Tax Blog/Blawg

As a follow up to my colleague George Connelly's earlier post concerning the IRS's recently announced "Global High Wealth" Industry Group, I offer some further thoughts on what the IRS is attempting to do with this new group focusing on wealthy individuals.  The IRS recently announced that the group has issued its first batch of audit letters and the audits of wealthy individuals will soon commence.

The IRS has created the group in the LMSB division, which generally handles audits of the largest corporations under a "team" audit concept.  A team audit means that the IRS assigns several agents to the case, including, where appropriate, specialists in areas like international taxes, financial products, and employment taxes, as well as engineers and economists.

The IRS is concerned with very wealthy individuals who own multiple entities using complicated structures to avoid U.S. federal income taxes.  The individuals may be operating foreign businesses or may have foreign investments through foreign trusts, partnerships, or corporations.

Last summer, the Ninth Circuit Court of Appeals handed the IRS a defeat that the IRS did not take lightly.  The Ninth Circuit ruled that an overstated basis, no matter how large, is simply not omitted income.  See Bakersfield Energy Partners, LP v. Commissioner , 568 F.3d 767 (2009).  The key to the decision is the definition of a four letter word, omit, which means “left out,” whereas an overstated basis by definition is stated on the return, i.e., not left out.  Without an omission of income, the three year statute of limitations applies, not the extended six year period.  The Ninth Circuit relied heavily upon a Supreme Court decision that came to the same conclusion.  Colony, Inc. v. Commissioner, 357 U.S. 28 (1958).

After Bakersfield, the IRS suffered a series of losses.  Not one to stand idly by, the IRS took matters into its own hands and seized upon a small opening left in the Ninth Circuit's decision: "The IRS may have the authority to promulgate a reasonable reinterpretation of an ambiguous provision of the tax code, even if its interpretation runs contrary to the Supreme Court's 'opinion as to the best reading' of the provision. . . . We do not." Bakersfield, 568 F.3d at 778 (citations omitted).  With that, the Treasury Department issued Temp. Reg. §§ 301.6229(c)(2)-1T and 301.6501(e)-1T, which provided "an understated amount of gross income resulting from an overstatement of unrecovered cost or other basis constitutes an omission from gross income."  With the new regulation in hand, the IRS went about attempting to overturn a series of unfavorable decisions.

The New York Times and Forbes Magazine are reporting on a study by the Transactional Records Access Clearinghouse, a research group affiliated with Syracuse University, which claims to show that the number of audits of corporations reporting assets of $250 million or more has dropped between 2005 and 2009, while audits of smaller companies have increased during that same time.

Believing that the IRS has misallocated its resources, TRAC blames this development on a "perverse quota system" within the IRS.  The IRS, however, disputes the study's findings.  From the NY Times article ...

President Obama's health-care legislation is becoming more of a tax issue on a daily basis.  In addition to the codification of economic substance (discussed here; see also yesterday's TNT story featuring our own Phil Karter) contained in the reconciliation bill, the consequences of the legislation seem to be increasingly a matter of tax, rather than health-care, policy.

Of particular relevance here is the brewing confrontation between Reps. Waxman and Stupak and the companies who have announced substantial hits to their financial statements as a result of provisions in the health-care legislation. In response to these announcements, Reps. Waxman and Stupak have requested that companies provide documentation verifying their assessment of the impact of the legislation and have indicated an intention to hold a hearing to examine the impact of the new law on these companies.  (Presumably, the documentation provided by the companies will be a central basis for whatever questions are directed at the executives who appear at these hearings.)

Without taking a position about the politics of the matter, the dynamics of the request (and any responses to it) may implicate sensitive areas of tax policy and procedure. At this point, Reps. Waxman and Stupak have merely requested that the corporate taxpayers provide information about the impact of the health-care legislation. Suppose, though, that one or more companies decline to produce the requested information.  The perceived costs and benefits of the health-care legislation are likely to be key issues in the upcoming Congressional races this fall.  If the request is declined, and Congressional Democrats fear that their signature achievement is being negatively perceived, would subpoenas to the taxpayers, demanding that they produce the information, come next?

Assuming that scenario, would taxpayers then be obligated to provide the information being sought?  Perhaps more importantly, would Congress be authorized to use that information in a public hearing?