Evolution of the Tax Home Concept as a Legal Term of Art

Anthony Malik*

INTRODUCTION

Tax home is, particularly when considered in an international context, a curious legal term with a specific meaning that is at odds with what it superficially suggests. Counterintuitively enough, it does not patently mean the location where one files, pays, or is otherwise responsible for income taxes.[1] It also does not patently mean the location of one’s residence. Rather, the term has a primarily vocational meaning that was concretized over time through judicial precedent.[2] The peculiarity of the meaning of this term, the false sense it conveys, warrants the exploration of its origin and evolution.

This paper takes a chronological approach to unfurl the particulars of several noteworthy court cases that appreciably contributed to the development of tax home as a term of art in the tax law. The limited discussion herein as to what constitutes a tax home and where it is located is incidental to the discussion of how a plain-English language word metamorphosed into a term of art over the course of legal history and is not itself the prime constituent of the thesis of this paper.

The central discussion will begin with when the plain-English language word home first appeared in an early American tax statute for a specific purpose. The paper will then consider how the courts subsequently construed the relevant statutory text within the factual contexts they were presented. The paper will finally come full circle by leading to the moment and purpose for which the eventually-developed term, after being imbued with special significance through a series of judicial actions, was first codified into statute.

THE ESSENTIAL CHRONOLOGY OF CONCEPTUAL DEVELOPMENT

Doctrinal Prehistory

The origin of the tax home concept can be traced all the way back to Section 214(a)(1) of the Revenue Act of 1921 when Congress first authorized a deduction for “traveling expenses (including the entire amount expended for meals and lodging) while away from home in the pursuit of a trade or business.”[3]  Home, as used in the Revenue Act of 1921, was not imbued with any special significance and was therefore meant to be understood in its ordinary linguistic sense. In enacting this rule, Congress apparently did not go beyond the consideration that taxpayers’ domestic and vocational lives may be centered in the same location. This observation is in no way meant to imply a shortcoming on the part of Congress since this was the arrangement in most, if not virtually all, cases at the time. Unironically, humankind’s propensity to conjure infinite sets of facts would destine this provision to be tested with rigor.

The first court case[4] involving a traveling expenses deduction dispute did not have to contend with the expected, thorny issues of ascertaining the constitution and location of the taxpayer’s home.[5] The taxpayer, a field investigator for the Bureau of Pensions, according to the text of the case, in line with both usual arrangements and Congress’ expectations, evidently simultaneously lived and primarily worked in Washington, D.C.

The only point of contention in this case was the deductibility of otherwise deductible traveling expenses incurred by the taxpayer while working outside of Washington, D.C. The Commissioner had denied taxpayer’s claim for reasons indiscernible from a reading of the text of the case. Nonetheless, what is illuminating for purposes of this paper is that the text of this case is suggestive that the court construed home, in all likelihood in accordance with Congressional intent, in its ordinary sense when it stated that the taxpayer was “away from home in connection with his employment” (i.e., the location of his employment was away from his residential home). It would not be long before the simplicity of home would lead to doubts.

Home as a Word of Art

Eventually home, within the context of the traveling expenses deduction, was initially suggested a vocational meaning by the court in Bixler v. Commissioner.[6] This case dealt with a taxpayer who maintained a residence in Alabama where his family lived, while he himself lived and worked in Louisiana and Texas for two years before returning to Alabama. The court upheld the Commissioner’s denial of the deductions claimed by taxpayer for the expenses he had incurred in traveling to and from, and for meals and lodging in, Louisiana and Texas under the rationale that one could not, based on personal preferences, reside in a location distant from one’s place of business or employment and still claim a deduction for such personally-motivated expenditures. In the words of the court:

“A taxpayer may not keep his place of residence at a point where he is not engaged in carrying on a trade or business, as this petitioner testified was true in this instance, and take a deduction from gross income for his living expenses while away from home. We think section 214(a)(1) intended to allow a taxpayer a deduction of traveling expenses while away from his post of duty or place of employment on duties connected with his employment.”

The articulation of the court’s reasoning above is noteworthy because it unambiguously acknowledged that Alabama was taxpayer’s home but nonetheless denied him the deduction for his traveling expenses on the basis that the taxpayer’s claim was not in line with what it thought was the spirit, no matter how in line with the letter, of the law. In doing so it likened the idea of home to, but did not explicitly label it as, a taxpayer’s place of business, duty, or employment. This was the prototypical decision that fractured the hitherto seamless continuity between the domestic and vocational impulses intrinsic to a home. By separating these two impulses, by drawing this interpretive divide, the court revealed the extent to which the considerations of any given taxpayer’s likely reality assert themselves on legislative language from the very beginning, structuring its very path.

Extending its own logic formulated in earlier cases to its natural conclusion, the court subsequently explicitly gave home a vocational meaning in Lindsay v. Commissioner,[7] a case in which a member of Congress from New York was denied a deduction for the amounts he expended for railroad trips from Washington, D.C. to New York and his lodging in Washington, D.C. on the basis that they represented personal living expenses. The court, citing Bixler[8] and Duncan,[9] reasoned that “since “home” as used in [the statute] means business location, post, or station,” taxpayer was not entitled to a traveling expenses deduction because his “business here was exclusively in Washington.”

Obviously, the Tax Court was treating home as a word of art, distinct from its plain-English language meaning, in its judicial pronouncements. Based on legal authority it would appear that the vocational component of home would resolve the ambiguities vis-à-vis its interpretive difficulties. However, since this was a conception based on speculated Congressional intent of only a trial-level court, the stage was set for a higher court to put this formulation to the test. As we will see, the Fifth Circuit Court of Appeals was thoroughly unconvinced that the lower court’s conception of home was not completely arbitrary or mysterious.

Home No Less Ordinary

The Fifth Circuit Court of Appeals, in a leading traveling expenses deduction case[10] that ultimately went before the Supreme Court,[11] rejected the establishment of the vocational meaning attributed to home by the lower court. The question presented in this case was whether deductions taken by a taxpayer for traveling expenses between Mississippi, his place of residence, and Alabama, his principal place of employment, and living expenses while in Alabama were allowable as traveling expenses while away from home in pursuit of a business.

The Tax Court had previously upheld the Commissioner’s disallowance of the taxpayer’s deductions on the basis that since Alabama, the taxpayer’s principal place of employment, was his home, his living expenses in Alabama and traveling expenses to and from Mississippi were nondeductible personal expenses.[12] The Court of Appeals disagreed with the Tax Court’s analysis in the following very forceful terms:

“The Tax Court held that home, as used in [the statute], means the post, station, or place of business, where the taxpayer is employed… We find no basis for this interpretation. There is no indication in the statute of a legislative intention to give the word an unusual or extraordinary meaning. For the court to do so would be an invasion of the legislative domain. We think the word home as used in the statute means the place where one in fact resides. Home is the fundamental idea of domicile, and yet there is a difference in the legal conception of the two words. Domicile expresses the legal relation existing between a person and the place where he has his permanent home in contemplation of law. Home denotes the principal place of abode of one who has the intention to live there permanently.”[13]

After firmly stripping home of its previously attributed vocational meaning, the appellate court, in applying the law to the taxpayer’s factual situation, went on to further say the following:

“The undisputed facts show that petitioner’s home was in Mississippi unless the statute fixes it at the place of employment. There are no facts in this record sufficient to support a finding that the petitioner’s home followed his vocation to another state; there is no legal requirement to induce this conclusion; the income tax statutes envisage a home in which the [taxpayer] lives with his dependents.”[14]

Thus the Court of Appeals reversed the Tax Court’s ruling thereby settling the case in the taxpayer’s favor. Dissatisfied with the result, the Commissioner petitioned the Supreme Court to review the appellate court’s decision. Upon hearing the case, contrary to all expectations, the Supreme Court sidestepped the slippery issue of the constitution and location of taxpayer’s home and instead resolved the case in the Commissioner’s favor on the basis that the expenses incurred by the taxpayer did not further the taxpayer’s employer’s business.[15]

Notwithstanding the Supreme Court’s ruling, Justice Rutledge’s dissenting opinion, correctly noting that the outcome of the decision hinged on the assumption that Alabama was the taxpayer’s home,[16] is critical for the purposes of this paper because it represents the first instance in U.S. tax legal history that the two words tax and home were not only placed side-by-side, but also in quotations (or, more accurately, in sneer quotes). Consider the following words from Justice Rutledge:

“I agree with the Court of Appeals that if Congress had meant “business headquarters,” and not “home,” it would have said “business headquarters.” When it used “home” instead, I think it meant home in everyday parlance, not in some twisted special meaning of “tax home” or “tax headquarters.” [17]

As can be seen, the text of the dissenting opinion was seminal in the development of tax home as a term of art; in pairing tax and home into a derisive term, it incidentally succeeded in establishing between these two words the link that had to necessarily precede the term’s usage and reification over time. Ironically, though in this instance the antecedence of tax was meant to undermine the meaning of a home, to mock its very idea, it ultimately provided the support necessary for its doctrinal reification.

Tax as a Quotative to Home as a Word of Art

The next case to place tax and home side-by-side was Stairwalt v. Commissioner.[18] The taxpayer in this case maintained a home with her husband in New York. Her husband was employed in New York and lived there during the entire tax year of dispute. Taxpayer was, for six months, employed in Delaware after which she returned to, and secured employment in, New York. The Commissioner denied her a deduction for her outlays for meals and lodging in Delaware. Alternatively, the court approved of the deductions in the following words:

“… enough has been shown here for petitioner to be entitled… to treat New York as her post of duty and her tax “home,” so that her expenses in [Delaware] were deductible as “traveling expenses***while away from home in the pursuit of***business.”

Though the court in this case was, through its evident use of quotations, treating only home as a word of art—for which there was, as already discussed, precedent by this juncture—by employing tax as a quotative it effectively, though not actually, formulated tax home as a term of art. This is because this specific textual arrangement would semantically connote an identical meaning: one’s permanent or principal place of business or employment is in fact one’s home for tax purposes. The mere conjoining of the two words, irrespective of the punctuation, made clear the way in which the meaningfulness of home could be sharpened and enhanced in the statutory context to which it was particular.

Tax Home as an Unquoted Term of Art

In Chandler v. Commissioner[19] a married couple brought a petition for a review of a Tax Court decision according to which a deficiency stemming from the disallowance of traveling expenses was determined. In this case the primary taxpayer resided in Attleboro, Massachusetts, where he was employed as a high school principal. He was also partially employed by Boston University as an accounting instructor in Boston, Massachusetts.

In denying taxpayer a deduction for the automobile expenses he incurred in traveling back-and-forth to Boston, the Tax Court did not ascertain the constitution and location of taxpayer’s home. Rather, the court denied the deduction on the basis that the automobile expenses did not represent traveling expenses. In the opinion of the court these were nondeductible commuting expenses because taxpayer’s travel did not involve an overnight stay. The appellate court reversed the Tax Court’s decision on the basis that “petitioner Chandler was clearly ‘away from home’ in the statutory sense when he traveled to Boston from his tax home in Attleboro despite the fact that he did not remain in Boston overnight.”[20]

Unlike the Tax Court which had previously employed tax as a quotative to home, the appellate court in Chandler[21] was the first to use tax home as a proper term of art in the very sense in which it continues to be used till present day. Though this decision can reasonably be credited with birthing tax home as a legal term with a specific—although not necessarily precise—meaning, what should be of interest to us is how the courts in succeeding cases took half a step backward by invoking this term in quotations, a clear indication that the term would not become solidified and suffused with the force of law without time-honored customary usage.

Tax Home as a Quoted Term of Art

In Conner v. Commissioner[22] the Tax Court dealt with another married couple disputing the Commissioner’s denial of its traveling expenses deduction. The husband of the couple was employed at the U.S. Naval Ammunition Depot in Indiana whereas the wife resided on her late father’s farm in Ohio. Husband would travel to Ohio every Friday to spend the weekend with his wife where they bred, raised, and sold Persian cats.[23] On Sunday evenings he would return to Indiana. He deducted the expenses he incurred for traveling between Indiana and Ohio and for the cost of meals and lodging incurred in Indiana. The Tax Court, in upholding the IRS’s disallowance of the deduction, stated the following:

“[The petitioners] argue that [husband] was only temporarily employed in [Indiana] and that his “tax home” was in [Ohio] where [his wife]… was required to live… [He] had but one occupation… that of an employee… [His] home for the purpose of deducting travel expenses was [Indiana], his place of employment. Accordingly, his expenses of meals and lodging there and his transportation expenses between [Indiana] and [Ohio] are personal expenses and not deductible by the petitioners in computing their gross income.”

Conner[24] was the first case after Chandler[25] to employ tax home as a term; whereas the latter employed it as an unquoted term, the former employed it as a quoted one. This was also not the last case in which the court would choose the quoted form. But, no matter the differences in punctuation, the court in both cases meant the same thing. The difference in presentation can only be attributed to the fact that the low incidence of tax home in judicial pronouncements at the time made its punctuation, lest there be any confusion, useful in order to signify its special meaning.

Hallowed by Usage, Consecrated by Time

After Conner[26] the courts began regularly employing tax home as both quoted and unquoted terms. The courts initially did not have a preference for one over the other. However, once the tax home concept became solidified as a judicial doctrine through usage over a protracted period, the courts developed a clear preference for tax home as an unquoted term. Naturally, as the meaning of this legal term became a commonly-understood standard, the quotation marks, signifiers that the term was being used in some special way, became superfluous. Though still not an entirely extinct judicial practice, it is now rare for the courts to primarily employ tax home as a quoted term.[27]

The inevitable semantic implication of pairing tax and home to form a proper legal term would be such that it would facilitate the term’s adaptability for tax purposes beyond only the tax-deductibility of business or employment-related traveling expenses. So, it is not entirely unsurprising that when this term was eventually introduced and codified into the Internal Revenue Code,[28] it was done so for purposes of qualifying a given claimant for the foreign earned income exclusion.[29] Indeed, it would not be unreasonable to surmise that in contemporary tax practice the incidence of tax home’s invocation for purposes of the foreign earned income exclusion far exceeds its invocation for purposes of the traveling expenses deduction.

