The following are likely IRS exam/audit issues according information made available by the IRS
This includes approximately 57 million taxpayers that are self-employed, businesses with assets of less than $10 million, estate and gift return filers, and individuals filing Form 1040 with Schedules C, E, F or Form 2106 (Employee Business Expenses).
As of 2020, the following issues have been identified as areas of focus for audits:
- Underreporting. For example: Cash income.
- Improper worker classification. For example workers classified as independent contractors instead of employees.
- Underpayment. For example: payroll tax deposits.
Large & International Businesses and High Net Worth Individuals
This includes approximately 210,000 taxpayers that are corporations, subchapter S corporations, partnerships with assets greater than $10 million, individuals with $100,000 of tax due or assets or income in the tens of millions of dollars (IRS has not clarified the actual threshold for high net worth individuals), taxpayers with related entities, as well as international tax compliance.
As of 2017, the LB&I Division uses an issue-based approach to identifying exams/audits. Those issues are called 'campaigns' and are listed below:
- Allocation of Success-Based Fees Without Rev. Proc 2011-29
- Captive Services Provider
- Corporate Direct (Section 901) Foreign Tax Credit (“FTC”)
- Costs that Facilitate an IRC 355 Transaction
- Domestic Production Activities Deduction, Multi-Channel Video Program Distributors (MVPD's) and TV Broadcasters
- Energy Efficient Commercial Building Property
- Expatriation of Individuals
- FATCA Filing Accuracy
- FIRPTA Reporting Compliance for NRAs
- Foreign Base Company Sales Income: Manufacturing Branch Rules
- Foreign Earned Income Exclusion
- Forms 1042/1042-S Compliance
- Form 1120-F Chapter 3 and Chapter 4 Withholding
- Form 1120-F Delinquent Returns
- Form 1120-F Interest Expense/Home Office Expense
- Form 1120-F Non-Filer
- Forms 3520/3520-A Non-Compliance and Campus Assessed Penalties
- High Income Non-filer
- Individuals Employed by Foreign Governments & International Organizations
- Individual Foreign Tax Credit (Form 1116)
- Individual Foreign Tax Credit Phase II
- IRC Section 965 for Individuals
- IRC 199 – Claims Risk Review
- IRC Sections 41 and 174 Research Issues
- IRC 457A - Deferred Compensation Attributable to Services Performed before January 1, 2009
- IRC Section 807(d) - Computation of Life Insurance Reserves
- IRC Section 807(d) – Re-Computation of Life Insurance Reserves
- IRC 956 Avoidance
- IRC 965 - Treatment of Deferred Foreign Income Upon Transition to Participation Exemption System of Taxation
- IRC 6426 Fuel Credit
- Limitations on Consolidated Net Operating Loss Carryovers
- Loose Filed Forms 5471
- Micro-Captive Insurance
- Nonresident Alien Individual (NRA) Tax Credits
- Nonresident Alien Rental Income from U.S. Property
- Nonresident Alien Schedule A and Other Deductions
- Nonresident Alien Tax Treaty Exemptions
- Offshore Private Banking
- Offshore Service Providers
- Offshore Voluntary Disclosure Program (OVDP) Declines-Withdrawals
- Post Offshore Voluntary Disclosure Program (OVDP) Compliance
- Puerto Rico Act 22, Individual Investors Act
- Related Party Transactions
- Repatriation via Foreign Triangular Reorganizations
- S Corporation Distributions
- S Corporation Losses Claimed in Excess of Basis
- S Corporations Built in Gains Tax
- Sale of Partnership Interest
- SECA Tax
- Swiss Banking
- Syndicated Conservation Easement Transactions
- Taxable Asset Transactions – Matching Buyers and Sellers
- Tax Cuts and Jobs Act (TCJA)
- U.S. Territories – Erroneous Refundable Credits
- U.S. Territories Self Employment Tax
- Verification of Form 1042-S Credit Claimed on Form 1040NR
- Virtual Currency
A “Reportable Transaction” is generally a transaction of a type that the IRS has determined as having a potential for tax avoidance or evasion. There are five categories:
1. Confidential Transactions:
Transactions that are offered under conditions of confidentiality, such as where the disclosure of a transaction is limited in any manner by express or implied understanding agreement whether or not such understanding or agreement is legally binding for transactions in excess of $250,000 for corporations and $50,000 for other transactions.
