IRS Voluntary Disclosure Practice update and pushout adjustments under CPAR

Examinations

The IRS recently updated Form 14457, Voluntary Disclosure Practice Preclearance Request and Application, and the form’s instructions. The Voluntary Disclosure Practice (VDP) generally offers criminal protection for taxpayer noncompliance in exchange for six years of tax returns and a civil fraud penalty. The recent updates to VDP include the following highlights:

• The revised instructions establish that the VDP can be used, under certain circumstances, to resolve estate tax liabilities. The prior version of the VDP instructions said that estates were ineligible for the VDP. This is welcome news for executors that may face personal liability.
• The revised instructions leave open the possibility for willful foreign bank account reporting penalties (FBAR penalties). Willful FBAR penalties, which equal 50% of the bank account balance each year, can be very large. Consequently, taxpayers should carefully evaluate whether to enter the VDP or the Streamlined Filing Compliance Procedures, which was created for non-willful taxpayers.
• The instructions also make clear that the VDP is unavailable to taxpayers engaged in illegal activity. As an example, because the sale of cannabis is illegal under federal law, the IRS excludes these taxpayers from the VDP.

Practitioners should carefully evaluate the partner-level implications of any pushout election under the centralized partnership audit regime (CPAR). Partners complete and attach IRS Form 8978 to their income tax returns in the year the pushout statement is received. TACS has confirmed that IRS’s Office of Chief Counsel takes the position that when a CPAR partnership files an Administrative Adjustment Request, any negative adjustments that reduce a partner’s tax liability act as nonrefundable credits for the partners in the statement year. A nonrefundable credit could produce a disastrous result for clients. Consider the following example:

• Partner A reports a 2018 tax liability of $200,000.
• During the 2020 calendar year, Partner A receives a partnership a pushout statement, Form 8986, allocating an additional $100,000 of depreciation related to the 2018 tax year.
• Partner A has no 2020 tax liability.
• Partner A’s 2020 Form 8978, which will be attached to the partner’s income tax return, reports a $37,000 credit (37% x $100,000). Because Partner A has no 2020 income tax liability, Partner A cannot recover the $37,000 reduction in tax that resulted from the Form 8986.

Revenue Procedure 2020-23 provides some temporary relief, under which partnerships can avoid this disastrous result through Sept. 30, 2020. For more details, please see the May 2020 TACS newsletter and our step-by-step process of AARs under CPAR.

Notices and collections

The IRS' People First Initiative effectively put a hold on most IRS examination and enforcement action through July 15, 2020. The IRS has informally stated that the due date to respond to Notices was tolled during the time in which the People First Initiative was in effect. Through discussions with IRS colleagues, TACS has learned that Aug. 1, 2020 is the date on which the IRS will restart the tolling of the time frame to respond to IRS Notices. For instance, a taxpayer that received an IRS Notice, dated May 1, 2020, would generally have 30 days to respond. While best practice is clearly to respond to this Notice by May 31, 2020, it appears that IRS will consider any response before Aug. 31, 2020 to be timely.

On July 2, 2020, the IRS released a practice unit to explain how to administer reasonable cause for purposes of penalty abatement to IRS agents. Unfortunately, the reasonable cause practice unit is almost entirely a reorganization of what was already contained within various provisions of the Internal Revenue Manual. TACS recommends the following with respect to penalty abatements:

• Whenever possible, request penalty abatement over the phone. The IRS is unlikely to process written penalty abatement requests any time soon due to extreme backlogs created by COVID-19.
• First-time abatement is often the easiest way to resolve a client’s penalty case; however, first-time abatement is not available for all penalties.
• Where a written request for penalty abatement is required, be sure to obtain collection holds on a client’s account. Most penalties in the Internal Revenue Code are assessed and collectible without first requiring deficiency procedures. As such, collection holds are extremely important, as the IRS is unlikely to process paper-filed abatement requests in the near future.
• Clients that are extremely sensitive to federal tax liens should consider paying any assessed penalties. This is the only way to be 100% certain that a lien will not be filed.

For more information on this topic or to learn how Baker Tilly specialists can help, contact our team.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.