CLOSING THOUGHTS

Contemporary authoritative tax guidance is often rooted, in one way or another, in long-established principles. Not uncommonly, such long-established principles underwent development or evolution in very different settings to very different ends. This inescapably contributes to the internal incongruities within the makeup of authoritative guidance which, in turn, contributes to challenges in its construction. As we can glean from the case of the tax home doctrine, the ambiguities of the principles of a storied past can be resolved through an understanding of their historical evolution.

This historical study is illustrative of the extent to which the meaning of legal verbiage depends on the factual circumstances to which it is to be related. The key to comprehending tax home is to grasp its underwhelming ordinariness. Whereas home would ordinarily connote residence and tax home would connote the place where one is responsible for taxes, the law purposefully extracts the qualitative ordinariness of these two terms, rendering them replete with their residual extraordinariness in order to adapt them to specific usage.

It is possible that, and appears as if, Congress in 1921 had no confusion about the meaning of home, that it had no less than a normal, objective linguistic conception of the word. Despite the fact that such intentional objectivity was not separate and apart from a contemplated idea of how the law would be implicated, in practice such objectivity can be empirically undermined thereby necessitating reliance on a subjective linguistic conception, as the courts did with home in this case.

*Anthony (“Tony”) Malik is the Principal Consultant at, and owner of, Point Square Consulting, an international tax specialty firm based in Atlanta and New York. In addition to compliance and advocacy, Tony frequently plays an advisory role in the financial dealings between and within international business groups. He can be reached at tony@pointsquaretax.com.

[1] See Johnson v. Commissioner, 7 T.C. 1040 (1946); Scheuren v. Commissioner, T.C.M. 52 (1961); and Michel v. Commissioner, T.C.M. 1977-345 (1977).

[2] The preponderance of the authoritative guidance holds that one’s tax home is one’s principal place of business or employment, not one’s place of residence; but, there are some exceptions. See Burns v. Gray, 287 F.2d 698 (1961); Rosenspan v. United States, 438 F.2d 905 (1971); and Coombs v. Commissioner, 608 F.2d 1269 (1979).

[3] Pub. Law No. 67-98, 42 Stat. 227 (November 23, 1921). Obviously enough, § 214(a)(1) of the Revenue Act of 1921 was the predecessor to § 162(a)(2) of the current version of the Internal Revenue Code of 1986.

[4] Technically, the U.S. Tax Court, originally known as the U.S. Board of Tax Appeals, was at the time an administrative review board instead of a proper court of law. It was not until the passage of the Revenue Act of 1942 that the Board of Tax Appeals was retitled as the U.S. Tax Court. See § 504(a), Revenue Act of 1942, Pub. Law No. 753, 56 Stat. 798 (October 21, 1942). Notwithstanding, due to its power to establish precedent, this paper will refer to the Board of Tax Appeals as a court instead of as a board.

[5] Palmer v. Commissioner, 1 B.T.A. 882 (1925).

[6] Bixler v. Commissioner, 5 B.T.A. 1181 (1927).

[7] Lindsay v. Commissioner, 34 B.T.A. 18 (1936).

[8] Supra, note 6.

[9] Duncan v. Commissioner, 17 B.T.A. 1088 (1929). Duncan involved a traveling salesman who had neither a fixed residence nor place of business. The court ostensibly suggested that in order for the relevant expenses to be deductible, the business had to require the taxpayer to be away from one of either his home or usual place of business and to also incur outlays incident to the furtherance of said business. It did not liken a home to, much less define it as, a place of business. Since taxpayer had none, the court denied him the deductions he sought.

[10] Flowers v. Commissioner, 148 F.2d 163 (1945).

[11] Infra, note 15.

[12] Flowers v. Commissioner, 3 T.C.M. 803 (1944).

[13] Supra, note 10.

[14] Ibid.

[15] Commissioner v. Flowers, 326 U.S. 465 (1946).

[16] Due to the Supreme Court’s reluctance to decide the tax home issue, it has only ever tacitly approved its vocational meaning. See Commissioner v. Stidger, 386 U.S. 287 (1967) and United States v. Correll, 389 U.S. 299 (1967).

[17] Supra, note 15.

[18] Stairwalt v. Commissioner, 11 T.C.M. 902 (1952).

[19] Chandler v. Commissioner, 22 F.2d 467 (1955).

[20] It should be at least tangentially mentioned that subsequent to this case the Supreme Court adopted the IRS’s position that in order for one to be considered away from one’s tax home the trip would have to be such that it would require one to stop for sleep or rest. United States v. Correll, 389 U.S. 299 (1967).

[21] Supra, note 19.

[22] Conner v. Commissioner, T.C.M. 1956-290 (1956).

[23] One of taxpayers’ assertion in this case was that their feline occupation rose to the level of a trade or business which the court ruled to be a hobby.

[24] Supra, note 22.

[25] Supra, note 19.

[26] Supra, note 22.

[27] For example, the District Court for the Northern District of Georgia was the last to have a clear preference for the quoted, over the unquoted, term. Deeb et. al. v. United States, No. 1:20-cv-01456 (N.D. Ga. 2022).

[28] Title 26 of the United States Code of Laws.

[29] § 911(d)(1), Economic Recovery Tax Act, Pub. Law No. 97-34, 95 Stat. 172 (August 13, 1981).

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Lessons Learned From Apple’s Tax Policy

By Anthony Malik

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Cost Allocation Base Selection for Transfer Pricing Purposes

By Anthony Malik

INTRODUCTION

The successful implementation of a cost-based transfer pricing policy necessitates the group of companies to devise robust internal cost allocation methodologies. The reasonability of the cost allocation method employed is largely contingent upon the prudent choice of an appropriate cost allocation base. The allocation base, a representative of the phenomena that drive costs, is the central variable or basis that ultimately governs the entire allocation split of a given cost allocation method. It just so happens that selecting an allocation base from among the identifiable alternatives can be a particularly tricky and effortful task.

In the ensuing sections of this paper, we will discuss considerations for selecting an allocation base for transfer pricing purposes in general and for the transfer pricing of intercompany services in particular.[1] Due to the abject lack of any elaborative, substantive provisions in the statute,[2] we will go directly to the relevant regulatory guidance to which the courts have historically and customarily granted significant deference.[3] After reviewing the relevant tax law we will infer practical implications and considerations based on what one can reasonably glean from the authoritative guidance. To keep the scope of the topic manageable, in the conversation to follow, we will use the term cost in the conventional sense. In practice the term cost is not always literal and can be imbued with some rather abstract qualities once microeconomic factors are weighed in.

REVIEW OF THE TAX REGULATION ON POINT

Regarding selecting an appropriate cost allocation base, Treasury Regulation Section 1.482-9 does not provide procedural details for taxpayers to follow. It does, nonetheless, succeed in conveying the basic intuition behind selecting an allocation base. This imparted intuition serves to subsequently lay the foundation to support one’s practical considerations. Treasury Regulation Section 1.482-9 has a clear instructional preference to emphasize judging the relative benefits enjoyed by each recipient of the intercompany services.

If the benefits of a cost-inducing activity undertaken by a member of a controlled group extend to other members of the controlled group, the costs must be allocated among the benefitted members.[4] For this purpose, “An activity is considered to provide a benefit to [a member] if the activity directly results in a reasonably identifiable increment of economic or commercial value that enhances the [member’s] commercial position.”[5] The costs for such value-adding intercompany services “must be allocated among the [members] based on their respective shares of the reasonably anticipated benefits from those services.”[6] Thus the costs must be allocated to the respective members in a manner commensurate with the quantum and quality of the benefit enjoyed by the respective members rather than on the basis of some “generalized or non-specific benefit.”[7]

The regulation’s explicit guidance regarding selecting an allocation base succinctly specifies that “consideration should be given to all bases…, including, for example,… assets, sales, compensation, space utilized, and time spent.”[8] The regulation also provides some helpful examples in an attempt to concretize its guidance on selecting an allocation base.[9] It is worthwhile to consider the essential kernels of a selection of these examples due to their relevance to our discussion:

• In the first case,[10] consider a parent company that centrally processes invoices for all its subsidiaries. In evaluating the respective shares of the reasonably anticipated benefits of each member, the total value of the merchandise sold may not be a reliable measure because it “does not bear a relationship to the anticipated benefits from the underlying [intercompany] services.”[11] Contrarily, “The total volume of orders and invoices processed may provide a more reliable basis for evaluating the shares of reasonably anticipated benefits from the data processing services.”[12]
• In the following example,[13] a parent company centrally performs human resources functions for all its subsidiaries. “In evaluating the shares of reasonably anticipated benefits from these centralized services, the total revenues of each subsidiary may not provide the most reliable measure of reasonably anticipated benefit shares because total revenues do not bear a relation to the shares of reasonably anticipated benefits for the underlying services.”[14] Contrarily, “Employee headcount or total compensation paid to employees may provide a more reliable basis for evaluating the shares of reasonably anticipated benefits from the [intercompany] services.”[15]
• Also instructive is an example[16] wherein a parent company, Company A, with two wholly-owned subsidiaries, Company B and Company C, hires an outside consultant for advice regarding a manufacturing process used by Company A and Company B. Company C, on the other hand, uses a manufacturing process sufficiently different such that it does not benefit from the outside consultant’s recommendations. In this example, when applying the chosen allocation base (i.e., sales), Company C’s weighted allocation base is excluded from the overall cost allocation equation. Accordingly Company C is excluded from the assignment of the costs incurred by Company A to hire the outside consultant. The point to absorb is that upon judging the suitability of an allocation base, whenever necessary, taxpayers must also consider implements to exclude the weighted allocation bases of any non-benefitting members.[17]

The review of the relevant paragraphs of Treasury Regulation Section 1.482-9 should make it apparent that the suitability of an allocation base is highly context-dependent. Rigid legal rules dictating the uses of allocation bases are unlikely to consistently produce outcomes that closely parallel the economic substance of the pertinent underlying business functions and arrangements. It is seemingly for this reason that the regulation liberally states that “Any reasonable [allocation base] may be used to allocate and apportion costs under [Section 482]”.[18] The guidance evidently leaves much to the discretion of taxpayers in devising their own cost allocation methodologies because taxpayers themselves, as opposed to an independent administrative agency, are in a position to be most familiar with the relevant business context.

Along this vein, there is further assurance that the IRS will potentially, though not conclusively, consider reliable taxpayers’ internally-devised cost allocation methods for their various legitimate non-tax business purposes.[19] Thus if a taxpayer reasonably concludes that it allocated its intercompany service costs “on a basis [(i.e., an allocation base)] that most reliably reflects [each members’] respective shares of the reasonably anticipated benefits attributable to such services… the Commissioner may not adjust such allocation basis.”[20]

PRACTICAL IMPLICATIONS AND CONSIDERATIONS

As can be gleaned from the regulatory guidance hitherto discussed, in practice, the main difficulty in selecting an allocation base is that one can often initially identify multiple ostensibly suitable allocation bases that bear a causal relationship to the allocable indirect costs accumulated in a given cost pool. The uncertainty regarding the suitability of an allocation base is an uncertainty regarding the nature of the cost pool—that is, the difficulty in judging the suitability of an allocation base stems from a difficulty in understanding how the allocation base pertains to the cost pool. Since there is no directly traceable causal relationship between the cost pool and the allocation base, there is usually no single obvious choice. Resultantly, selecting an allocation base necessarily involves subjective professional judgment.

Good judgment in the selection of an allocation base is critical because it can be highly consequential to the pertinent cost objects during the cost allocation process. Different allocation bases will invariably bear different causal relationships to their cost pools. The difference between these causal relationships can be quite significant. One must not mistake these differences as something entirely random or devoid of meaning. Rather, it reflects the differences between the relationships between the considered cost pool and the business processes and activities underlying the respective allocation bases. An examination of these underlying business processes and activities aids ascertaining the degree of relevance of each allocation base to the given cost pool.

The degree of an allocation base’s relevance is dependent upon the quality, degree, and strength of the causal relationship it bears to the considered cost pool. There need to be present some aspects that conjoin these two variables. Naturally, the relevance of an allocation base is vitiated if such vital aspects are weak. On the other hand, the stronger the causal relationship between the allocation base and the cost pool (i.e., the greater the allocation base’s degree of relevance to the cost pool), the greater its efficacy in relating the allocable indirect costs to the cost object. The importance of selecting the most relevant allocation base identifiable or available is that even a marginally less relevant allocation base can result in too much or too little overhead being assigned to a given cost object thereby distorting the arm’s length charges.[21]

As can be seen, wisely selecting an allocation base requires the practitioner to holistically view and understand the business without being hemmed in by disciplinary boundaries. Selecting an allocation base is inescapably somewhat arbitrary. Consequently, the entire process of cost allocation is inherently imprecise. Notwithstanding, upon implementation some methodologies will clearly prove themselves to be inferior to others. Thus practitioners must aspire to devise methodologies that will result in the least amount of cost distortion. Identifying with this objective will enable the practitioner to bypass the deadlock wherein an arm’s length transfer price needs to be established but the practitioner is at the same time incapable of reifying this need.

To help concretize what we have hitherto discussed, let’s look at a couple of examples wherein each of the same two different allocation bases being considered for implementation can be more or less relevant depending on the nature of the indirect costs being allocated. We will see that an imprudent choice of an allocation base can significantly distort the arm’s length charge.

