Don't Mess With Taxes

Photo by cottonbro studio

Last week, the Internal Revenue Service Criminal Investigation unit released its fiscal year 2024 annual report that touted the success the agency’s law enforcement branch had in taking down tax criminals. Yes, Al Capone’s name was mentioned.

This week it’s the overall IRS’ turn to brag.

In its quarterly update on Dec. 12 to its Strategic Operating Plan, the IRS detailed accomplishments that have, among other things, allowed the IRS to recovered $4.7 billion in taxpayer dollars.

More than $1.3 billion of that total comes from wealthy, high-income individuals who have not filed taxes or paid overdue tax debt. Approximately $2.9 billion is related to the aforementioned IRS-CI work into tax and financial crimes. And another $475 million comes from proceeds in criminal and civil cases attributable to whistleblower information.

IRS launches new enforcement campaign: “The IRS continues to show dramatic progress on a wide array of the agency’s transformation efforts, producing real-world improvements to help taxpayers and businesses while also taking important steps in the law-enforcement and compliance arena to protect billions from ongoing schemes, ensure high-income individuals file returns and pay their taxes and penalties, and battle everything from terrorist financing to drug traffickers,” said IRS Commissioner Danny Werfel.

But the IRS is not resting on its laurels. The agency this week also announced the launch of a new enforcement campaign.

These next steps, says the IRS, also will continue to work on ways to improve taxpayer compliance among those with complex returns or those who intentionally evade tax responsibilities.

An IRS Fact Sheet highlights some of the areas in the initiative. Below are some of the areas of tax focus.

Deferred legal fees: The IRS has launched an examination campaign to address a tax deferral transaction where taxpayers, specifically plaintiff’s attorneys or law firms, fail to report legal fees earned from representing clients in litigation on a contingency fee basis.

These deferred fees have multiple components.

First, plaintiff’s attorneys or law firms representing clients in lawsuits on a contingency fee basis may receive as much as 40 percent of the settlement amount that they then defer by entering an arrangement with a third party unrelated to the litigation.

This third party then may distribute funds to the taxpayer in the future, generally 20 years or more from the date of the settlement.

The taxpayer fails to report the deferred contingency fees as income at the time the case is settled or when the funds are transferred to the third party. Instead, the taxpayer defers recognition of the income until the third party distributes the fees under the arrangement.

The goal of the newly launched IRS enforcement campaign is to ensure taxpayer compliance and consistent treatment of similarly situated taxpayers. This requires the contingency fees be included in taxable income in the year the funds are transferred to the third party.

Offshore tax evasion: Taxpayers or their agents sheltering taxable income in foreign accounts is an ongoing area of IRS interest, particularly offshore tax evasion through unreported financial accounts and structures. 

While the IRS is employing existing tools and data analytics to address the various forms of offshore tax evasion that undermine fairness in the tax system, the agency acknowledged that it still have extensive work ahead to deter willful tax evaders.

Often, certain offshore schemes only come to light because of whistleblowers.

Tax whistleblowing process: To ensure that such whistleblower information can be maximized, the IRS reminds those with credible information to properly file a claim with the IRS Whistleblower Office.

The IRS pays monetary awards to eligible individuals whose information is attributable to taxes and other amounts collected by the IRS.  The award percentage depends on several factors, but generally falls between 15 and 30 percent of the proceeds collected and attributable to the whistleblower's information.

Whistleblower awards, however, can only be issued once a final determination can be made. Plus, award payments cannot be made until the taxpayer has exhausted all appeal rights and the taxpayer no longer can file a claim for refund or otherwise seek to recover the proceeds from the government.

In fiscal year 2024, the IRS paid awards totaling approximately $123 million based on tax and other amounts collected of approximately $475 million attributable to whistleblower information.

Proper use of Form 8275: The IRS also is looking to ensure that Form 8275, Disclosure Statement (excerpt below), is filed properly. This form is used by taxpayers and tax return preparers to disclose items or positions, except those taken contrary to a regulation, that are not otherwise adequately disclosed on a tax return in order to avoid certain penalties.

See more tax forms and more about them at Tax Forms 2024.

Form 8275 is not intended as a free pass on penalties for positions that are false, the IRS emphasizes. It also notes that the key to a Form 8275 filing is that the position taken by the taxpayer has a reasonable basis.

However, the IRS points out that reasonable basis is a relatively high standard of tax reporting, one that is significantly higher than not frivolous or not patently improper. The reasonable basis standard is not satisfied by a return position that is only arguable.

The IRS says that in its review of Form 8275 filings, it has identified multiple instances that do not qualify as adequate disclosures that would justify avoidance of penalties.

The bottom line is that Form 8275 disclosures lacking a reasonable basis do not provide penalty protection. Taxpayers in this posture should consult a tax professional or advisor to determine how to come into compliance.

Tax Felon Friday: While the IRS’ Strategic Operating Plan update and Fact Sheet on the agency’s new enforcement initiative aren’t aimed solely at those who willfully evade taxes, the agency’s commitment to making sure tax laws are followed earns featuring in this week’s Tax Felon Friday.

It is always better for the IRS and taxpayers to stop questionable tax actions before they expand to full-fledged criminal prosecution. The IRS doesn't have to spend added effort, agent time, and taxpayers money on cases, and taxpayers can correct error situations before they get out of hand.

If you want to catch up on all sorts of tax miscreants, including those who have ended up in the court system, the ol' blogs' special Tax Felon Friday page is a good place to start.

And if you want more tax crime posts, notably those that were published long before I gave them a special end-of-week feature, you can peruse, what else, the tax crimes category. You'll find this post at the top of that collection right now, so just scroll down for more.

You also might find these items of interest:

• Offshore tax loophole helps U.S. tax cheats
• Second defendant in alleged vast connected federal tax evasion network dies
• IRS Whistleblower Office awards more than doubled in FY23, but it still faces substantial backlog

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