure to file required returns, resulting in owing $217,758. In the above example, the accuracy-related penalty is 20% of the underpayment; the civil fraud penalty is up to 75% of the unpaid tax liability attributable to the fraud.
Tax Practitioners Responsibilities Treasury Department Circular 230 explains tax practitioners responsibilities. Section 10.21 requires a practitioner who has knowledge of a clients omission or error on any return, affidavit or document, to advise the client promptly of its existence and explain the related consequences provided under the Code and regulations. Section 10.22 requires a practitioner to exercise due diligence in preparing and filing any return, affidavit or other document and to determine the accuracy of all oral and written representations made by the practitioner to clients and to the IRS on any IRS matter; for details, see Gardner, et al., Circular 230 Final Regs. (Part I), TTA, January 2003, (Part II), February 2003.
Contact Information For more information on the Initiative, taxpayers and practitioners can call (215) 516-3537 or send an email to VCI@irs.gov, which the IRS has established to address questions about the program. From Jack N. Rosenberg, CPA, Partner and Director of Tax Services, and Deborah L. Frishman, J.D., CPA, MBA, Senior Tax Associate, Koch Reiss and Company, P.A., Hollywood, FL
The High Cost of Subsidized Eating Facilities and Employees Eating In Every employers dream is a diligent worker munching on a sandwich at his or her desk during lunch hour. Because the cost of a meal is small potatoes when compared to the value of a highly productive employee, employers regularly pick up lunch and dinner tabs, often assuming that this expense is not required to be included in an employees gross income. Although they are often correct in their assumption, they do not realize that employer-provided meals must meet objective tests under the Code to be excluded. Employers might face significant exposure to additional employment taxes if they do not meet the tests.
Exclusion Tests Sec. 119(a) is the primary authority on meals or lodging provided for an employers convenience. Under that provision, meals furnished to an employee (or the employees spouse or dependents) would be excluded from his or her gross income if the employer provides the meals (1) on its business premises and (2) for its convenience. Whether meals are convenient is an objective determination based on the facts and circumstances. Generally, it means that employers provide meals for a substantial noncompensatory business reason, rather than as additional employee compensation. Although Regs. Sec. 1.119-1(e) indicates that cash allowances or reimbursements for meals do not qualify for exclusion, Regs. Sec. 1.132-6(d)(2)(i)(C) provides that meal money paid on an occasional basis to an employee working overtime, is an excludible de minimis fringe benefit. Under Regs. Sec. 1.119-1(a)(2)(ii)(a)(f), meals are provided for a substantial noncompensatory business reason when furnished: 1. To allow an employee to be on emergency call during meal periods; 2. Because an employers business restricts an employee to a short meal period (e.g., 3045 minutes), and it is impossible for the employee to eat elsewhere in such a short time; 3. Because an employee cannot secure meals within a reasonable period (e.g., the vicinity has no sufficient eating facilities); 4. To a restaurant or food-service employee, irrespective of whether the employer furnishes meals during, or immediately before or after, working hours; 5. At a place of business, and the reason for furnishing meals to substantially all of the employees who are furnished the meals is a substantial noncompensatory business reason (the meals then furnished to each of the other employees will be regarded as a substantial noncompensatory business reason); and 6 Immediately after working hours, if an employees duties prevented him or her from obtaining a meal during working hours. Under Regs. Sec. 1.119-1(a)(2)(iii), meals would be for a compensatory business reason if they were furnished to promote the employees morale or goodwill.