Suppose that the AAA engineering firm, headquartered in Country X, has two wholly-owned subsidiaries, BBB and CCC, in Countries Y and Z, respectively. Of all the three entities, AAA is the longest-established and employs the most experienced engineers. Firms BBB and CCC, due to their different competencies, will soon collaborate on a newly-secured engagement. Both subsidiaries, at the outset of the engagement, receive broad-based technical training from AAA in order to work most efficiently. The cost to AAA for providing this technical advisory is $10,000. Both BBB and CCC benefit from the training in some capacity and the cost of the training is not directly traceable to any single subsidiary. Under these circumstances, upon what basis should the costs of training be allocated to BBB and CCC?

After careful consideration AAA has identified two potentially suitable allocation bases (i.e., the number of billable hours worked by the employees of each subsidiary and the amount of revenue earned by each subsidiary) and is now trying to judge which one of the two is a comparatively superior metric. AAA first considers the number of billable hours worked by the employees of both BBB and CCC as the allocation base because it has a readily discernible causal relationship to the allocable costs. If in the completion of the engagement BBB’s employees work 100 billable hours while CCC’s employees work 150 billable hours, this allocation base would result in the following cost allocation:

At first glance the results generated by this allocation base appear perfectly reasonable; following the training, each of BBB and CCC worked 100 and 150 hours, respectively, to complete their tasks. Since the benefit of the training extends over 50 more billable hours from CCC, it seems logical that the allocated costs should be proportionately higher to CCC. However, the appropriateness of this allocation base comes into question once we consider the disparate seniority levels and billing rates of the employees of BBB and CCC.

Suppose BBB’s employees are more experienced and credentialed than CCC’s. Consequently, during the course of the engagement, BBB’s employees perform higher profile services that ultimately add more value to the recipient. BBB’s firm-wide hourly billing rate is $250 per hour. On the other hand, though CCC’s employees also perform vital specialized services, they perform services of a lower profile than BBB’s employees. CCC’s firm-wide hourly billing rate is $125 per hour. Keeping this in mind, using the revenue earned from the engagement (based on the respective number of billable hours worked and hourly billing rates) by each of BBB and CCC as the allocation base results in the following cost allocation:

In the example above, the revenue earned from the engagement by each of BBB and CCC seems a superior allocation base. BBB evidently benefitted more from AAA’s training because it enabled it to provide services of a higher profile and resultantly earned a greater share of the revenue from the engagement compared to CCC. This is suggestive of a stronger causal relationship to the training costs. Comparing the costs allocated to each of BBB and CCC using the two different allocation bases quantitatively highlights the consequentiality of the choice of the allocation base to the cost objects and how an imprudently chosen allocation base contributes significantly to cost distortion; there is almost a complete reversal of the financial charges to each of BBB and CCC under the two different scenarios (i.e., $4,000 to BBB and $6,000 to CCC versus $5,714 to BBB and $4,286 to CCC).

Now let’s qualitatively consider a different indirect cost with respect to which the suitability of the same two allocation bases is arguably reversed. Suppose that AAA centrally provides remote desktop IT support services to help the employees of each of AAA, BBB, and CCC resolve issues accessing the various enterprise-wide proprietary software and databases. The incidence of providing these IT services is strongly correlated with the amount of billable hours worked by the employees of AAA, BBB, and CCC. There is no evidence or reason to believe that more complex or higher caliber services performed by any given employee additionally strain the enterprise-wide IT infrastructure resulting in more system glitches requiring troubleshooting. In fact, based on service tickets, there is some evidence that BBB’s more experienced employees, compared to CCC’s relatively less experienced ones, are more adept at self-resolving many of the routine software glitches and hence less likely to tie up organizational resources.

Under these circumstances, due to the weaker causal relationship, revenue, compared to billable hours, would be the less relevant allocation base and would therefore contravene the tax law’s arm’s length standard. Contrarily, billable hours, though not perfect, due to its greater efficacy of relating the costs of the IT services to BBB and CCC, would be the superior allocation base because its usage would result in smaller cost distortion.

CLOSING THOUGHTS

Treasury Regulation Section 1.482-9 discusses the potential of alternatives among, and the comparative suitability of, different allocation bases but does not explicate the reasons as to what renders one alternative superior over another. The regulatory language, although not ambiguous, lacks conceptual fullness due to its brevity. By minimizing the depth of field, the guidance creates a sense of flatness with respect to evaluating the suitability of an allocation base. Indeed, the interpretive difficulty of the regulatory guidance is precisely attributable to this fact that it presents a field constituting only a surface. At no time does this become more apparent than when a practitioner turns to the relevant guidance while designing a cost-based transfer pricing policy to meet the tax law’s arm’s length standard.

In practice, without a sufficient epistemic understanding of what renders one allocation base suitable over another, it is unlikely that one will prudently select the best allocation base from among the alternatives. The professional subjectivity inherent in selecting an allocation base is such that the ultimate efficacy of even the best choice of allocation base is not to be found in a singular endpoint wherein all the fragments of a given cost pool neatly fit. As we discussed, the practical implication of the regulatory guidance is that it is the degree of the causal relationship between the allocable costs and the allocation base that is the most efficacious determinant of the shares of the reasonably anticipated benefits of the respective controlled group members. Discerning the causal relationships among the potentially suitable allocation bases and the allocable costs undoubtedly requires a comprehensive understanding of the underlying business activities, functions, and arrangements.

* This article is reprinted with the author’s permission from the April 2024 issue of the Journal of International Taxation, Thomson Reuters.

[1] Notably for the services cost method under Treas. Reg. § 1.482-9(b), the cost of services plus method under Treas. Reg. § 1.482-9(e), and the comparable profits method under Treas. Reg. §§ 1.482-5 and 1.482-9(f).

[2] See IRC § 482.

[3] “[No] challenge to the validity of [the] regulations issued under §482 on the grounds that they constitute an unreasonable interpretation of the statute or one plainly inconsistent with the statute has ever been successful.” Lepard, 551-2^nd T.M., Section 482 Allocations: General Principles in the Code and Regulations. See, for example, Foster v. Commissioner, 80 T.C. 34 (1983); PPG Industries, Inc. v. Commissioner, 55 T.C. 928 (1970); Kahler Corp. v. Commissioner, 58 T.C. 496 (1972); and Latham Park Manor, Inc. v. Commissioner, 69 T.C. 199 (1977).

[4] Treas. Reg. § 1.482-9(k)(1).

[5] Treas. Reg. § 1.482-9(l)(3)(i).

[6] Treas. Reg. § 1.482-9(b)(7)(ii)(B).

[7] Supra note 4.

[8] Treas. Reg. § 1.482-9(k)(2)(i).

[9] Treas. Reg. § 1.482-9 more often uses the alternative cost accounting term allocation key instead of allocation base.

[10] Treas. Reg. § 1.482-9(b)(8), Ex. 16.

[11] Ibid.

[12] Ibid.

[13] Treas. Reg. § 1.482-9(b)(8), Ex. 17.

[14] Ibid.

[15] Ibid. See also Treas. Reg. § 1.482-9(b)(8), Exs. 18-19 which are also centered around the idea of relating the allocation base to the taxpayers’ reasonably anticipated benefits.

[16] Treas. Reg. § 1.482-9(k)(3), Ex. 2.

[17] See also Treas. Reg. § 1.482-9(l)(3)(ii) the implication of which is that recipients of a remote or negligible benefit from a shared intercompany function or service are to not be allocated a share of the costs of such intercompany function or service (i.e., they are not to be assigned a weighted allocation base).

[18] Supra note 8.

[19] Treas. Reg. § 1.482-9(k)(2)(ii).

[20] Treas. Reg. § 1.482-9(b)(7)(ii)(B).

[21] Ever since the promulgation of their first incarnation, the regulations under the predecessor of § 482 in the Revenue Act of 1934 have specified an arm’s length charge standard for intercompany transactions. Reg. 86, art. 45-1(b) (1935).

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The Creditability of Contemporaneously Paid Foreign Taxes

By Anthony Malik

INTRODUCTION

Taxpayers earning foreign source income can satisfy their foreign tax liabilities in one of several different ways depending on the character of the income earned, the taxpayer’s level of foreign activity, and local tax laws and practices, among other factors. A comprehensive understanding of a taxpayer’s foreign activities and the mechanisms by which such taxpayer satisfies his or her foreign tax liability is critical for United States (“U.S.”) tax practitioners because this allows them to ascertain the proper amount of foreign taxes paid for U.S. creditability purposes.[1] In practice, it is not uncommon for practitioners to view their clients’, particularly those on the cash basis method of accounting, foreign tax payments in a static manner. There is a tendency to simply translate into U.S. dollars taxpayers’ total amount of foreign taxes paid within their U.S. tax year via all mechanisms (e.g., withholding, estimated tax payments, prepayments, and payments remitted along with the filing of their foreign tax returns etc.) followed with the calculation of the foreign tax credit thereon. However, depending on any given cash basis taxpayer’s facts and circumstances, there could very well be differences between the amount of foreign taxes paid during his or her U.S. tax year and the amount of paid foreign taxes that may be claimed by the taxpayer as a credit during that same U.S. tax year.

As we shall see, possible divergence between the amount of foreign taxes paid and the amount of paid foreign taxes that are creditable can lead to timing differences. While this paper is written from the perspective of an individual claimant,[2] the rules discussed herein also apply almost equally to corporate claimants. To keep the topic manageable, the foreign taxes discussed herein should be construed as qualified (i.e., creditable) income taxes representing a U.S. taxpayer’s legal and actual liability contemporaneously remitted to a foreign country that is not sanctioned by the U.S. Secretary of the State.

In the ensuing sections of this paper, we will first examine the non-authoritative guidance on this issue as provided through material developed by the Internal Revenue Service (“IRS”) that is specifically directed toward the public for promoting, and assisting in, tax compliance—we will not review any relevant guidance that may be contained within material developed by the IRS for internal employee training and guidance (e.g., Audit Technique Guides, Practice Units, Internal Revenue Manual etc.) that the IRS is obligated to electronically publish pursuant to disclosure laws generally applicable to federal agencies.[3] Once we reach the limits of what one can reasonably and responsibly discern therein, we will then turn to the specificity of the relevant guidance contained within the law to round out our understanding of the subject matter.

REVIEW OF THE RELEVANT IRS MATERIAL

Material provided by the IRS is an appropriate starting point for our discussion because compliance-oriented tax practitioners are most likely to—in many cases, for very good reason—first turn toward instructions to tax forms and various handbooks in the resolution of queries germane to their clients’ reporting requirements. While the purpose of such material is undoubtedly to lead return preparers step-by-step to accurately report the necessary information required by the law, it is no secret that in many instances it fails to provide appreciable guidance. As we shall see, claiming a credit for paid foreign taxes pursuant to Internal Revenue Code (“IRC” or “Code”) Section 901(a) is one such instance.

Form Instructions

The instructions to Form 1116 are surprisingly scant in this area. They state, in relevant part, that “Generally, you can take a foreign tax credit in the tax year you paid… the foreign taxes.”[4] They further state that “Generally, you must enter in Part II[5] the amount of foreign taxes… that relate to the category of income checked above Part I.[6] Taxes are related to the income if the income is included in the foreign tax base on which the tax is imposed.”[7]

Remarkably, the instructions do not state anything beyond this regarding the determination of either the amount of foreign taxes paid for creditability purposes or the U.S. tax year within which such paid foreign taxes become creditable. As we shall see, particularly once we begin delving into the authoritative sources of the law, this is problematic because witting reliance on the form instructions alone largely misleads practitioners in both regards. It can be hoped that experienced practitioners would recognize that the insufficiency of the forgoing instructions conceal something practically consequential and that the process of questioning, the search for answers, is to continue.

Publication 514

Fortunately, however, Publication 514, Foreign Tax Credit for Individuals, at least partially addresses these issues. Publication 514 specifies that “If you use the cash method of accounting, you can claim the credit only in the year in which you pay the tax. You are using the cash method of accounting if you report income in the year you actually or constructively receive it, and deduct expenses in the year you pay them.”[8] “You can claim the credit for a qualified foreign tax in the tax year in which you pay it… “Tax year” refers to the tax year for which your U.S. return is filed, not the tax year for which your foreign return is filed.”[9] This verbiage serves to implicitly convey guidance of greater consequence; taken together, it is at least rudimentarily instructive with respect to the determination of the U.S. tax year within which paid foreign taxes become creditable.

While not immediately obvious, it provides that taxpayers are not to apportion the paid amount of their foreign taxes between two separate U.S. tax years in the event of a foreign fiscal year that does not coincide with the Gregorian calendar-based U.S. tax year. To illustrate, consider the UK fiscal year that runs from April 6 of any given year to April 5 of the following year. Now, in the context of the UK fiscal year ending April 5, 2023, if a U.S. taxpayer accurately determines and pays the full amount of his or her final UK tax liability on April 6, 2023, the taxpayer ought not apportion the payment between two U.S. tax years over which the UK fiscal year falls (i.e., from April 6, 2022 to December 31, 2022 and January 1, 2023 to April 5, 2023). Rather, for purposes of potential U.S. creditability, such taxpayer would claim the entire amount of the paid UK taxes during his or her 2023 U.S. tax year.

Publication 514 is also instructive—though, again, not explicitly—in that paid foreign taxes do not relate back to the U.S. tax year in which the liability arose. This happens to be the case whether or not the foreign fiscal year coincides with the U.S. tax year. For the sake of simplicity, let us consider a U.S.-coincident foreign fiscal year. If a hypothetical U.S. taxpayer remits payment in satisfaction of his or her 2022 foreign tax liability on January 1, 2023, while the foreign income on which the tax is eventually imposed is taken completely into account during the 2022 U.S. tax year, the correct reading of Publication 514 is that the foreign taxes are taken into account in 2023.[10] Such temporary timing mismatches between cash basis taxpayers’ foreign source income and the remittance of taxes thereon are very common.

