Regularly, the Internal Revenue Service focuses its attention on new areas that may need regulation and tax scrutiny from the federal government. Because of the IRS’s reputation, it’s easy to confuse related initial contacts with audits, but the IRS has a very specific approach when it comes to creating new tax regulatory schemes over previously unregulated areas.

On the corporate tax side, it’s the IRS’ Large Business and International (LB&I) that handles much of the new compliance development. For 2018, the LB&I has specified five new target areas that either represent brand new regulation or enhanced attention from the tax agency. These include:

• S corporation distributions
• Cryptocurrency or virtual currency
• Transition tax
• AMT credits carryforwards, and
• Reorganizations

Again, a compliance campaign, which is the term used by the IRS, is not an audit contact per se. In many ways, the activity is a field research exercise by IRS analysts and management when developing a new regulatory scheme. The process begins with identifying a topic to be examined. Internally, the IRS then comes up with a draft mockup of how compliance should work with existing federal laws. However, the mockup is untested. Further, taxpayers will need to be trained on how any compliance addition or change should work, which requires additional planning and content to be developed correctly as well.

The field research comes in the form of what is known in tax jargon as a “soft letter.” It’s not an audit per se but the notice definitely counts as a potential red flag that a taxpayer should pay attention to. The communication is couched as an “inquiry” which 1) tells the taxpayer a specific activity may be an issue, and 2) it may ask for additional data from that taxpayer (basically to see how the issue plays out in real time). The combination of internal analysis recommendations within the IRS bureaucracy and the results from the inquiries then builds the case for the campaign conclusions, ultimately generating a new tax compliance change in final form. It’s important to understand as well that just because the LB&I seems to be focused on corporations by name, it doesn’t mean small businesses are off the hook. If the compliance view applies, a small business is just as vulnerable to a new compliance change as any corporation.

S Corporations

Given how much gray area there is on rules for S corporations, the IRS has pegged three specific areas for additional examination and potential compliance tightening.

The first involves property transfer to a shareholder. Specifically, a property distribution to a shareholder is expected to be reported to the IRS. No surprise, it could be considered as a gain from the IRS perspective.

The second has to do with omission on the part of the S corporation, failing to identify whether a given distribution is really a dividend or a transfer of ownership, either in cash or alternatively, as property.

Finally, the third area focuses on the S corporation shareholder who doesn’t report non-dividend distributions beyond what his or her stock basis was at the time, basically being seen as a taxable bonus.

These areas speak to how a shareholder is made whole for the initial property provided to the S corporation to get it started or enhance its growth. If the later distribution is within the basis amount of stock held by the shareholder, then it’s not taxable. If over, on the other hand, the tax gloves come off. Tracking, as in any business case, is the burden of the business for tax reporting, but some are failing, and the IRS is paying attention.

Cryptocurrencies

All over the news people are earning lots of money on Bitcoin investment and cryptocurrencies. However, in 2016, the IRS only received 802 personal tax returns showing a cryptocurrency taxable income. That was out of 132 million tax returns filed through e-file or electronic filing. Clearly, a good number of folks have decided that taxes don’t yet apply to their gains, which the IRS probably has a bit of a different opinion on (as well as the rest of the federal government). To true up the cryptocurrency world, which isn’t going away anytime soon, the IRS is now beefing up its apparatus to fully incorporate cryptocurrencies as a taxable income area for compliance. And that means that there is a very real possibility of an IRS contact coming to a mailbox near you sometime soon if you dabble in Bitcoins and the like.

Transition Tax

Under existing tax code (Section 965), a shareholder in the U.S. has to pay a transition tax when repatriating earnings from a foreign source corporation that has not already been taxed. This rule applies even if the funds, in fact, have not yet been repatriated. To many, this is essentially applying taxes to overseas income earned in another country simply because one is a U.S. shareholder. Most folks are not fully aware of this implication of Section 965, but now the IRS is going to make sure it’s widely known going forward.

AMT Credit Carryforward

Under certain circumstances, a corporation can utilize an Alternative Minimum Tax or AMT credit which can then be applied, or carried forward, to the next tax year. This means that if the company has higher losses than revenues in a given tax year, the losses can roll forward and be applied against revenues in the next year. So far, so good. However, in 1985 the federal laws were changed under the Balanced Budget and Emergency Deficit Control Act. In that bill, also commonly referred to as the Gramm-Rudman-Hollings Act, companies must also reduce their credit by what is known as a “sequestration rate.” This caps the losses to be claimed, meaning that there is no recovery whatsoever above a certain threshold. In other words, you don’t get to defer them to another tax year. However, some companies do so regardless. As a result, the IRS is now clamping down on this practice.

Reorganizations

Foreign triangular reorganization – that’s a term to say three times fast. Most folks would roll their eyes as soon as the topic comes up or think it has something to do with an account in the Bahamas. In reality, the matter has to do with companies that purchase or acquire stock of their parent corporation. The parent corporation then uses the funds to acquire a foreign company. In theory, the foreign company acquisition is assumed to be tax-free insofar as it is an offshore business transaction. The IRS has decided to challenge these “purchases” to be certain they are in fact, tax-free.