Employer Safe Harbors Frequently, a company has many employees; while some are entitled to the meal exclusion (e.g., hospital workers who must be available for emergencies), others are not. Keeping track of this is an onerous task. Thus, Sec. 119(b)(4) provides a safe harbor for employers: if more than one half of employees qualify for the exclusion, all such meals furnished to employees would be treated as having been provided for the employers convenience. The value of all the meals under these circumstances would be excludible from the employees income and deductible by the employer. Sec. 274 sets forth rules entitling an employer to a deduction. Unless the employer meets one of the exceptions, Sec. 274(n)(1) generally limits the deduction allowance to 50% of meal costs. If an employer does not meet the Sec. 119 convenience test, it might be able to claim a deduction if it subsidizes eating facilities for its employees. Sec. 132(e)(2) provides that an employers operation of an eating facility will be treated as a de minimis fringe benefit if the (1) facility is on or near its business premises and (2) facilitys revenues equal or exceed its direct operating costs on an annual basis; see Regs. Sec. 1.132-7(a)(1). For the exclusion to apply, Regs. Sec. 1.132-7(a)(2) states that the employer must: 1. Own or lease the facility; 2. Operate the facility; 3. Locate the facility on or near its business premises; and 4. Furnish meals during or immediately before or after the employees workday. Note: For this exclusion to apply, the nondiscrimination rules as to highly compensated employees must be satisfied. If the subsidized meals do not meet either the Sec. 119 or 132(e) requirements for exclusion, the taxable value of the meals is includible in the employees gross income and subject to FICA, FUTA and Federal income tax withholding. Further, if Sec. 132(e) does not apply, Temp. Regs. Sec. 1.61-2T(j) provides a special rule to determine the taxable value of the meals to be included in the employees gross income. The value of all meals provided at an employer-operated eating facility will be deemed to equal 150% of the facilitys direct operating costs. Under the regulation, the taxable value of the meals provided at the eating facility is then determined by the employers choice of either an individual meal subsidy or a total meal subsidy formula.
Conclusion If an employer has not included the value of meals in an employees gross income subject to employment taxes, the IRS, on audit, might determine that the employer is responsible for the income tax withholding (27%, the supplemental wage withholding rate for 2002 and 2003) and the combined employee and employer share of FICA/Medicare and FUTA taxes that it should have withheld. Because the facilitys direct operating costs are grossed up by 150% to determine the meals value, the resulting additional tax assessed against the employer could be staggering. Moreover, the Service might contend that the employers deduction for the meal subsidy is limited to 50% of cost, under Sec. 274(n). Thus, an unsuspecting employer not otherwise entitled to exclude from its employees gross income the cost of subsidized meals may find itself providing a very costly fringe benefit. From James Brennan, CPA, Principal, and Nancy Chassman, J.D., LL.M., Senior Manager, IRS Practice & Procedure Group, Ernst & Young LLP, New York, NY
The vision of the IRS Office of Appeals (Appeals) is to provide premier dispute-resolution services through the use of innovative approaches and dynamic processes. Appeals has implemented a number of changes to achieve this vision: new leadership, new structure, various initiatives to encourage earlier resolution of issues and a more proactive role in tax shelters. The goal is to become more efficient and to enhance the independent administrative appeals process for all taxpayers.
Leadership Changes In spring 2002, Dave Robison replaced Dan Black as the Chief, Appeals. Mr. Robison brings a wealth of knowledge to Appeals from his 30 years of IRS experience. Formerly, Mr. Robison was the Industry Director of Financial Services in the Large and Mid-Size Business (LMSB) Compliance division. He also held the position of Assistant Director of the Manhattan District and gained extensive international experience while working in Jakarta, Indonesia and Riyadh, Saudi Arabia. Karen Ammons is the new Deputy Chief, Appeals. She also worked in the LMSB Compliance division. Formerly, Ms. Ammons was a Director, Field Operations for the Heavy Manufacturing & Transportation group. In addition to her LMSB experience, she has an extensive background with the IRS in the International, Computer Audit Specialist and Appeals divisions. Mr. Robison and Ms. Ammon face a number of challenges in their new positions. The first is revitalizing Appeals. Historically, Appeals had the highest employee satisfaction record at the IRS, but this trend changed due to the type of work assigned to Appeals Officers and the divisions reorganization. Prior to the Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA 98), 95% of Appeals work came from the Office of Examination. After the IRSRRA 98, more than 50% of its work comes from the Office of Collection (Collections). This switch frustrated Appeals Officers; they were not trained in Collections and felt that the work was not of the same caliber as income tax work. In addition, the huge influx of Collections work (e.g., liens and levies) with short deadlines, caused workload problems. Frustration led to a workforce that felt the organization was not focused. Mr. Robison recognizes this challenge and is taking steps to alleviate it. A major challenge for Appeals is to regain the workforces historical enthusiasm while reorganizing for a third time in recent years. Fortunately, both Mr. Robison and Ms. Ammon are experienced in reorganizations, having been actively involved in the LMSB stand-up and in the subsequent changes to the LMSBs structure. Also, they receive the support of experienced executives and management and a talented workforce willing to take on the challenge to once again make Appeals an outstanding organization that serves the American public, rendering fair and impartial decisions to both taxpayers and the government.