The chief problem with the relevant guidance in Publication 514 is that it too zealously pegs the year of credit to the year of payment. Further compounding the problem is the fact that the line verbiage of Form 1116, Part II,[11] upon asking for the date of payment of the foreign taxes, when considered in the context of the relevant guidance contained in the instructions to Form 1116 and Publication 514, can easily mislead practitioners into unexceptionally reporting the amount of foreign taxes paid during the U.S. tax year for which the form is being prepared. It is not at all obvious that, counterintuitively enough, the correct date of payment to be listed on Form 1116 for a given year can pertain to a past (though not a future) U.S. tax year. A review of the IRS material, no matter how thorough, does not make it obvious that in some cases foreign taxes paid in a current U.S. tax year may not become creditable until a future U.S. tax year. Although the narrative coherence of the IRS material is assuring, making the relationship between the payment transaction and the timing thereof appear dyadic, it effectively precludes one from questioning whether there are instances wherein the two are separable.

It is not until we turn to legal guidance in this area that we begin realizing that the treatment prescribed by the IRS material is most generally applicable to taxpayers with relatively limited foreign activities. In other cases, the determination hinges largely on the specific facts and circumstances of the taxpayer and, to a lesser extent, on the practitioner’s discretion.

OVERVIEW OF THE RELEVANT LAW

In spite of the useful guidance provided by Publication 514, it falls short of explaining how the rules apply in specific instances of relatively common cross-border scenarios. In this section we shall turn to substantive guidance to gain a more complete understanding. We shall approach the subject matter by considering how the rules apply to taxpayers with differing levels of foreign activity earning various types of foreign source income.

Foreign Taxes on Portfolio Income

An overview of the law makes it clear that the odds of immediate creditability of contemporaneously remitted foreign taxes are inversely proportional to the taxpayer’s level of foreign activity. To wit, a credit is allowed for a reasonable approximation (or, for that matter, less than a reasonable approximation) of a taxpayer’s final foreign tax liability. This rule applies most aptly to taxpayers with minimal foreign activities. If the amount withheld is reasonably assuredly the amount of a taxpayer’s final foreign tax liability then a credit can be claimed for the amount of foreign taxes withheld during the U.S. tax year. This would be most true, for example, of a gross basis withholding tax applied against an isolated stream of portfolio income[12] of a U.S. taxpayer lacking a trade or business in the foreign country.

In this regard, Revenue Ruling (“Rev. Rul.”) 57-516[13] provides that “The credit provided in section 901 of the Code is not based on tax withheld by a foreign country or possession of the United States during the taxable year, since tax withheld is merely an advance collection of what may or may not be an actual tax liability.” After this elucidation Rev. Rul. 57-516 proceeds to allow a credit for foreign taxes withheld by a foreign corporation paying dividends to a U.S. taxpayer. The language of the ruling suggests that the dividends are the only foreign source income of the U.S. taxpayer.

It should be noted that the straightforward guidance handed by Rev. Rul. 57-516 inheres in the foreign source portfolio income of taxpayers with minimal foreign activity. Though the acknowledgement of this guidance may assure one with the feeling that one is in a space replete with meaning and that the law is not completely arbitrary or mysterious, one cannot overlook that the treatment articulated in Rev. Rul. 57-516 would not necessarily be applicable to all taxpayers earning foreign source portfolio income. For example, reliance on Rev. Rul. 57-516 would probably not be appropriate for a taxpayer with an active trade or business in a foreign country who was also earning foreign source portfolio income subject to withholding taxes at source. Such a taxpayer would, depending on his or her complete set of facts, likely be required to determine his or her final foreign tax liability following the close of the foreign fiscal year before he or she could claim a foreign tax credit. In such cases the withheld foreign taxes are akin to estimated tax payments which are uncreditable until such taxpayer’s final foreign tax liability is settled.[14]

Foreign Taxes on Trade or Business Income

On the other end of the spectrum, foreign taxes paid during the U.S. tax year either via withholding, estimated payments, or prepayments do not qualify for the foreign tax credit during the same U.S. tax year if the taxpayer is engaged in a trade or business in the source country. The apparent rationale for this treatment, as can be gleaned from the guidance, is that business profits are taxed on a net, instead of on a gross, basis determined under foreign legal principles.

Rev. Rul. 71-517[15] addressed the question of creditability when a U.S. partnership was engaged in a business in Peru. Under Peruvian law at the time, entities incorporated or registered outside of Peru that were engaging in mining operations in Peru where required to prepay an amount representing a percentage of the net value of the mining products exported. These prepayments would subsequently be applied against such entities’ ultimate Peruvian income tax liability once it was determined. It was held that the advanced payments were not taxes at the time of payment because they were more akin to deposits against a future tax liability than payment of taxes. However, the ruling specified that any portion of such prepayments, once applied against the properly determined and assessable amounts of Peruvian income taxes qualified as payments of creditable foreign income taxes.

Rev. Rul. 70-425[16] had previously also reached a similar conclusion in denying an immediate credit for foreign taxes withheld on income attributable to business profits. The ruling considered a taxpayer that earned both business and non-business income from Italian sources. With respect to the taxpayer’s non-business income, the ruling didn’t address whether a reasonable approximation of the withheld Italian taxes would be immediately creditable; instead, it simply provided that the ultimate liability against which such withheld taxes would be applied would be creditable. As for the Italian taxes withheld on the taxpayer’s business income, the ruling was clear that such withheld taxes would not be separately allowable as a credit until the taxpayer’s final Italian tax liability was settled.[17] As such, the settlement is essentially the event that transmutes uncreditable advance deposits against future foreign tax liabilities into actual payments of foreign tax liabilities, creditable to the extent of the settled amounts. The reasonability of the approximated final foreign tax liability is apparently immaterial with respect to income derived in the course of a trade or a business.

Rev. Rul. 74-373[18] also considered the issue of prepayment of foreign taxes on business profits. However, what should make this ruling of interest is that it did so in the context of multiyear payments. In the case at hand, a U.S. corporation that was transacting business in Peru was required to remit compulsory prepayments to the Peruvian Government which would be subsequently credited in equal parts against the U.S. corporation’s ultimate Peruvian income and complementary tax liabilities for the next eight years. Consistent with the substantive guidance hitherto discussed, the ruling held “that the payments [were] not taxes at the time of their payment since they [were] merely deposits against future liability for tax. However, the payments when actually applied as a credit[19] against a Peruvian tax that does qualify as an income tax within the meaning of section 901 of the Code, qualify as creditable income taxes for purposes of section 901.”[20]

An important implication of the guidance handed by Rev. Rul. 74-373 also relates back to our immediately preceding discussion regarding foreign source portfolio income. Specifically, though multiyear prepayments on non-business income are even more unlikely, they are not impossible and based on the treatment prescribed by Rev. Rul. 74-373 their apparent correct treatment, irrespective of whether or not a reasonable approximation, is that as a mere deposit against a future, rather than an immediate payment of a currently, creditable income tax liability.

Foreign Taxes Paid on Employment Income

U.S. taxpayers living and employed abroad are in an evidently grayer area of the law compared to their counterparts who are either earning only foreign source investment income at an arm’s length from the source country or deriving profits through a fixed place of business therein. Consider how Rev. Rul. 59-101[21] addressed the creditability of foreign taxes remitted via both withholding and estimated payments by wage earners in Puerto Rico. The taxpayers discussed in the ruling have a relatively simple set of facts as they are not mentioned as earning any additional streams of income from Puerto Rico (or foreign country) sources. The ruling held that both the withheld and the estimated foreign taxes were creditable during the U.S. tax year of payment to the extent that such amounts represented the taxpayers’ legal and actual tax liability.[22]

There is also at least one Generic Legal Advice Memorandum (“GLAM”)[23] which is, although not precedential,[24] highly instructive considering it pertains to foreign wage withholding tax when the taxpayer’s foreign fiscal year is at odds with his or her U.S. tax year. The GLAM concludes that a cash basis taxpayer can claim credits in the U.S. tax year within which the withholding occurs to the extent that the amount withheld does not exceed a reasonable approximation of the final amount of the taxes owed at the end of the taxpayer’s foreign fiscal year. This is instructive because it clarifies that it need not matter that the taxes paid during the U.S. tax year pertain to a foreign fiscal year with a different ending date. Rather, foreign wage withholding taxes “are creditable in the year paid, even if the allowable amount is not finally determined until a subsequent U.S. tax year in which the foreign tax year ends.”[25] The analysis contained therein also strongly suggests the allowance of creditability in the event of overwithholding of foreign taxes during the portion of the foreign fiscal year that coincides with the latter part of the first U.S. tax year followed by a corrective adjustment to underwithhold foreign taxes during the portion of the foreign fiscal year that coincides with the first part of the second U.S. tax year.

Notwithstanding, while any semblance of unambiguous guidance is welcomed, matters of taxation are rarely completely devoid of confounding elements. Consider that the exercise of employment, at least in the inbound context, constitutes a trade or business.[26] However, as evident from the guidance hitherto discussed, the exercise of employment is, at least in the foreign tax credit context, alienated from the constitution of a trade or business. One must also not ignore that the available guidance addresses taxpayers with very simple factual scenarios. In practice, it is not uncommon for taxpayers, particularly sophisticated ones, to earn multiple types of foreign source income items in countries with complex tax regimes.[27] This inevitably poses difficulties for even the most astute practitioners in judging the reasonability of their clients’ approximated final foreign tax liabilities. Though the calculation of a taxpayer’s estimated final foreign tax liability by an experienced local practitioner would likely constitute a reasonable approximation for purposes of U.S. creditability, it by no means guarantees that the ultimate foreign tax liability could not be at variance with the approximation. This can cause, for U.S. purposes, a foreign tax redetermination[28] event which then obligates taxpayers to amend their previously filed original U.S. tax returns.[29] To avoid the potential unnecessary administrative burdens and compliance costs of filing multiple tax returns for the same U.S. tax year, the prudent course of action appears to be to, whenever possible, advise the taxpayer to have him or her finalize (and file) their foreign tax returns before finalizing their original U.S. tax returns.

FINAL THOUGHTS

The determination of the accurate amount of contemporaneously paid foreign taxes for purposes of U.S. creditability is quite a bit more nuanced than what many compliance-oriented practitioners may suspect. The difficulty inherent in the determination stems from the unique way in which the law distinguishes the transaction from its temporal dimension. Whereas the IRS material suggests parity between the two, the law severs them, revealing how the non-authoritative guidance serves unwittingly as a curtain against the dynamism of the law. While it may be tempting to conclude that the extent of the relevant information provided in the IRS material ought to be sufficient in determining a tax return position, as we saw, such temptation can impel the tax professional to forgo something consequential in its implication. As our walk through the authoritative sources of tax guidance relevant to our query reveals, practitioners must remain ever vigilant knowing that even something seemingly as simple as determining a foreign tax payment amount can be highly fact-dependent and subject to keen professional judgment.

[1] See IRC § 901(a).

[2] Assuming that such individual did not elect to claim the foreign tax credit on an accrual basis pursuant to IRC § 905(a).

[3] Freedom of Information Act, 5 U.S. Code § 552.

[4] Instructions, Form 1116 (December 28, 2022), pg. 19.

[5] Referring to Form 1116 (2022), Part II—Foreign Taxes Paid or Accrued, pg. 1.

[6] Referring to Form 1116 (2022), Part I—Taxable Income or Loss From Sources Outside the United States, pg. 1.

[7] Supra note 5.

[8] Publication 514 (January 31, 2023), pg. 5.

[9] Ibid.

[10] Though not the subject, and outside of the scope, of this paper, it should be tangentially noted that this treatment is consistent with the tax accounting rules. See. Treas. Reg. §§ 1.446-1(c)(1)(i) and 1.461-1(a)(1).

[11] Supra note 6.

[12] Portfolio income generally includes gross income, other than that derived in the ordinary course of a trade or a business. See generally Temp. Treas. Reg. § 1.469-2T(c)(3).

[13] Rev. Rul. 57-516, 1957-2 C.B. 435.

[14] For a more targeted discussion on the tax treatment in such scenarios see Rev. Rul. 70-425, 1970-2 C.B. 151, discussed infra.

[15] Rev. Rul. 71-517, 1971-2 C.B. 268.

[16] Supra note 15.

[17] See also Rev. Ruls. 68-147, 1968-1 C.B. 338 and 68-318, 1968-1 C.B. 342.

[18] Rev. Rul. 74-373, 1974-2 C.B. 203.

[19] I.e., for Peruvian, not U.S., tax purposes.

[20] In this vein, see also New York & Honduras Rosario Mining Co. v. Commissioner, 168 F.2d 745 (2d Cir. 1948), wherein a New York corporation prepaid income taxes to cover a twenty year period. The Court decided that the sum advanced stood as a credit to the taxpayer and that the Court was concerned with the debits charged against such credit in those years. The debits, the Court held, were payments of income tax to a foreign country.

[21] Rev. Rul. 59-101, 1959-1 C.B. 189.

[22] See also Rev. Rul. 56-124, 1956-1 C.B. 97 which considers the issue of the deductibility of withheld and estimated payment amounts of Maryland state income taxes against the eventual tax liability resulting from a cash basis individual’s salary. The ruling references §§ 164(a) and 461(a) in allowing the deduction in the year of payment.

[23] GLAM 2008-05 (May 9, 2008).

[24] IRC § 6110(k)(3) denies written determinations precedential status but it is not entirely clear whether the nomenclature “precedent” connotes only “binding authority” or “persuasive authority” as well. Indeed, Courts have considered written determinations in formulating their judgments. See American Express Co. v. United States, 262 F.3d 1376 (Fed. Cir. 2001) and Western Company of North America v. United States, 323 F.3d 1024 (Fed. Cir. 2003).

[25] Supra note 24.

[26] IRC § 864(b); Treas. Reg. § 1.864-2(a).