2. Transactions with Contractual Protection:
These are transactions when the taxpayer has the right to a full or partial refund of fees paid to any person who makes or provides an oral or written statement about the potential tax consequences of a transaction if it is not sustained, or if fees are contingent on the taxpayer's realization of tax benefits from the transaction.
3. Loss Transactions:
- For individuals, at least $2 million in a single tax year or $4 million in any combination of tax years.
- For corporations (excluding S corporations), at least $10 million in any single tax year or $20 million in any combination of tax years.
- For partnerships with only corporations (excluding S corporations) as partners (looking through any partners that are also partnerships), at least $10 million in any single tax year or $20 million in any combination of tax years, whether or not any losses flow through to one or more partners.
- For all other partnerships and S corporations, at least $2 million in any single tax year or $4 million in any combination of tax years, whether or not any losses flow through to one or more partners or shareholders.
- For trusts, at least $2 million in any single tax year or $4 million in any combination of tax years, whether of not any losses flow through to one or more beneficiaries.
- A loss from a foreign currency transaction under Internal Revenue Code section 988 is a loss transaction if the gross amount of the loss is at least $50,000 in a single tax year for individuals or trusts, whether or not the loss flows through from an S corporation or partnership.
4. Transactions of Interest:
- Grantor-type trusts terminating and then being re-established: This transaction uses a grantor trust, and the purported termination and subsequent re-creation of the trust's grantor trust status, for the purpose of allowing the grantor to claim a tax loss greater than any actual economic loss sustained by the taxpayer or to avoid inappropriately the recognition of gain.
- Sale of an interest in a charitable remainder trust: A sale or other disposition of all interests in a charitable remainder trust (subsequent to the contribution of appreciated assets to and their reinvestment by the trust), results in the grantor or other noncharitable recipient receiving the value of that person's trust interest while claiming to recognize little or no taxable gain.
- U.S. Taxpayer who owns a foreign partnership or trust through another U.S. entity: A taxpayer uses a domestic partnership to prevent the inclusion of subpart F income. In this transaction a U.S. taxpayer that owns controlled foreign corporations (CFCs) that hold stock of a lower-tier CFC through a domestic partnership takes the position that subpart F income of the lower-tier CFC or an amount determined under section 956(a) of the Internal Revenue Code (Code) related to holdings of United States property by the lower-tier CFC does not result in income inclusions under section 951(a) for the U.S. taxpayer.
- Contribution of Successor Member Interest: A taxpayer directly or indirectly acquiring certain rights in real property or in an entity that directly or indirectly holds real property, transfers the rights more than one year after the acquisition to an organization described in § 170(c) of the Internal Revenue Code, and claims a charitable contribution deduction under § 170 that is significantly higher than the amount that the taxpayer paid to acquire the rights.
- Basket Contracts: Certain transactions denominated as an option, notional principal contract, forward contract, or other derivative contract to receive a return based on the performance of a basket of referenced assets (the “reference basket”). The assets that comprise the reference basket may include (1) interests in entities that trade securities, commodities, foreign currency, or similar property (“hedge fund interests”), (2) securities, (3) commodities, (4) foreign currency, or (5) similar property (or positions in such property). The Basket Contracts attempt to defer income recognition and may attempt to convert short-term capital gain and ordinary income to long-term capital gain.
- Micro-Captive Insurance: Transactions in which a taxpayer attempts to reduce the aggregate taxable income of the taxpayer, related persons, or both, using contracts that the parties treat as insurance contracts and a related company that the parties treat as a captive insurance company. Each entity that the parties treat as an insured entity under the contracts claims deductions for premiums for insurance coverage. The related company that the parties treat as a captive insurance company elects under § 831(b) of the Internal Revenue Code (the “Code”) to be taxed only on investment income and therefore excludes the payments directly or indirectly received under the contracts from its taxable income. The manner in which the contracts are interpreted, administered, and applied is inconsistent with arm's length transactions and sound business practices.
5. Listed Transactions:
- Accelerated Deductions for Contributions to Retirement Plans: This is a transaction in which a taxpayer claims a deduction for contributions made to a qualified retirement plan even though the related compensation is not earned by plan participants until after the end of the taxable year. The transaction is required to be reported even if the employer's liability to make the contribution is fixed before end of the year.
- Trusts Purported to be Multiple Employer Welfare Benefit Funds: These are certain multiple-employer trust arrangements that claim to satisfy the requirements for the 10-or-more employer plan exemption under IRC §§419 and 419A but where contributions are determined in a way that insulates each employer from the experience of other subscribing employers.