Appeals Reorganization Appeals was originally structured geographically to serve all types of cases in each location. A few years ago, it reorganized into two structures: Large Business and Specialty Programs (LBS) and General Appeals. LBS handled large cases; General Appeals, small cases and collection issues. However, this setup presented a number of obstacles. For example, Appeals Officers in many instances were located in different cities from their managers, causing communication problems, limiting management involvement and slowing down the approval processes. As a result, Appeals is reorganizing to consolidate LBS and General Appeals and structuring the organization on a more geographic basis. The field structure will be geographically based, dividing the country into east and west sectors:
The new structure also provides for field specialists:
Headquarters will be staffed by the Chief, Appeals, the deputy and their respective staff. Headquarters will also contain the Directors of Field Technical Services and of Strategic Planning. The Director of Field Technical Services will manage the Director of Technical Guidance, the Director of Tax Policy and Procedures for each of the divisions and the Director of Processing. The Director of Strategic Planning will manage the newly created office of Strategic Planning; Measures and Analysis; Appeals Quality Measurement System; Strategic Human Resources; Finance and Administration; and Business Systems Planning. These changes should not greatly affect taxpayers. Actually, taxpayers should benefit from the reorganization, because the approval process should be expedited between the Appeals Officer and Managers, resulting in quicker case resolution.
Alternative Dispute Resolution Techniques Appeals is unique in that Officers can use mediation skills and weigh the hazards of litigation to resolve cases. Appeals is now attempting to use these skills early in the examination process. The IRS has introduced several programs over the past couple of years to promote the use of these skills, such as fast-track dispute resolution, post-appeals mediation and arbitration. Fast-track dispute resolution (Notice 2001-67) uses Appeals tools while the case is still in Examination. Appeals Officers can use either mediation or settlement authority to assist a Revenue Agent and taxpayers in resolving cases. Post-appeals mediation (Rev. Proc. 2002-44) is a nonbinding program that uses a mediator, either an IRS Appeals Officer who has not been involved in the case or a team consisting of an independent Appeals Officer and a non-IRS mediator, to facilitate communications between the Appeals Officer and the taxpayer to resolve a case. Arbitration (Anns. 2000-4 and 2002-60) is a program that employs an arbitrator to enter into the process and render a binding decision. Each of these programs allows a taxpayer to have his or her case looked at by someone who has not been involved previously. Taxpayers and the IRS have had great success with these programs thus far.
Tax Shelters Appeals is also using its specialized skills in the tax shelter arena, playing a major role in IRS settlement initiatives. After analyzing the hazards of litigation, Appeals is creating a settlement offer to be used for all taxpayers who enter into particular transactions. This approach provides an expedited resolution process, rather than looking at each taxpayers transaction. For example, Appeals developed the settlement offer on liability management company transactions. One of the options under the offer is to use fast-track dispute resolution to resolve the issue. If the parties do not resolve their issue this way, they can request arbitration to obtain a settlement. This example exemplifies the use of Appeals skills to resolve a large number of cases.