[27] As a very convenient example, consider our very own U.S. tax regime that makes available various tax-advantageous preferences to various classes of taxpayers, imposes multiple types of income-based taxes, and applies varying graduated tax rates to different types of income.

[28] Treas. Reg. § 1.905-3(a).

[29] Treas. Reg. § 1.905-4.

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Essential Tax Rules of Cross-Border Gifting

By Anthony Malik

Introduction

Strategic gift planning, done usually to minimize or eliminate the estate and expatriation[1] taxes, is firmly within the purview of tax and financial advisors. The vast majority of gifting occurs in a purely domestic setting and most experienced advisors are indeed aware of the essential tax consequences to the parties involved in such gifting. The U.S. gift tax consequences, however, may not necessarily be immediately intuitive or apparent, even to many seasoned advisors, when one party to the transaction is a nonresident.[2] Advisors who specialize in working with international clients are undoubtedly familiar with the plethora of special obligations and penalties for noncompliance imposed on both cross-border gift donors and donees under the Internal Revenue Code (“IRC” or “Code”). Considering that we live in an increasingly integrated world wherein global human movement and settlement is the norm, it would be highly beneficial for generalist advisors to also become familiar with at least the essential tax rules of cross-border gifting.

The ensuing sections of this paper will provide a general overview of the U.S. tax consequences of cross-border gifting. It should go without saying that the complex nature of U.S. tax law renders an in-depth, comprehensive analysis—which would depend on the completeness of each individual set of facts—of the scenarios considered herein a rank impossibility. For example, to keep things manageable, a very incomplete list of things that this paper will not delve into—all of which may or may not have a bearing on either the U.S. or nonresident donor or donee—include the creditability of foreign gift taxes, the impact of an applicable estate and gift tax treaty on the outcome, U.S. state & local tax consequences, gifts of future interests, income tax consequences (e.g., basis determination, recharacterization of an accession to wealth as taxable income by the Internal Revenue Service (“IRS”) etc.), or gifts from business or fiduciary entities. With this important caveat out of the way, let us now turn to some cross-border gifting scenarios that advisors can come across.

Gifts from U.S. Donors to Nonresident Donees

This is an appropriate starting point for the substance of our discussion because assets held by U.S. donors, irrespective of their situs, gifted to nonresidents are subject to the same general tax rules as to gifts in a purely domestic setting. In determining a U.S. donor’s taxable gifts, certain statutory exclusions and deductions are permitted. The most commonly availed exclusion is the automatic maximum annual exclusion for the first $15,000[3] of gifts made to each nonresident donee during any single tax year. Gifts of up to the maximum annual exclusion amount can be made every tax year completely tax-free and without reporting consequences to as many nonresident donees as a U.S. donor may desire. However, gifts to any single nonresident donee during a single tax year exceeding the maximum annual exclusion amount generally cannot be made on a tax-free basis. As another example, the law also provides an unlimited exclusion for the payment of qualified tuition or medical expenses of a nonresident donee.[4] So as a tax planning strategy, U.S. donors seeking to aggressively manage their high net worth could be advised to fund the entirety of each of their intended nonresident beneficiaries’ education and medical costs in addition to gifting each of them up to the maximum annual exclusion amount in cash and other assets each tax year.

Taxable gifts (i.e., gifts exceeding the maximum annual exclusion amount in any single tax year) to any single nonresident donee are reported annually to the IRS on Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.[5] On Form 709 U.S. donors can claim a generous lifetime unified credit against their resulting gift tax liability which for the most recently passed tax year (2021) was as high as $4,625,800.[6] Consequently, though a U.S. donor may be responsible for making taxable gifts, he or she may not necessarily owe any tax after utilizing any portion of the available lifetime unified credit. Form 709 is generally due between January 1 and April 15 of the year following the tax year in which the gifts are made.[7] The IRS can impose penalties on the U.S. donor for both late filing and payment of gift taxes unless it can be established to the satisfaction of the IRS that there was reasonable clause for the delay. Compliance-wise, nonresident donees, on the other hand, are outside of the U.S.’s taxing jurisdiction and thus free of any reporting obligations.

Gifts from U.S. Donors to Their Nonresident Spouses

Married couples, in a purely domestic context, generally need not be concerned with gift taxation due to the unlimited interspousal gift tax deduction afforded to them by the law.[8] However, this cardinal benefit is not extended to gifts from a U.S. donor to his or her nonresident spouse.[9] Gifts to nonresident spouses instead have an annual inflation-adjusted deduction which for the most recently passed tax year (2021) totaled $159,000.[10] The apparent rationale for imposing limits on the nontaxability of asset transfers from a U.S. donor to his or her nonresident spouse is that in the absence of such a remedial provision, taxpayers could, under a number of different scenarios, freely transfer highly appreciated assets outside of the U.S.’s taxing jurisdiction and have the accompanying realized capital gains escape U.S. taxation altogether.

Gifts valued at more than the maximum annual exclusion amount to a nonresident spouse in any single tax year incur a tax cost and are required to be reported on Form 709 to the IRS by the applicable due date. As in the previous scenario, the U.S. spouse can utilize any portion of his or her available lifetime unified credit amount against the resulting gift tax liability. The nonresident donee spouse, on the other hand, is not subject to reporting under the Code.

Gifts from Nonresident Donors to U.S. Donees

U.S. donees are required to report to the IRS on Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, their receipt of gifts from nonresidents if the aggregate value of such gifts from any single nonresident donor during any single tax year exceeds $100,000.[11] The filing deadline for Form 3520 is pegged to the filing deadline of the donee’s U.S. income tax return (i.e., Form 1040, U.S. Individual Income Tax Return).[12] Once the $100,000 threshold is exceeded, each gift, in excess of $5,000, received during the year must be separately reported to the IRS.[13] It is particularly with such inbound gifts that U.S. taxpayers must be very vigilant about their federal tax reporting duties because noncompliance in this area is cause for draconian penalties. To wit, a U.S. donee who does not properly report an inbound gift on Form 3520 by his or her filing deadline, or who fails to include all of the required information, or includes incorrect information is subject to a penalty equal to 5% of the total value of the gift for each month, or fraction thereof, that the failure continues, up to a maximum penalty of 25%.[14]

An interesting consideration with respect to inbound gifts is that gifts from multiple nonresident donors can be treated, depending on the facts, as having been made by a single nonresident donor. The U.S. donee, in determining whether he or she received gifts in excess of $100,000 from a single nonresident during a single tax year, must aggregate gifts from foreign persons that the U.S. donee knows, or has reason to know, are related within the meaning of Code Section 643(i)(2)(B).[15] Notice here that no such aggregation rule exists with respect to gifts from a U.S. donor to nonresident donees. In effect, when determining whether a U.S. donor makes taxable gifts to any single nonresident donee during any single tax year, he or she is not required to aggregate gifts to foreign persons that such U.S. donor knows, or has reason to know, are related. The aggregation rule thus, inapplicable to outbound gifts, is a unique feature of inbound gifts.

For the aggregation rules to apply, the stipulation is that the nonresident donors themselves must be related to one another and not necessarily related to the U.S. donee. The following example provided by the IRS is very helpful in concretizing the guidance on this matter:

“A is a U.S. citizen who is married to B. B and all of B’s brothers, C, D, and E, are not U.S. persons. In a single taxable year, B makes a gift of $90,000 to A, C makes a gift of $40,000 to A, D makes two gifts to A (one of $4,000 and one of $3,000), and E makes a gift of $4,000 to A. For that taxable year, A must report the receipt of $141,000 in gifts from foreign persons. A must separately identify the $90,000 gift from B, because B and his brothers gave gifts in excess of $100,000. A must also separately identify the $40,000 gift from C, because C and his brothers gave gifts in excess of $100,000. A must identify the receipt of $7,000 in total gifts from D because D and his brothers gave gifts in excess of $100,000, but is not required to separately list information about each transaction because no gift is in excess of $5,000. A is not required to separately identify transaction information about E’s gifts, because gifts from foreign individuals of less than $5,000 are not required to be separately identified.”[16]

On the other hand, gifts valued at under $100,000 received from multiple unrelated nonresident donors in a single tax year are not subject to reporting even if the aggregate value of all such gifts exceeds $100,000. Along the same vein, it should be mentioned that in the case of having received gifts in excess of $100,000 from multiple unrelated nonresident donors in a single tax year, the guidance is suggestive, but not determinative, that the U.S. donee should file a separate Form 3520 with respect to reportable gifts from each nonresident.[17]

Insofar as the nonresident donor’s obligations under the Code are concerned, the determination of the situs of the gifted assets is an essential component. Nonresident donors are not subject to U.S. gift taxation under Code Section 2501 unless the gift consists of U.S. situs real or tangible personal property.[18] Gifts of intangible properties, even of U.S. situs, from nonresident donors to U.S., or for that matter nonresident, donees do not trigger U.S. gift taxation.[19] While at first mention foreign ownership of valuable U.S. situs assets may seem like a curious concept, experienced U.S. cross-border advisors can affirm that it is not uncommon for high net worth nonresidents to educate their children at U.S. universities, spend a considerable amount of leisure time in the U.S., invest in the U.S. financial and real estate markets, and to own expensive U.S. situs tangible personal property (e.g., cars and boats). Once subject to U.S. gift taxation, in 2021, similar to U.S. donors, nonresidents also enjoy an exclusion of the first $15,000 of gifts.[20] Gifts of U.S. situs exceeding $15,000 made to any single U.S. or nonresident donee in a single tax year are reportable on Form 709.

An extremely important point to note is that unlike U.S. donors, who can benefit from utilizing any portion of their available lifetime unified credit against their gift tax liability, nonresidents cannot utilize any such credit against their gift tax liabilities.[21] Nonresident donors’ taxable gifts are instead taxed cumulatively over their lifetime at graduated rates ranging from 18% to 40% for gifts made after 2012.[22] The comparatively more immediate gift tax consequences to nonresidents make considerations such as asset selection, donee identification, and disciplined timing very important elements of their overall gift-giving strategy.

Gifts from Nonresident Donors to Their U.S. Spouses

The available guidance on gifts from nonresident donors does not make any special mention, modification, exemption, or exclusion for gifts from nonresident spouses of U.S. donees. Thus, the aforementioned general rules of inbound gift taxation are applicable in full force to U.S. recipients of gifts from their nonresident spouses thereby making them subject to the same reporting requirements as are U.S. recipients of gifts from any other nonresident donors.

The gift taxation of the nonresident spouse, on the other hand, is altogether different from that of the generic nonresident donor under the immediately preceding heading in this paper. During the course of a given tax year, a nonresident spouse may gift U.S. or non-U.S. situs assets of an unlimited value to his or her U.S. spouse on a completely tax-free basis without creating a concomitant Form 709 filing requirement for oneself. It is tempting to postulate that the reason for such tax treatment, at least insofar as the nonresident spouse’s U.S. situs assets are concerned, is that appreciated assets remain in the hands of a taxpayer who is subject to U.S. taxation. However, should that be the case, then it is not at all clear as to why nonresident donors are subject to harsh taxation upon gifting U.S. situs assets to U.S. donees other than their spouse.[23]

In the consideration of this topic, it is also useful to contrast the gift tax treatment of the nonresident-spouse donor with that of his or her U.S. counterpart. While gifts going from a U.S. donor to his or her nonresident spouse do not qualify for the unlimited marital deduction, as we have just discussed, gifts flowing in the opposite direction do.

Gifts from Former U.S. Persons to U.S. Donees

In a stark departure from customary U.S. gift tax law (i.e., the donor is primarily liable for the payment of gift taxes[24]), Congress, on June 17, 2008, added Code Section 2801 to the Code to legislatively shift the gift tax burden to U.S. donees in the case of receipt of gifts from certain former U.S. persons who either previously renounced their U.S. citizenship or relinquished their green cards. In addition, the Code Section 2801 gift tax is imposed on the U.S. donee more onerously than how the gift tax is generally imposed on donors in most cases; to wit, the lifetime unified credit is unavailable to the U.S. donee to eliminate—or at the very least, mitigate—his or her gift tax liability.[25] Resultantly, gifts in excess of the maximum annual exclusion amount are subject to U.S. gift taxation at the highest prevailing marginal gift and estate tax rate.[26]

Very interestingly, though the Code Section 2801 gift tax was statutorily codified almost a decade-and-a-half ago, the U.S. Department of the Treasury (“Treasury Department”) never issued finalized regulations providing guidance as to the administration of, and compliance with, this newly enacted gift tax. The IRS, for its part, has announced that it intends to release new Form 708, U.S. Return of Gifts or Bequests From Covered Expatriates, once final regulations are promulgated. U.S. donees can, until such time that Form 708 is released, enjoy both tax-deferral and a reporting exemption courtesy of the IRS.[27] Notwithstanding, to the Treasury Department’s credit, it has issued proposed regulations[28] that provide interim guidance. However, since proposed regulations are subject to change, even to substantial change, prior to final promulgation, the time and effort required to divine their detailed meanings for purposes of our discussion is not warranted.

Closing Thoughts

The preceding discussion is meant to provide readers with a fundamental conceptual understanding of, and an appreciation for, the U.S. rules of cross-border gift taxation. In practice, the more complicated one’s client’s set of facts as they pertain to cross-border gifting, the deeper one must delve into the devilish details to ascertain the proper treatment. As a general rule of thumb, advisors should, when helping international clients plan their gifting strategy, obtain as much relevant background information possible. Some of the items for which information from clients should be requested include the constitution of their net worth, situs of their assets, applicable foreign transfer taxes, and long-term residence/domicile intentions as they relate to the U.S. etc. It is only after a reasonably comprehensive understanding of a client’s long-term personal, financial, immigration, and business goals can an optimal gift-giving strategy be crafted.

