May 29, 2018 IRS announces six new LB&I campaigns On May 21, 2018, the IRS Large Business and International Division (LB&I) identified six new campaigns that expand the focus areas under its issue-based examination program. These campaigns are in addition to the 13 campaigns announced on January 31, 2017 (see Tax Alert 2017-0234), the 11 campaigns announced on November 3, 2017 (see Tax Alert 2017-1876) and five campaigns announced on March 13, 2018 (see Tax Alert 2018-0577). Campaigns are designed to select returns with identified potential compliance risks. As before, LB&I plans to address noncompliance through a variety of treatment streams, including issue-based examinations, traditional examinations and outreach/education. LB&I stated that the six campaigns were identified through LB&I data analysis and suggestions from IRS compliance employees. LB&I's stated goal for its campaigns is to improve return selection, identify issues representing a risk of non-compliance and make the greatest use of limited resources. In the announcement, LB&I briefly explained the issue, described the treatment streams, and named the lead LB&I executive and practice area. Withholding & International Individual Compliance Practice Area 1. F3520/3520-A non-compliance and campus assessed penalties The IRS will focus on improving compliance for the timely and accurate filing of information returns reporting ownership of and transactions with foreign trusts. This campaign will use a variety of treatment streams to address noncompliance, including examinations and penalties when the forms are received late or are incomplete. 2. Forms 1042/1042-S compliance Withholding, deposit and reporting requirements apply to taxpayers that pay US-source income to foreign persons. The campaign description indicates that the IRS will focus on withholding agents that make such payments but fail to meet all of the associated compliance obligations. The IRS will use a variety of treatment streams to address noncompliance and errors, including examination. 3. Nonresident alien tax treaty exemptions According to the IRS, some nonresident alien (NRA) taxpayers improperly claim treaty benefits and exempt US-source income from taxation because they: (1) misunderstand or misinterpret applicable treaty articles; (2) provide incorrect or incomplete forms to withholding agents; or (3) rely on incorrect information returns provided by US payors. The campaign's focus will be on increasing compliance in NRA individual tax treaty exemption claims related to both effectively connected income and fixed, determinable, annual periodical income. The IRS will use various treatment streams to address noncompliance, including outreach/education and traditional examinations. 4. NRA Schedule A and other deductions The IRS pointed out that some NRA taxpayers: (1) may misunderstand or misinterpret the rules for allowable deductions under the previous and new Code provisions; (2) do not meet all the qualifications for claiming the deduction; or (3) do not maintain proper records to substantiate the expenses claimed. Through this campaign, the IRS intends to increase compliance in the proper deduction of eligible expenses by NRA individuals on Form 1040NR Schedule A. The IRS will use various treatment streams, including outreach/education and traditional examinations. 5. NRA tax credits Some NRA taxpayers erroneously claim certain dependent related tax credits even though they: (1) have no qualifying earned income; (2) do not provide substantiation/proper documentation; or (3) do not have qualifying dependents. Some NRA taxpayers also claim education credits (which are only available to US persons) by improperly filing Form 1040 tax returns. The IRS will use various treatment streams to address noncompliance, including outreach/education and traditional examinations. Enterprise Activities Area 6. Interest capitalization for self-constructed assets Section 263A requires taxpayers to capitalize interest expense when they engage in certain production activities. Interest capitalization applies to interest a taxpayer pays or incurs when producing designated property. Section 263A(f) defines designated property as any real or tangible personal property that has: (1) a long useful life (depreciable class life of 20 years or more); or (2) an estimated production period exceeding two years; or (3) an estimated production period exceeding one year and an estimated cost exceeding $1 million. The campaign will focus on ensuring taxpayer compliance by verifying that taxpayers are properly capitalizing interest for designated property and the calculation to capitalize the interest is accurate. According to the campaign description, the treatment stream for this campaign will be issued-based examinations, education soft letters and educating taxpayers and practitioners to encourage voluntary compliance. Implications As noted, five of these six campaigns are in the international area.This continues LB&I's increasing focus on international tax compliance.The fact that there are now 35 campaigns also reflects LB&I's determination to move to an issue-based examination program in which a return is selected for audit because of an identified issue.LB&I has previously stated that its goal is to have campaigns account for more than 50% of its examination program. For all campaigns, taxpayers should continue to ask their examination team to confirm whether their audit, or any issues on their audit, are part of a campaign.If a taxpayer could potentially be the recipient of a "soft letter" as part of a campaign, the taxpayer should ensure that such a letter is routed to the right personnel in its organization. Specific implications for business travelers and withholding Since a few of these campaigns address payments to NRAs, withholding agents that make payments for services, royalties, license fees, rents, interest, dividends and other fixed or determinable, annual or periodical payments may benefit from reviewing the effectiveness of policies, procedures and controls of the various paying functions within the organization that address the relevant requirements.Withholding agents that make these payments must: (1) determine the US vs non-US status of the recipient; (2) determine the source of income paid; (3) collect and validate withholding tax certificates (e.g., IRS Form W-8 series), including treaty claims;(4) determine amounts to withhold and deposit; and (5) report on Form 1042 and 1042-S at year end. In addition to reviewing procedures, it may also be helpful to give a sound check to the Forms 1042 and 1042-S that the organization files to see if they are properly completed and include payment types and amounts that the organization expects it would generally pay.Reviewing these items may allow a company to identify areas of high risk and allow it to remedy the matter before any IRS action. With the increased focus on taxation of nonresidents under the new campaigns, companies/employers should review their procedures for reporting and withholding requirements for their business travelers as well as their procedures associated with payments to any other non-US vendors and other payees.Failure to properly report income and withhold tax will result in penalties and withholding tax liability. Employers should review whether their cross-border travelers are filing required income tax returns. As part of the new campaign, the IRS indicates that it will include outreach and education for nonresident taxpayers. The IRS already provides detailed explanations of the tax rules for nonresidents in the instructions to Form 1040-NR and Publication 519. The rules can be very confusing, however, which the IRS seems to be acknowledging as part of the new campaigns. Lack of monitoring of an organization's cross-border business travelers can create risks in a number of areas, including immigration, permanent establishment, employment tax, regulatory compliance, employee exposure, and the reputation of the enterprise. The recently announced campaigns may amplify these areas of risk and will require careful monitoring of a company's business travelers. ———————————————
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