- ASA Investerings – Type Partnerships: These are transactions involving contingent installment sales of securities by partnerships to accelerate and allocate income to a tax-indifferent partner, such as a tax-exempt entity or a foreign person, and to allocate losses to a taxable partner.
- Short-term Charitable Remainder Trusts: This is a transaction in which a taxpayer contributes highly appreciated assets to a charitable remainder trust that has a short term and a high payout rate in order to convert the appreciated assets into cash while avoiding tax on any gain from the disposition. The trustee borrows funds to pay the annual distributions, which the taxpayer reports as non-taxable return of the trust corpus, then the assets are sold, the loan paid off, and the remainder interest distributed to the designated charitable beneficiary.
- “BOSS” (Bond-and-Option Sales Strategy): These are transactions involving the distribution of encumbered property in which taxpayers claim tax losses for capital outlays they have in fact recovered. These transactions typically involve taxpayers acting through a partnership to contribute cash to a foreign corporation in exchange for the corporation's common stock. The corporation then borrows money from a bank, giving the bank a security interest in the stock acquired by the foreign corporation that has a value equal to the amount borrowed. The corporation then distributes the security interest to the partnership, subject to the debt, and this distribution reduces the value of the remaining stock to zero.
- Fast-pay Stock Arrangements: Fast-pay stock is stock that is structured so dividends are economically a return of the holder's investment, as opposed to only a return on the holder's investment. Stock is presumed to be fast-pay if it has a dividend rate that is reasonably expected to decline, as opposed to fluctuate or remain constant, or if the stock is issued for an amount that exceeds the amount at which the holder can be compelled to dispose of it.
- Debt Straddles: These transactions involve the acquisition of two debt instruments that are structured so that value of one debt instrument increases while the value of other instrument decreases. These transactions attempt to recognize a loss on the sale of the instrument that decreases in value while not recognizing gain on the instrument that increases in value.
- Inflated Partnership Basis (Son of BOSS): These transactions generate losses by artificially inflating the basis of partnership interests. One of these types of transactions includes a taxpayer borrowing money at a premium, where the debt and the stated principal amount are different, and then contributing the proceeds to the partnership subject to the debt. In another transaction a taxpayer buys and writes options, and then creates positive basis in their partnership interest by transferring the option positions to the partnership.
- Improper Use of a Subsidiary in Stock Compensation Transactions: These transactions involve the purchase of a parent corporation's stock by a subsidiary, then a transfer of the purchased parent stock from the subsidiary to the employees of the parent company, and the eventual liquidation or sale of the subsidiary.
- Guam Trusts: This type of transaction is where a trust is set up that purportedly qualifies as both a domestic trust under U.S. law and a Guam resident trust for purposes of Guamanian law. Promoters claim these trusts are able to only pay income taxes to Guam, instead of to the U.S., on income derived from U.S.-based sources.
- Intermediary Transactions: These transactions have been used in the sale of corporate businesses. Shareholders of a corporation normally face double taxation on the sale of the corporation (the corporation pays tax on the gain from sale of its assets and then the shareholders pay tax on the gain from the liquidation of the corporation). Intermediary transactions attempt to satisfy both the buyer and seller through the use of a tax-indifferent third party. Basically, the shareholders will sell their corporate stock to a third-party intermediary. The original corporation, now owned by the intermediary, then sells some or all of its assets to a third outside buyer. The intermediary has existing net operating losses or credits and therefore the sale of the original corporation's assets is not fully taxable, thus avoiding the double taxation.
- Transfers Using Contingent Liabilities: These types of transactions involve the transfer of a high basis asset, i.e. an asset with a basis that approximates its fair market value, to a corporation purportedly in exchange for stock of the transferee corporation and the transferee corporation's assumption of a liability that the transferor has not yet taken into account for federal income tax purposes.
- Foreign Leverage Investment Portfolio (FLIP) & Offshore Portfolio Investment Strategy (OPIS): This type of transaction is a purported redemption of stock owned by a tax-indifferent party, e.g., a foreign party not subject to US taxes, that is treated as a dividend. A variety of devices, i.e., forward open contract, options, puts and calls, etc., are used to enable the redeemed shareholder to claim that it has continuing interests in the entity that is redeeming their stock. Promoters claim that all or a portion of the basis of the redeemed stock can be added to the basis of stock in the redeeming corporation owned by the taxpayer. Then, the taxpayer sells the stock and claims a loss.