Anthony (“Tony”) Malik is Principal Consultant and owner of Point Square Consulting, an international tax specialty firm, in Atlanta. In addition to tax compliance and planning for international families and businesses, Tony is also a non-attorney taxpayer advocate (Enrolled Agent) and has successfully represented numerous taxpayers in international tax disputes and offshore amnesty procedures before the IRS and other subnational tax authorities. He can be reached at tony@pointsquaretax.com.

[1] The expatriation tax is a net worth based exit tax that is imposed on certain U.S. citizens and long-term permanent legal residents upon the renunciation of their U.S. citizenship or relinquishment of their green cards. See IRC §§ 877 and 877A.

[2] In very simple terms, a nonresident for U.S. estate and gift tax purposes is a non-U.S. citizen domiciled abroad. See Treas. Reg. §§ 20.0-1(b) and 25.2501-1(b).

[3] Inflation-adjusted by IRC § 2503(b)(2), the exclusion for the most recently passed tax year (2021) was $15,000. (Rev. Proc. 2020-45; Instructions, Form 709 (August 26, 2021), pg. 2.

[4] IRC § 2503(e).

[5] IRC § 6019.

[6] IRC § 2505. The lifetime exemption of $11,700,000, using the blended estate and gift tax rate, yields a credit of $4,625,800.

[7] Treas. Reg. § 25.6075-1.

[8] IRC § 2523(a).

[9] IRC § 2523(i).

[10] Rev. Proc. 2020-45.

[11] IRC § 6039F(a); Notice 97-34, 1997-1 C.B. 422.

[12] “In general, a U.S. person’s Form 3520 is due on the 15^th day of the 4^th month following the end of such person’s tax year for income tax purposes, which, for individuals, is April 15…” See the text under the heading When and Where to File, Instructions, Form 3520 (November 30, 2021), pg. 2.

[13] Instructions, Form 3520 (November 30, 2021), pg. 12.

[14] IRC § 6039F(c)(1)(B).

[15] Notice 97-34, 1997-1 C.B. 422, § VI(B)(3). Ascertaining related parties under the Code for various tax purposes can be a wondrously complex exercise. For purposes of our discussion, suffice it to say that family members (i.e., siblings, half siblings, spouses, ancestors, descendants, and the spouses of any of these) constitute relatives. See IRC § 267(c)(4).

[16] Ibid.

[17] See the verbiage in Notice 97-34, 1997-1 C.B. 422, § VI(B)(1).

[18] Burnet v. Brooks, 288 U.S.378 (1933); Treas. Reg. § 25.2511-3(a)(1)(i).

[19] However, a nonresident’s U.S. situs intangible property is subject to U.S. estate taxation. IRC §§ 2031, 2103, and 2106. Therefore, for estate tax planning purposes, a nonresident may be advised to reduce his or her net worth by making inter vivos gifts of U.S. situs intangible property.

[20] Ibid.

[21] A nonresident can, however, claim a meager estate tax credit worth $13,000. See IRC § 2102(b). Technically, the effect of this credit is to shelter the first $60,000 of the nonresident’s gross U.S. taxable estate from the federal estate tax.

[22] IRC §§ 2001(c) and 2502(a) (amended by the American Taxpayer Relief Act of 2012, P.L. 112-240, § 101(c)).

[23] Along the same vein, also consider gifts in a purely domestic setting wherein the gift tax is indeed applicable.

[24] IRC § 1619.

[25] On the other hand, had the former U.S. person gifted his or her assets to the same U.S. donee prior to expatriating, the donor would be allowed to utilize a lifetime unified credit worth as much as $4,625,800 against any potential U.S. gift tax liability and the U.S. donee could enjoy a tax-free accession to wealth.

[26] In 2021 the highest marginal estate and gift tax rate was 40%. See IRC §§ 2001(c) and 2502(a).

[27] Preamble to REG-112997-10; Announcement 2009-57, 2009-29 I.R.B. 158.

[28] Prop. Treas. Reg. §§ 28.2801-0 through 28.2801-7.

View the galley version of this paper in PDF format: Essential Tax Rules of Cross-Border Gifting (JoFP Galley Version)

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Timing the Creditability of Accrued Foreign Taxes

By Anthony Malik

INTRODUCTION

Compliance-oriented tax professionals are—in many cases, for very good reason—most likely to first turn toward material published by the Internal Revenue Service (“IRS”) via instructions to tax forms and various handbooks in the resolution of queries germane to their clients’ reporting requirements. While the purpose of such material is undoubtedly to lead return preparers step-by-step to accurately report information required by the law, it is no secret that it often fails to provide appreciable instruction. One such instance has to do with taxpayers claiming a credit for, pursuant to an election under Internal Revenue Code (“IRC” or “Code”) Section 905(a), accrued foreign tax on Form 1116, Foreign Tax Credit (Individual, Estate, or Trust). The incomplete guidance offered through the IRS’s relevant published material can, unless the return preparer is an experienced international tax specialist or a genuinely inquisitive tax professional skilled in legal research, lead to a misunderstanding and misapplication of the rules.

In the ensuing sections of this paper, we will first examine the non-authoritative guidance on this issue as provided through material developed by the IRS that is specifically directed toward the public for promoting, and assisting in, tax compliance—we will not review any relevant guidance that may be contained within material developed by the IRS for internal employee training and guidance (e.g., Audit Technique Guides, Practice Units, Internal Revenue Manual etc.) that the IRS is obligated to electronically publish pursuant to disclosure laws generally applicable to federal agencies.[1] Once we reach the limits of what one can reasonably and responsibly discern therein, we will then turn to the completeness and specificity of the guidance contained within the law. What will follow is a general discussion regarding authoritative sources of tax guidance addressing common timing issues of accrued foreign tax for creditability purposes.

REVIEW OF THE RELEVANT IRS MATERIAL

Turning first to Form 1116 itself, the heading for Part II, Foreign Taxes Paid or Accrued, prominently refers return preparers to the Instructions to Form 1116, which in their most essential guidance on this matter read only the following:

“Generally, you can take a foreign tax credit in the year you paid or accrued the foreign taxes, depending on your method of accounting. If you report on the cash basis, you can choose to take the credit for accrued taxes by checking the “accrued” box in Part II… Generally, you must enter in Part II the amount of foreign taxes… that relate to the category of income[2] checked above Part I. Taxes are related to the income if the income is included in the foreign tax base on which the tax is imposed.”[3]

As is obvious from a reading of the foregoing portion of the Instructions, they leave unaddressed a core element of the issue, i.e., the determination of the annual accounting period under U.S. tax principles within which the creditable tax accrues. As we will discover, particularly once we turn to the authoritative sources of tax guidance on this issue, this determination requires an understanding of certain technicalities that modify the standard tax accounting rules in two significant respects.[4] These technicalities are flatly unmentioned in the Instructions to Form 1116.

Moreover, the Instructions, due to their unfortunate usage of both verbiage and syntax, can also be easily misconstrued to mean that the foreign source income to which the reportable accrued tax relates is to be reported on the U.S. tax return for the same year, i.e., there is to be no timing difference between the recognition of income and the accrual of the related tax.[5] This confusion can come about because as the Instructions direct the return preparer to report in Part II of Form 1116 the amount of the foreign tax that “relate[s] to the category of income checked above Part I” and line 1a of Form 1116 itself directs the preparer to report in Part I of Form 1116 “gross income… of the type checked above” Part I, the return preparer, in comprehending the textual instruction through the lens of that which has just been comprehended, may reasonably conclude this to mean that one must report in Part II of Form 1116 the amount of accrued foreign tax that relates to the amount of the category of income that is reported above on that very same Form 1116. It is not at all obvious from the Instructions that the properly reportable amount of accrued foreign tax may relate to income that may be reportable on a tax return for an entirely different year. Thus the Instructions’ lack of clarity and specificity leaves considerable room for error.

Fortunately, however, Publication 514, Foreign Tax Credit for Individuals, at least partially addresses both issues. It first spells the general rule for determining the U.S. annual accounting period in which the foreign tax accrues in the following manner:

“In most cases, foreign taxes accrue when all the events have taken place that fix the amount of the tax and your liability to pay it. Generally, this occurs on the last day of the tax year for which your foreign return is filed.”[6]

Publication 514 does not expand on this further but nonetheless, in saying as much, specifies that the timing of the accrual of foreign tax is contingent upon the taxpayer’s foreign fiscal year, not the taxpayer’s U.S. annual accounting period. As we will see ahead, this is an important piece of information.

Publication 514 later also partially resolves the second issue by highlighting the normalcy of timing mismatches between the recognition of foreign source income and the payment—although not accrual, incidentally the topic of this discussion—of the tax thereon:

“If, in earlier years, you took the credit based on taxes paid, and this year you choose to take the credit based on taxes accrued, you may be able to take the credit this year for taxes from more than [one] year.”[7]

This is immediately followed by a realistic example that helps concretize the guidance:

“Last year, you took the credit based on taxes paid. This year, you choose to take the credit based on taxes accrued. During the year, you paid foreign income taxes owed for last year. You also accrued foreign income taxes for this year that you did not pay by the end of the year. You can base the credit on your return for this year on both last year’s taxes that you paid and this year’s taxes that you accrued.”[8]

There are a couple of things to note in this example, the first of which definitively clarifies the meaning of the portion of the Instructions considered earlier: the amount of the creditable foreign tax reportable on Form 1116 for a given year need not relate to the foreign source income in the sense that such income must be included in the foreign tax base on which such tax is imposed in the same U.S. annual accounting period. Rather, the income may be recognized in a U.S. annual accounting period which may be different from that in which the related tax may be paid.

The second thing to note in this example is that no such timing difference exists between the recognition of the current year’s foreign source income and the accrual of the portion of the tax thereon, i.e., both the recognition of the income and the accrued tax occur during the same U.S. annual accounting period. The remainder of Publication 514 remains silent on this very issue leaving taxpayers making an election under Code Section 905(a) uncertain as to how to comply with the law in the event of timing differences.

OVERVIEW OF THE RELEVANT LAW

Fortunately, the well-developed body of law in this area can be relied upon to provide comprehensive guidance. In this section, we will first explore the general rules regarding the accrual of foreign tax. In doing so, we will ground the hitherto considered non-authoritative guidance in actual law. We will then consider a few exceptional situations wherein the accrual of foreign tax may be contingent upon its payment. Lastly, we will also look at a couple of noteworthy instances of contradictory guidance issued by the IRS to gain a greater understanding of, and appreciation for, the dynamic nature of U.S. income tax law.

General Rules Regarding the Accrual of Foreign Tax

While individual taxpayers ordinarily, if not always, file tax returns using the cash basis method of accounting,[9] Code Section 905(a) allows cash basis taxpayers to elect to claim the foreign tax credit on an accrual basis regardless of their general method of accounting.[10] This is the first significant respect in which Code Section 905(a) modifies the standard tax accounting rules. This modification can potentially cause confusion in ascertaining the year of accrual when matching income earned on the cash basis method of accounting with the related tax incurred on the accrual basis method of accounting. Under the standard tax accounting rules, a liability does not accrue until the all events test[11] is met, i.e., (i) the amount and the fact of the liability is determined with reasonable accuracy and (ii) there is economic performance. In the case of a tax liability, the economic performance requirement is essentially an obviating provision; under the regulations, economic performance occurs when a tax liability is actually paid.[12] However, per an exception, if the tax liability is for a foreign tax that is creditable under Code Sections 901 or 903, the economic performance requirement of the all events test is waived.[13] This exception is ineluctably integrated into the broader regulations governing tax accounting methods thereby characteristically modifying the all events test for purposes of determining the amount of accrued but unpaid creditable foreign tax. The importance of this exception is such that without it the election handed by Code Section 905(a) would be rendered inoperative.

Court cases and administrative rulings addressing this issue, in addition to requiring a reasonably accurate determination of the amount and the fact of the liability, also emphasize that foreign tax does not accrue unless there is a strong certainty of collection by the relevant foreign governmental tax agency. For example, in Revenue Ruling (“Rev. Rul.”) 60-146,[14] the IRS ruled that the liability for tax accrued in the year in which the income on which the tax was computed was recognized, even though the liability would be assessed in a later year. Rev. Rul. 60-146, in citing a consequential earlier case, strongly suggested that its rationale was that the tax would be imposed on the taxpayer’s profits whether or not it liquidated prior to the time of actual collection. That case, Universal Winding Co. v. Commissioner,[15] held that the tax accrued on the last day of the tax year for which the taxpayer’s UK tax return was filed because the taxpayer would be taxed on the income earned through the end of the UK fiscal year either in the year of assessment if it were to remain in business until such time or, pursuant to the termination provisions of UK law, at a time prior to actual assessment if it were to liquidate.

The Government’s concern in conditioning the strong certainty of collection for the recognition of accrual of a creditable foreign tax is highlighted by the fact that Universal Winding Co. reached a conclusion that was opposite from the one reached in an earlier case[16] that considered the same question but in the context of different UK law as was in effect at the time. In Columbia Carbon Inc. v. Commissioner[17] the Court held that the UK tax did not accrue until the year of assessment because, under pre-1926 UK law, no tax would be due if the taxpayer liquidated before such time.