Conclusion Appeals is going through a number of changes. In the end, it should be a better organization that can contribute more to the overall tax system. These changes should, in turn, contribute to a more efficient and effective Appeals process for taxpayers, thus reducing both the cost and burden to the taxpayer and the IRS. From Jim Dougherty, CPA, Director, and Rona Faust, CPA, Senior Manager, Tax Controversy, Deloitte & Touche LLP, Washington, DC
IRS Resumes K-1 Matching Program The voluntary nature of the U.S. self-assessment tax system works best when three powerful forceswithholding, information reporting and information matchingreinforce it. Even when withholding is not feasible, the combination of information reporting and matching helps motivate high levels of compliance. Mindful of this reality, the IRS announced in early 2002, that it would expand its matching of K-1s from partnerships, S corporations and trusts with the Forms 1040 filed by the beneficial owners of these flowthrough entities. As partial rationale for expanded matching, the IRS pointed to an internal study that documented the recent significant growth in the number of flowthrough entities. The study also estimated that between 6% and 15% of a total of $1.2 trillion in flowthrough income would not be reported on 2001 returns. Coincidentally, these revelations came at a point at which the IRS was making very little compliance use of the K-1 information it possessed. In the first year of the matching program, the IRS processed more than 18 million tax-year (TY) 2000 Schedules K-1. It screened approximately 378,000 potential mismatches down to a universe of 69,000 taxpayers, to whom notices were issued. In evaluating the approximately 300,000 cases for which notices were not issued, the primary reasons for screening cases out included: combining K-1 income and expenses, or offsetting income by employee business expenses or by at-risk or flowthrough losses; and reporting K-1 income elsewhere on the return. Of the 69,000 notices issued, more than 60% were ultimately closed as no-change (i.e., the IRS accepted the returns and Schedules K-1 as originally filed). The primary reasons cases were closed as no-change closely mirrored the original screen-out results. Approximately 22,000 cases were closed as agreed; taxpayers agreed to $25 million in additional assessments attributable to misreported K-1 items. Before launching the K-1 matching program, the AICPA and other stakeholder groups cautioned the IRS to proceed slowly. They warned the IRS of the potential for error attributable to the wide variation in the way K-1 information flows onto various Form 1040 lines and schedules. Because of the significant number of erroneous notices (i.e., notices that lead to no-change cases), on Aug. 1, 2002, the IRS ceased issuing K-1 mismatch notices. It characterized its actions as a pause and promised to consult fully with interested parties before resuming the matching program. At a meeting in January 2003, the IRS previewed its plans for resuming a modified K-1 matching program, outlining both short- and long-range steps to improve K-1 matching. For the longer term, the IRS said it was evaluating modifications to Schedules K-1 (1065, 1120S and 1041) as well as to Schedule E. However, it does not expect any resulting changes to be effective until sometime in TY 2004. Until then, the IRS will process TY 2001 K-1 matches in a manner it hopes will drastically reduce the likelihood that taxpayers will receive notices that result in no changes. As this item went to press, the IRS was still finalizing its approaches, but provided an overview of the primary elements of the TY 2001 program. Notices will be issued when it appears information from a K-1 is completely absent on a return. When the information reflected on the K-1 and the corresponding returns and schedules mismatch significantly, the IRS will check to see if the taxpayer received a K-1 mismatch notice for the prior-return year. If a notice was received and a change resulted, the IRS will issue a TY 2001 notice. Conversely, if the prior-return-year notice resulted in a no-change, the IRS will not automatically issue a TY 2001 notice. The IRS reserves the right to issue a notice when the two primary conditions are not met (complete absence on return and prior-year adjustment), but a large discrepancy exists between the totals reported on the K-1s and the amount reflected on Form 1040. Despite its early foot faults, the IRS is committed to K-1 matching. Notwithstanding an unacceptably high level of no-change case results, Service personnel view the 2000 results as evidence that there is a sufficient level of noncompliance to warrant continued focus on K-1 matching. To its credit, the Service has accepted both the input and assistance from stakeholder groups and appears intent on tackling both the short- and long-range issues in collaboration with these groups. Even with the modified program in place, considerable potential for confusion remains. Tax professionals will continue to be called on to help IRS tax examiners reconcile differences that will often be the result of return preparation and software protocols, rather than actual underreporting. The good news is that the Service has taken several constructive steps toward eliminating the instances in which a taxpayer will be drawn into an unnecessary controversy. However, the K-1 matching program will continue to produce uneven results until the longer-term cures can be affected. Michael P. Dolan, J.D., National Director, IRSPolicies & Dispute Resolution, Washington National Tax, KPMG LLP, Washington, DC |