- Inflated Basis Devices Using Loan Assumption Agreements (CARDs): These transactions involve the use of a loan assumption agreement to inflate the basis in assets acquired from another party to generate tax losses. Generally, these types of transactions have a taxpayer becoming liable for the debt of the transferor of assets where the debt has a stated principal amount exceeding the fair market value of the assets separately transferred to the taxpayer in consideration for its agreement to pay part of the loan. These losses are not allowable to the extent the benefit attributable to the basis exceeds the fair market value since the parties are liable for loan repayment in accordance with their relative ownership of the assets immediately after transfer to the taxpayer.
- Abusive Notional Principal Contract: These transactions involve the use of a notional principal contract to claim current deductions for periodic payments made by a taxpayer, while disregarding the accrual of a right to receive offsetting payments in the future.
- Partnership Straddle Tax Shelters: There are three different transactions that allow taxpayers to claim noneconomic losses that are listed. The first involves the use of a straddle, a tiered partnership structure, a transitory partner and the absence of a §754 election. The second type of transaction involves the use of a straddle, an S corporation (or a partnership) and one or more transitory shareholders or partners to claim a loss while deferring an offsetting gain. The third type of abusive partnership straddle is a transaction involving the use of economically offsetting positions, one or more tax indifferent parties and common trust fund accounting rules to allow a taxpayer to claim a noneconomic loss.
- Lease-in/Lease-out (LILO) Transactions: These are transactions in which a taxpayer leases property and then purports to immediately sublease it back to the lessor.
- Abusive ESOP/S Corporation Arrangements: These are arrangements involving the use of an ESOP-owned S corporation(s) to gain the tax advantages of an ESOP without actually giving employees participation in the ESOP. Typically, the owners of a profitable closely held operating corporation establish an ESOP-owned S corporation management company, which employs only the owners. Earnings of the operating company are stripped out via management fees, and the purported result is tax-deferred income to the owners without the participation of non-owner employees in the ESOP.
- Offshore Deferred Compensation Arrangements: This type of transaction is an arrangement involving leasing companies that have been used to avoid or evade federal income and employment taxes. Typically, an individual taxpayer terminates an existing employment relationship with a domestic corporation and then purports to lease his services back to his former employer through a foreign leasing corporation and then through a domestic leasing corporation.
- Abusive Collectively Bargained Welfare Benefit Funds: These are arrangements that are purportedly welfare funds that are bargained in good faith with a labor representative, are excepted from the account limits of §§419 and 419A and are currently deductible when paid. Typically under these types of arrangements the benefits that are provided to employees who are also owners are more favorable than the benefits provided to employees who are not owners.
- Compensatory Stock Option Sales to Related Parties: These transactions typically involve an individual transferring a compensatory stock option to a related person or through a family limited partnership, which “pays” for the option's value with a long-term, unsecured nonnegotiable note, calling for a balloon payment at end of the note's term. Promoters contend the individual doesn't recognize compensation for the purchase price of the option until the buyer/FLP pays the amount due on the note.
- Lease-strips or Stripping: Lease-strips are transactions in which one tax-indifferent participant claims rental or other income from property or service contracts while another, taxable, participant claims the deductions related to that income. The lease-strip transactions promoted also apply to licenses of intangible property, service contracts, leaseholds or other non-fee interests in property and the prepayment, front-loading or retention (rather than assignment) of rights to receive future payments.
- Contested Liability Acceleration Strategies (CLAS): These are transactions that use contested liability trusts improperly to accelerate deductions for contested liabilities. Proponents claim these transfers allow a taxpayer to deduct a contested liability in a year before the ultimate resolution of liability. These trusts fail to qualify because the taxpayer has not transferred the consideration outside of their control. Three types of transfers illustrate this concept: (1) the taxpayer retains powers over the trust assets; (2) transfer to the trust of related party notes under circumstances indicating the liability is not genuine or there is no intent between the parties to enforce the obligation; or (3) the taxpayer uses the trust for contested tort, workers compensation or other liabilities, for which economic performance requires payment to the claimant.
- Offsetting Foreign Currency Option Contract Transactions: This is a transaction in which a taxpayer claims a loss on the assignment of a §1256 contract to a charity but fails to report the recognition of gain when the taxpayer's obligation under an offsetting non-§1256 contract with a gain position terminates.
- Roth IRA Abuses: These transactions are designed to avoid the annual limitations on contributions to Roth IRAs. Examples include transactions in which a Roth IRA-owned “Corporation” acquires property, such as accounts receivable, from a business for less than fair market value; contributions of property, including intangible property, by a person other than the Roth IRA, without a commensurate receipt of stock ownership; or any other arrangement between the Roth IRA “Corporation” and the taxpayer, a related party or a business that has the effect of transferring value to the Roth IRA corporation comparable to a contribution to the Roth IRA.