In addition to emphasizing certainty of collection, Universal Winding Co. also established the year of accrual of UK tax with respect to the taxpayer’s UK source earnings for a fiscal year (July 1, 1933 – June 30, 1934). In doing so, it effectively provided that foreign tax accrues at the end of the foreign fiscal year that ends with or within the taxpayer’s U.S. annual accounting period. Along the same vein, the IRS eventually issued Rev. Rul. 61-93[18] which went a step further in providing that taxpayers cannot prorate accrued foreign tax liabilities between two U.S. annual accounting periods over which two portions of a foreign fiscal year fall. Rather, the entire amount of the accrued foreign tax is to be factored into the singular U.S. annual accounting period within which the foreign fiscal year ends.[19] A common consequence of this guidance for taxpayers earning foreign source income in a country that has a fiscal year at odds with their U.S. annual accounting period is that for the portion of their first U.S. annual accounting period over which their foreign fiscal year falls, such taxpayers will be required to recognize income when earned[20] but will be prevented from claiming a corresponding credit for the taxes attributable thereto, unless the excess foreign tax amount accrued in the following U.S. annual accounting period can later be carried back.[21]

Accrual of Foreign Tax Upon Payment

Taxpayers making, or who have previously made,[22] a Code Section 905(a) election generally cannot claim a credit for foreign tax paid, either via withholding-at-source or by voluntarily remitting estimated tax payments, until such time that the tax accrues. Also, per the guidance hitherto considered, the payment of a tax is not tantamount to its accrual.[23] Notwithstanding, there are some possible situations in which an exception applies, i.e., the foreign tax may accrue upon payment. These situations involve (1) tax disputes, (2) delays in the payment of tax, and (3) substantial noncompliance. Let us now look at each situation more carefully.

Disputed Foreign Tax

A disputed foreign tax necessarily fails the modified all events test required for its accrual.[24] However, the payment of a creditable disputed foreign tax allows for its accrual, to the extent paid, prior to its final determination.[25] In such cases, if the amount of the foreign tax taken as a credit differs from its ultimately settled (i.e., accrued) liability, then the taxpayer must adjust the initially claimed credit for the year in which the liability arose.[26] This is the second significant respect in which Code Section 905 modifies the standard tax accounting rules. The regulations term any such event a foreign tax redetermination.[27]

The foreign tax redetermination rules modify the standard tax accounting rules by requiring that a foreign tax that accrues after the year in which the tax is credited must be reflected by amending the return for the year in which the credit was claimed, rather than by reporting it in the year in which the correct amount of the tax ultimately accrues.[28] Thus although the final amount of a foreign tax may accrue at a point later in time, as a function of the foreign tax redetermination rules, it relates back to the year in which the liability initially arose. ​The apparent rationale for the foreign tax redetermination rules is to eliminate the timing difference between the recognition of income and the tax calculated thereon so as to ensure that the foreign tax credit mechanism functions to prevent double taxation of the same income.

Two-Year Rule

In order to avoid unnecessary compliance headaches, it is particularly important for tax practitioners to consult their clients regarding this rule because any credit claimed for accrued foreign tax is eliminated if a taxpayer does not pay such tax within two years after the end of the tax year in which the credit was claimed.[29] Resultantly, taxpayers running afoul of the two-year rule may find themselves in a position wherein they must file an amended U.S. tax return to pay tax due to the reduction or elimination of their foreign tax credit amount. While the accrual of the creditable foreign tax is subsequently restored once it is paid,[30] it is nonetheless still an unenviable position for taxpayers to be in because of the extra administrative and compliance costs they would incur for filing multiple U.S. tax returns for the same year.

Treasury Regulation (“Treas. Reg.” or “Regulation”) Section 1.905-3(a) classifies both of the above instances of accounting adjustments to the accrued foreign tax, i.e., the revocation of its accrual due to nonpayment and the subsequent restoration of its accrual upon payment, as foreign tax redetermination events which, as already discussed, require adjustments to the credit claimed in the year to which the liability relates.[31] It should also be noted that the latter foreign tax redetermination event is subject to a special currency translation rule. Though taxpayers claiming an accrual basis foreign tax credit must ordinarily translate the amount of their foreign tax paid in the currency of denomination into U.S. dollars using the average exchange rate for the year to which the tax relates (i.e., the year of accrual),[32] taxpayers enjoying a retroactive restoration of the accrual of their foreign tax must retranslate such tax into U.S. dollars using the exchange rate as of the date they were paid.[33]

Noncompliance with Foreign Tax Laws

Foreign tax also seemingly does not accrue if the taxpayer makes no effort to comply with foreign tax laws. Cruz[34] was an interesting criminal tax evasion case wherein the taxpayer had deficiencies for the years 1975 through 1978, inclusive. The taxpayer had claimed a foreign tax credit for accrued Dominican Republic tax but he neither filed a Dominican Republic tax return nor otherwise paid any Dominican Republic tax. Code Section 905, as was in effect at the time, did not contain the two-year rule discussed directly above. Nonetheless, after careful deliberation, the Court reached a conclusion that would not have been dissimilar to one had the two-year rule been in effect at the time (considering the Dominican Republic tax owed in this case was delinquent by more than two years after the end of the taxable year for which the taxpayer claimed a foreign tax credit)—the Court decided that, if the taxpayer fails to comply with foreign tax laws, foreign tax accrues only once the tax is levied or paid.

While the two-year window eventually handed by Code Section 905(c) is relatively short, the implication of Cruz can nonetheless be correctly understood to be such that taxpayers should, during the two-year window, if not remit payment to secure the accrual of their foreign tax to the extent paid, make at least a demonstrable effort toward fulfilling their foreign tax obligations (e.g., obtain a foreign taxpayer identification number, retain local tax counsel, budget or set aside funds for eventually paying the accrued foreign tax etc.) or otherwise risk a possible foreign tax redetermination before the expiration of the two-year period.

Noteworthy Contradictory Guidance

Something that potentially turns the door knob to uncertainty is that there are at least a couple instances wherein the IRS, to one degree or another, deviated from established principles in its judgment. In the first, and more important, example, Rev. Rul. 288[35] held that foreign tax was to accrue under foreign legal rules instead of under previously established U.S. tax principles that had set the foreign tax to accrue generally upon the culmination of the foreign fiscal year. The ruling pertained to a U.S. taxpayer, reporting foreign source income under the completed contract method, which was allowed to claim a credit for all foreign tax attributable to the portion of the income included in its gross income for U.S. tax purposes that stemmed from contract completion during the taxpayer’s U.S. annual accounting period. This ruling apparently creates a taxpayer-friendly exception for taxpayers reporting foreign source income under the completed contract method of accounting.

There is also at least one very interesting Private Letter Ruling (“PLR”) which is, although not precedential,[36] worth mentioning because it reveals the IRS’s position regarding the relevant law.[37] PLR 8401071, considering a taxpayer with considerably different facts and circumstances, also based the accrual of foreign tax on the implications of foreign tax procedure. The taxpayer, to whom the ruling applied, had earned income in a foreign country during the years 1977 and 1978 which qualified for an exemption from tax therein pursuant to the relevant provisions of an existing income tax treaty (“old treaty”) with the U.S. However, in 1975 the foreign country had signed a new income tax treaty (“new treaty”) with the U.S. according to the relevant provisions of which the foreign country would have been permitted to tax the local source earnings of the taxpayer. The new treaty would not enter into force until April 25, 1980. It was, however, retroactive to April 6, 1975.

In light of the new treaty’s retroactivity, the foreign country’s tax authority asserted a tax against taxpayer prior to the new treaty entering into force. The taxpayer subsequently paid, and also disputed, a portion of the total amount of the asserted foreign tax. The ruling, rather contrary to the expected outcome, held that both the paid and the disputed portions of the total amount of the foreign tax would accrue on the date the new treaty was ratified to grant taxing rights to the foreign country.

FINAL THOUGHTS

The purpose of this paper is obviously not to disparage instructions to tax forms published by the IRS or the tax professionals who utilize them in their practice. Rather, the goal is to encourage compliance-oriented tax professionals to develop a sense to better recognize the point at which they reach the limits of the instructive usefulness of the relevant IRS material. While it may be tempting to conclude that the extent of the relevant information provided in the IRS material ought to be sufficient in determining a tax return position, as we saw, such temptation can impel the tax professional to forgo something consequential in its implication. In our case of trying to ascertain the timing of the accrual of creditable foreign tax, on the level of our immediate interpretive interaction with the pertinent IRS material, it eventually presents us with telltale signs that one must go beyond its limits into authoritative sources of tax guidance.

The unconditional justification for the inadequacies of the IRS’s Instructions to Form 1116 and Publication 514 lies in their necessity. Their inadequacy is the result of the kind of legal guidance they attempt to distill in plain language about the complex interrelationships between different and distinct fact patterns and the laws applicable thereon. As our walk through the authoritative sources of tax guidance relevant to our query reveals, even something seemingly as simple as determining when an accrual accounting event takes place can be highly fact-dependent, governed by a complex set of crisscrossing laws, and subject to keen professional judgment—the coverage by IRS materials of the length and breadth of which is an unrealistic expectation.

Anthony (“Tony”) Malik is the Principal Consultant and owner of Point Square Consulting, an international tax specialty firm, in Atlanta. Tony is also a non-attorney taxpayer advocate (Enrolled Agent) and has successfully represented numerous taxpayers in international tax/penalty disputes and offshore amnesty procedures before the IRS and other subnational tax authorities. He can be reached at tony@pointsquaretax.com.

[1] Freedom of Information Act, 5 U.S. Code § 552.

[2] Referring to the various categories of income prescribed by IRC § 904(d) for purposes of applying the overall method of limiting the calculation of the foreign tax credit.

[3] Instructions, Form 1116 (December 3, 2020), pg. 17.

[4] IRC § 905 modifies, as discussed in the following section of this paper, the general rules of §§ 446 and 461.

[5] This is not to mean that the Instructions are hopelessly or, for that matter, even solely prone to misinterpretation. Indeed, there are instances wherein the underlying law is itself suggestive that income and the related tax liability are meant be taken into account in the same year. For an example, see the creditability limitation rules under IRC § 904(d).

[6] Publication 514 (February 25, 2021), pg. 3.

[7] Ibid.

[8] Ibid.

[9] See Brander v. Commissioner, 3 B.T.A. 231 (1925); Marks v. Commissioner, 6 B.T.A. 729 (1927); and Perry v. Commissioner, 19 T.C.M. 540 (1960).

[10] This precept is incorporated in IRC § 446 and the regulations thereunder.

[11] IRC § 461(h)(4) and Treas. Reg. § 1.461-1(a)(2).

[12] Treas. Reg. § 1.461-4(g)(6)(i).

[13] Treas. Reg. § 1.461-4(g)(6)(iii)(B).

[14] Rev. Rul. 60-146, 1960-1 C.B. 276.

[15] Universal Winding Co. v. Commissioner, 39 B.T.A. 962 (1939).

[16] Columbia Carbon Inc. v. Commissioner, 25 B.T.A. 456 (1932).

[17]Ibid.

[18] Rev. Rul. 61-93, 1961-1 C.B. 390.

[19] See also Chief Counsel Advice Memorandum 2008-005 (May 9, 2008) which considers the year in which a U.S. citizen can claim a credit for withheld foreign taxes where the taxpayer has different U.S. and foreign tax years.

[20] Income is reported when received, regardless of when earned. Treas. Reg. § 1.446-1(c)(1)(i).

[21] As provided by the rules under IRC § 904(c) and Treas. Reg. § 1.904-2.

[22] Per IRC § 905(a), once a taxpayer elects to claim foreign tax credits on the basis of foreign taxes accrued, “the credits for all subsequent years shall be taken on the same basis.”

[23] Ibid.

[24] Ibid.

[25] Rev. Rul. 58-55, 1958-1 C.B. 266; Rev. Rul. 84-125, 1984-2 C.B. 125; and Cuba R.R. Co. v. United States, 124 F. Supp. 182 (S.D.N.Y. 1954).

[26] IRC § 905(c)(1).

[27] See Treas. Reg. §§ 1.905-3 and 1.905-4.

[28] See Van Norman Co. v. Welch, 141 F.2d 99 (1^st Cir. 1944) wherein the Court held that a retroactively imposed tax accrues in the year the tax is enacted, not in the prior year in which the income subject to such retroactively imposed tax is earned. See also United States v. Anderson, 269 U.S. 422 (1926).

[29] IRC § 905(c)(2)(A).

[30] IRC § 905(c)(2)(B).

[31] Ibid.

[32] IRC § 986(a)(1)(A); Treas. Reg. § 1.986(a)-1(a)(1).

[33] IRC § 905(c)(2)(B)(ii); Treas. Reg. § 1.986(a)-1(a)(2)(i).

[34] United States v. Cruz, 698 F2d 1148 (11^th Cir.), cert. denied, 464 U.S. 960 (1983).

[35] Rev. Rul. 288, 1953-2 C.B. 27.

[36] IRC § 6110 (k)(3); Treas. Reg. § 301.6110-7(b).

[37] In spite of their non-precedential status, the fact remains that many Courts have, in both pre- and post-IRC § 6110 cases, lent weight to, and cited, PLRs in support of their interpretation of substantive provisions of the IRC, e.g., see Hanover Bank v. Commissioner, 369 U.S. 672 (1962); International Business Machines Corp. v. United States, 343 F.2d 914 (Ct. Cl. 1965); and Rowan Companies v. United States, 452 U.S. 247 (1981).

View the galley version of the paper in PDF format: Timing the Creditability of Accrued Foreign Taxes (Galley Version)

The post Timing the Creditability of Accrued Foreign Taxes appeared first on New York International Tax and Business Consulting.

An Inquiry into the Factors Aiding Clemency for Foreign Corporations Requesting Protective Tax Return Filing Deadline Waivers

By Anthony Malik[1]

• INTRODUCTION

Foreign corporations (“FCs”) often have varying degrees of U.S. business activities which in turn subject them to varying degrees of U.S. tax exposure. Depending on a given FC’s country of incorporation, size, business model, and activities it can be difficult—even for seasoned international tax specialists—to accurately assess the FC’s U.S. tax position without diligently analyzing the facts and circumstances. Despite said difficulty, it is not uncommon for such FCs to receive advice regarding their U.S. tax positions from their foreign or U.S. generalist tax advisors. Unfortunately this often leads such FCs to have a false sense of their U.S. tax exposure thereby potentially putting them at severe risk of adverse action by the various U.S. tax authorities.

