FS-2024-32, December 2024 The IRS is launching a new enforcement campaign and highlighting continued focus on improving taxpayer compliance among those with complex returns or those who intentionally evade tax responsibilities. Here are some of the latest issues the IRS is looking at: Deferred legal fees The IRS 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. How these transactions work: Plaintiff’s attorneys or law firms representing clients in lawsuits on a contingency fee basis may receive as much as 40% of the settlement amount that they then defer by entering an arrangement with a third party unrelated to the litigation, who then may distribute 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 this newly launched campaign is to ensure taxpayer compliance and consistent treatment of similarly situated taxpayers which requires the contingency fees be included in taxable income in the year the funds are transferred to the third party. Offshore tax evasion The IRS remains very focused on 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, there is still extensive work to be done to deter willful tax evaders. Often, certain schemes only come to light because of the courage of a whistleblower to come forward. How whistleblowers can help the IRS: Individuals with credible information that can assist the IRS in uncovering offshore tax evasion are encouraged to consider filing a whistleblower claim. The IRS pays monetary awards to eligible individuals whose information is attributable to taxes and other amounts collected by the IRS. 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 Form 8275, Disclosure Statement, is used by taxpayers and tax return preparers to disclose items or positions, except those taken contrary to a regulation, that are not otherwise correctly disclosed on a tax return in order to avoid certain penalties such as: Portions of the accuracy-related penalty due to disregard of rules, or Substantial understatement of income tax for non-tax shelter items if the return position has a reasonable basis. Reasonable basis is a relatively high standard of tax reporting 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. In its review of Form 8275 filings, the IRS has identified multiple filings that do not qualify as adequate disclosures that would justify avoidance of penalties. Form 8275 is not intended as a free pass on penalties for positions that are false. Examples of disclosure lacking a reasonable basis: The Tax Cuts and Jobs Act amended section 174 to require amortization of certain specified research or experimental expenses paid or incurred in taxable years beginning after Dec. 31, 2021. The IRS issued several items of guidance to address this change. Some taxpayers chose to disregard the law change and filed a Form 8275 indicating that they will wait to see if the law is changed, is repealed or will adopt the law change in a later year. Some disclosures received with respect to section 280E which disallows all deductions or credits for any amount paid or incurred in carrying on any trade or business that consists of illegally trafficking in a Schedule I or II controlled substance within the meaning of the federal Controlled Substances Act. This applies to businesses that sell marijuana, even if they operate in states that have legalized the sale of marijuana. Section 280E does not prohibit a participant in the marijuana industry from reducing its gross receipts by its properly calculated cost of goods sold to determine its gross income. A review of Form 8275 filings has revealed that some taxpayers have taken the position of disregarding the section 280E limitation using a variety of rationales that do not constitute reasonable basis. Taxpayers should be aware that Form 8275 disclosures that lack 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.
