On March 13, 2018, the IRS Large Business and International division (LB&I) announced the identification and selection of five additional compliance campaigns, as part of its move toward issue-based examinations. The initial rollout began on January 31, 2017, with the announcement of 13 campaigns, followed by an additional 11 campaigns announced on November 3, 2017. See prior Tax News and Developments article, IRS’s LB&I Division Releases Five New Transfer Pricing Directives (March 2018).
The campaigns are the culmination of an extensive effort to redefine large business compliance work and build a supportive infrastructure inside LB&I. Each campaign was identified through LB&I data analysis and suggestions from IRS compliance employees. The goal is to improve return selection, identify issues representing a risk of non-compliance, and make the greatest use of limited resources.
Of the five most recently announced campaigns, three are in the practice area of pass-through entities. Taxpayers in this practice area should be aware of these campaigns and undertake efforts to avoid falling within their scope.
The first campaign is aimed at limited partners and limited liability company (LLC) members who render services on behalf of the partnership or LLC but do not report flow-through income as earnings from self-employment and, thus, do not pay self-employment tax under the Self-Employment Contributions Act (SECA) on such income.
Generally, if a partner is an individual who renders services on behalf of a partnership, the partner’s distributive share of income is subject to SECA tax. There is an exception under Code Section 1402(a)(13), which excludes from the definition of “net earnings from self-employment” the distributive share of any item of income or loss of a limited partner, as such, other than certain guaranteed payments. However, the exception has been interpreted narrowly under case law. For example, in Renkemeyer, Campbell & Weaver, LLP, et al. v. Commissioner, 136 T.C. 137 (2011), the Tax Court held that attorney-partners of a law firm set up as a limited liability partnership (LLP) were not limited partners for purposes of Section 1402(a)(13) because the distributive shares received “arose from legal services they performed on behalf of the law firm” and “did not arise as a return on the partners’ investment.”
LB&I’s goal in this campaign is to increase compliance with the law as supported by several recent court decisions. The “treatment streams” for this campaign include issue-based examinations and outreach to practitioners, professional service provider associations, and software vendors.
Partnership Stop Filer
The second campaign targets partnerships that stop filing tax returns for various reasons, yet still have economic transactions that are not being reported to their partners. Consequently, such partnership activity likelyis not being reported by the partners to the IRS. The treatment streams for this campaign include issue-based examinations, soft letters encouraging voluntary self-correction, and stakeholder outreach.
Sale of Partnership Interest
The third campaign addresses taxpayers who either fail to report the sale of a partnership interest or do not report the resulting gain or loss correctly. Generally, the sale or exchange of a partnership interest results in capital gain or loss under Code Section 741. If a partner held its interest for more than one year, the long-term capital gain generally is taxed at a maximum rate of 20 percent. Higher capital gain rates may apply to the extent of depreciated real property (25 percent) or appreciated collectibles (28 percent). In addition, a portion of the gain or loss may be recharacterized as ordinary income or loss to the extent of any “hot assets” of the partnership (i.e., inventory items or unrealized receivables) at the time of the sale or exchange.
For purposes of this campaign, incorrect reporting includes not only the amount of the gain or loss but also the rate applicable to such gain or loss (e.g., reporting the entire gain as long-term capital gain when a portion of the gain is ordinary income or taxed at the 25-percent or 28-percent long-term capital gain rates). A variety of treatment streams are set forth to address taxpayer noncompliance, including examinations and, when appropriate, soft letters. Additional treatment streams include practitioner and taxpayer outreach, tax software vendor outreach, and tax form and publication change suggestions.
The above campaigns can be accessed here.