- Prohibited Allocations of Securities in an S Corporation: These are transactions that involve segregating the business profits of an ESOP-owned S corporation into a qualified subchapter S subsidiary so that the rank-and-file employees do not benefit from participation in the ESOP.
- Abusive Transactions Involving Insurance Policies in Section 412(i) Retirement Plans: In these arrangements, an employer deducts contributions to a qualified pension plan for premiums on life insurance contracts that provide for death benefits in excess of the participant's death benefit, where under the terms of the plan, the balance of the death benefit proceeds revert to the plan as a return on investment.
- Abusive Foreign Tax Credit Transactions: These transactions are where, pursuant to a prearranged plan, a domestic corporation purports to acquire stock in a foreign target corporation and then make an election under §338 (treating the purchase as a purchase of corporate assets rather than corporate stock) then selling all or substantially all of the target corporation's assets in a preplanned transaction that generates a taxable gain for foreign tax purposes (but not for U.S. tax purposes).
- S Corporation Income Shifting to Tax Exempt Organizations: In these transactions shareholders of an S corporation attempt to transfer the incidence of taxation on S corporation income by purportedly donating S corporation nonvoting stock to an exempt organization while retaining the economic benefits associated with that stock.
- Intercompany Financing through Partnerships: These are transactions in which corporations claim inappropriate deductions for payments made through a partnership. Typically these transactions include an affiliated group of entities, including a foreign person/entity, and shift the US tax burden through the use of guaranteed payments and other non-economically motivated allocations.
- Sale-in/Lease-out Arrangements: This type of transaction is one in which a taxpayer enters into a purported sale-leaseback with a tax-indifferent person in which substantially all of the tax-indifferent person's payment obligations are economically eliminated and the taxpayer's risk of loss from a decline, and opportunity for profit from an increase, in the value of the leased property is limited.
- Loss Importation Transactions: These transactions involve a U.S. taxpayer using offsetting positions with respect to foreign currency or other property for the purpose of importing a loss, but not the corresponding gain, in determining U.S. taxable income.
- Abusive Trust Arrangements Utilizing Cash Value Life Insurance Policies Purportedly to Provide Welfare Benefits: These are transactions in which certain trust arrangements claiming to be welfare benefit funds and involving cash value life insurance policies improperly claim federal income and employment tax benefits. The trust arrangements utilize cash value life insurance policies and purport to provide welfare benefits to active employees, and are promoted to closely held businesses as a way to provide cash and other property to the owners of the business on a tax-favored basis. These arrangements are sometimes called “single employer plans” or 419(e) plans and advocates of these transactions claim that the employers' contributions to the trust are deductible, but there is not a corresponding inclusion in the owner's income.
- Distressed Asset Trust (DAT): This is a transaction in which a tax-indifferent party, either directly or indirectly, contributes one or more distressed assets, assets with high basis and low market value, to a trust or series of trusts and sub-trusts, and a U.S. taxpayer acquires an interest in the trust for the purpose of shifting built-in loss from the tax-indifferent party to the U.S. taxpayer.
- Basket Option Contracts: This notice describes certain transactions involving a contract that is denominated as an option referencing a basket of actively traded personal property. The Basket Option Contract attempts to defer income recognition and convert short-term capital gain and ordinary income to long-term capital gain using a contract denominated as an option contract. This notice was published in the Internal Revenue Bulletin on November 16, 2015. This notice was previously listed under Notice 2015-47 which was revoked.
- Syndicated Conservation Easement Transactions: This notice describes certain transactions in which some promoters are syndicating conservation easement transactions that purport to give investors the opportunity to obtain charitable contribution deductions in amounts that significantly exceed the amount invested. The promoters identify a pass-through entity that owns real property, or form a pass-through entity to acquire real property. Additional tiers of pass-through entities may be formed. The promoters then syndicate ownership interests in the pass-through entity or tiered entities that owns the real property, suggesting to prospective investors that they may be entitled to a share of a charitable contribution deduction that equals or exceeds two and one-half times the amount of the investor's investment. The promoters obtain an inflated appraisal of the conservation easement based on unreasonable conclusions about the development potential of the real property. The entity then donates a conservation easement encumbering the property to a tax-exempt entity. Investors then claim a charitable contribution relying upon the pass-through entity's holding period.