Given the fact-intensive nature of U.S. taxability determination, it is often in a FC’s best interest to consider the advantages of filing protective tax returns.[2] In practice, however, many FCs are either unaware of the option, or are specifically advised not to, file protective tax returns. This may be, depending on the factual situations, perfectly harmless, less so, or flat-out unwise. The reason being that protective tax returns, as do virtually all (if not all) U.S. tax returns, have legally prescribed due dates[3] by which they must be filed with the Internal Revenue Service (“IRS” or “Service”). Much more importantly, apart from the open-ended statute of limitations under Internal Revenue Code (“IRC” or “Code”) Section 6501 and the potentially applicable penalties under IRC Section 6651, that most U.S. tax practitioners are familiar with, the real peril for non-filing FCs is the potential disallowance of otherwise allowable deductions and credits[4] for purposes of computing their U.S. taxable incomes[5] if it is later determined that such FCs derived income that was effectively connected (“ECI”)[6] with the conduct of a U.S. trade or business (“USTB”).[7] Consequently FCs that do not file, when the prevailing facts and circumstances warrant the filing of, protective tax returns are at undue risk of being taxed on their gross incomes from U.S. sources.[8]

Fortunately for FCs in such predicaments, the IRS has established procedures[9] whereby they can request filing-deadline waivers for their prior years’ unfiled protective tax returns pursuant to Treasury Regulation Section 1.882-4(a)(3)(ii).[10] A waiver then enables such FCs to file their prior years’ protective tax returns and reclaim the ability to preserve all allowable deductions and credits. For this purpose, a given FC seeking a waiver must establish to the satisfaction of the Commissioner (and his or her delegates) that the FC, based on the facts and circumstances, acted reasonably and in good faith in not filing a prior year’s protective tax return. The Commissioner will in turn consider the following factors to determine whether the FC acted reasonably and in good faith:

• Whether the FC did not become aware of its ability to file a protective tax return by the deadline for doing so;[11]
• Whether the FC had not previously filed a protective tax return;[12]
• Whether the FC voluntarily identifies itself to the IRS as having failed to file a protective tax return;[13]
• Whether there are other mitigating or exacerbating factors; and[14]
• Whether the FC failed to file a protective tax return due to intervening events beyond its control.[15]

In addition to these factors, the waiver is also preconditioned on the stipulation that:

• The FC cooperate in the process of determining its income tax liability for the taxable year for which the protective tax return was not filed.[16]

Despite the regulatory text’s listing of the above factors, it should be noted that the requirement is not that one must satisfy each factor. Rather the Commissioner’s determination of a given FC’s reasonable behavior and good faith is primarily based on the preponderant merit of its cumulative facts and circumstances. There is a conspicuous degree of overlap between some of the factors and different combinations of these factors will be more relevant in developing strong claims in different situations.[17]

In the ensuing sections, we will inquire into the aforementioned factors designed to aid clemency for FCs requesting protective tax return filing deadline waivers. Obviously, this paper cannot examine each factor by holding it up to the lens of every reasonably possible eventuality an international tax practitioner may encounter. Rather what follows is a general discussion meant to help readers construe the factors more productively in developing compelling claims.

• UNAWARE OF ABILITY TO FILE A PROTECTIVE TAX RETURN BY THE DEADLINE

Before moving forward, it should be briefly mentioned that an understanding of the longstanding authorities regarding what constitutes “reasonable cause,” would be highly useful in construing these factors.[18] That said a FC’s previous non-filing due to ignorance of the U.S. law is normally acceptable as an indicator of reasonable behavior and good faith. This is because unlike U.S. taxpayers, foreign taxpayers, let alone awareness with respect to technical U.S. tax return filing options, are not at all oriented to the U.S. tax system. As foreign taxpayers with limited U.S. business activities (and thus prospective protective tax return filers), it is understandable that FCs are often not—and cannot reasonably be expected to be—aware of the option to timely file protective tax returns.[19]

Some readers may no doubt ponder this seeming deviation from the general principle of Boyle[20] (i.e., ignorance of filing dates is not acceptable). However, apart from the fundamentally different fact patterns in cases involving foreign protective tax return filers, the touchstone of this factor is not unawareness of the filing due date but rather the abject unawareness of the option to file a protective tax return in the first instance. Perhaps the potency of such base-level unawareness lays in the fact that it would summarily withdraw, from even the most prudent taxpayer, all reason to explore filing deadlines or for that matter any other tax obligations related to, or springing from, the filing requirement itself.[21]

In practice, a situation that often occurs which allows making a strong claim with respect to this factor is when such a FC’s foreign tax advisor, without any input from a U.S. international tax specialist, begins rendering U.S. tax advice. To such foreign tax advisors’ credit, they are usually familiar with the international tax treaty concept of permanent establishment (“PE”).[22] They consider a given FC’s facts and circumstances, correctly determine that the FC does not have a U.S. PE,[23] and then incorrectly advise the FC that it need not concern itself with U.S. tax matters. Consequently such a FC is led to an incorrect understanding of its U.S. tax exposure because PE is not the correct standard for initially determining U.S. taxability (and thus not the correct standard for determining U.S. tax compliance obligations). Rather, the correct standard to initially determine U.S. taxability is the lower USTB threshold. Generally foreign tax advisors are unfamiliar with this U.S. law concept unless they regularly collaborate with U.S. international tax advisors to serve international businesses with U.S. activities.

Another common scenario is when such FCs engage general U.S. tax practitioners (i.e., not U.S. international tax practitioners) to advise them regarding their U.S. tax positions. These generalists, unfamiliar with the finer points of U.S. international taxation, then hurriedly skim the international provisions of the Code. These generalists may succeed in learning about the option of filing protective tax returns to the point where they can excursively discuss them with the FCs. However, it is quite rare for these generalists to, in such a short amount of time, gain enough competence in this specialized area of practice to coherently advise the FCs regarding the benefits of filing, the possible consequences of non-filing, and even the deadlines of filing such forms. Moreover, such generalists, due to their inexperience in this area, are usually squeamish about the prospect of preparing tax forms for international businesses and thus have a tendency to implicitly advise non-filing. Consequently many FCs walk away mistakenly feeling that exploring protective tax returns is not a useful or necessary endeavor.

The challenge of such a scenario is that it provides for attenuated (though not ineffectual) claims with respect to this factor. While the generalist may have made the FC aware of its ability to file a protective tax return, the generalist may not necessarily have made the FC “aware of its ability to file a protective return… by the deadline for filing a protective return.”[24] Given the optional nature of protective tax returns and the framing of the advice, it is not inconceivable for a FC to think that such returns are not subject to filing deadlines. In fact, protective tax returns were previously not subject to filing deadlines under prior law.[25] The point being that FCs do not necessarily forego learning about the relevant due dates willfully or negligently.

Nonetheless, given its weaker position, it is important to bolster such a claim with additional support. As an example, one could point towards the generalist’s infractions of various provisions of Treasury Department Circular No. 230 (“Circ. 230”)[26] and invoke reasonable cause due to reliance on a tax advisor.[27] As another example, one could point towards the lack of a meaningful incentive to not file to support their claim of unawareness of the necessity of filing by a deadline. Protective tax returns are tax-inconsequential, i.e., they essentially serve information reporting rather than income tax remittance purposes. Thus FCs usually lack a motive to deliberately forego filing protective tax returns.

• NO PREVIOUSLY FILED PROTECTIVE TAX RETURNS

The obvious function of this factor is to count against previously filing FCs that subsequently stopped filing. Holding such a corporate “stop-filer”[28] that previously filed protective tax returns to a higher standard than a FC that never filed in the first instance is understandable given such FC’s previous demonstration of its knowledge regarding its U.S. tax return filing responsibilities followed by its decided non-filing. Further to this point, Example 6 in Treasury Regulation Section 1.882-4(a)(3)(iii) describes a corporate stop-filer as not having met the appropriate standard to receive a waiver. However this by no means guarantees doom for stop-filing FCs. Rather the likelihood of any waiver request’s success is contingent upon the merits of the overall underlying facts and circumstances. Consider that the example given is one of a FC that:

• Earned ECI (i.e., it is probably a regular income tax return, not a protective tax return, filer);
• Stopped filing more than four years ago;
• Did not voluntarily identify itself to the IRS as having failed to previously file U.S. tax returns and did not make efforts to comply with U.S. tax laws until it was approached by an IRS examiner;
• Did not present evidence that intervening events beyond its control prevented it from filing U.S. tax returns; and
• Did not claim the presence of any mitigating factors in its defense.

Thus it is not hard to see that this example could have articulated a contrary result had a couple of the foregoing factual points been taxpayer-friendly.

The filing logistics are also an important consideration in this factor. Consider the realistic situation where a FC, after years of conducting limited business activities in the U.S., reaches out to a U.S. international tax practitioner for advice on miscellaneous tax issues. During the conversation the practitioner recommends the FC to consider filing protective tax returns. This is the first time that the FC has learned of this option. The practitioner’s advice makes sense but before committing to engage the practitioner to prepare a waiver request and handle all prior years’ protective tax returns, the FC understandably decides to engage the practitioner to prepare only its current year’s timely protective tax return. After the FC’s current year protective tax return is filed, the FC becomes much more comfortable with the U.S. tax system. Also, by having gone through the process once, the FC better realizes the value of protective U.S. tax compliance. This newfound appreciation for protective tax returns then impels the FC to engage the practitioner to prepare its protective tax returns for all prior years during which the FC had any U.S. business connection. Does the previously filed timely current year’s protective tax return preclude the FC from satisfying this factor’s standard?

The short answer is that it most likely does not. Regarding this very factor the IRS’s prior Compliance Initiative for Nonresident Aliens and Foreign Corporations[29] specified that taxpayers would remain eligible for clemency so long as they had not “previously filed a U.S. federal income tax return or a protective return for any taxable year prior to a taxable year for which a waiver [was] requested.” It follows that the FC would be able to satisfy this factor’s standard since it last engaged the practitioner to prepare only delinquent protective tax returns for taxable years preceding the current year.

Notwithstanding it is vital to mention that the IRS’s most current guidance is silent on this specific issue. On February 1, 2018 the Large Business and International Division (“LB&I”) of the IRS issued a memorandum[30] to its employees with Guidelines for Handling Delinquent Forms 1120-F and Requests for Waiver Pursuant to Treas. Reg. § 1.882-4(a)(3)(ii).[31] An attachment to this memorandum provides LB&I employees a two-paged Waiver Summary Analysis document containing seven items to which employees are curiously asked to provide “detailed responses” in very limited spaces. Regarding previous filings, this document simply states “Whether the corporation had not previously filed a U.S. income tax return”[32] and beneath this one-line statement provides a response space that is approximately 0.5 inches long and 5.0 inches wide. This points to a strong possibility that LB&I employees, mechanically following this form, will (at least initially) count timely filed current year’s protective tax returns against FCs. Thus, to avoid any unnecessary problems, it is advisable to recommend non-filing FCs to consider requesting a waiver pursuant to Treasury Regulation Section 1.882-4(a)(3)(ii) upfront and then filing all relevant protective tax returns in one fell swoop.

• VOLUNTARILY IDENTIFYING ITSELF TO THE IRS AS NOT HAVING PREVIOUSLY FILED PROTECTIVE TAX RETURNS

The importance of voluntary compliance in this area can be better understood by considering the IRS’s history in inducing non-filers to comply with the U.S. tax law. As discussed earlier, protective tax returns did not initially have statutory filing deadlines. Resultantly FCs would forego filing U.S. tax returns until and unless they were pursued by the IRS. Understandably, the tax evasion opportunities available to FCs were troubling to the IRS. To curtail this behavior the IRS began denying filers of “delinquent”[33] tax returns the benefits of otherwise allowable deductions. The Courts[34] were in turn sympathetic to the IRS’s position.

In Taylor Securities, Inc. v. Commissioner[35] the Board of Tax Appeals held that “it [was] inconceivable that Congress contemplated… that taxpayers could wait indefinitely to file returns and eventually when the [IRS] determined deficiencies against them they could then by filing returns obtain all the benefits to which they would have been entitled if their returns had been timely filed. Such a construction would put a premium on tax evasion, since a taxpayer would have nothing to lose by not filing a return as required by statute.” Eventually in 1990 revised Treasury Regulation Section 1.882-4[36] handed deadlines to induce non-filers to voluntarily file timely protective tax returns otherwise they would lose their ability to claim any allowable deductions and credits in the event of a subsequent determination of U.S. taxability. Then most recently, the IRS on October 30, 2018 announced a new audit campaign targeting non-filing FCs.[37]

Given this special history and the IRS’s modern enforcement efforts, no FC should unnecessarily delay filing its protective tax returns once it becomes aware of the option of doing so. The waiver request, with respect to the FC’s voluntary compliance, should ideally lay out a timeline of the events and point out the FC’s prompt action and responsible behavior in honoring its U.S. tax commitments. The waiver should also alert the adjudicator that the FC, depending on the facts, has never been requested to file U.S. tax returns, has never been requested to produce information that would suggest to the FC that it may be noncompliant in any regard, or that the FC is not currently under audit pursuant to the new campaign targeting non-filing FCs.

It is also undoubtedly helpful to point out the optional nature of protective tax returns. This can allow for a case to be made that the prior non-filing was not necessarily violative of U.S. revenue laws and that the subsequent voluntary filing was done in an effort to meet a higher standard of compliance. This claim is particularly likely to be influential when a given FC determines that it lacks a USTB[38] and also happens to not derive any non-ECI from U.S. sources.[39]

• OTHER MITIGATING FACTORS

This is the most open category of factors and provides for an expanded opportunity to state a case. This category does not necessarily specifically pertain to extenuating circumstances in connection with the failure to file. These factors can be used to bolster the overall claim as to why a waiver would be appropriate in a given case. Below are some factors that may, depending on the situation, merit the approval of a waiver.

• Prompt Action by Taxpayer

As previously mentioned, the waiver request should ideally lay out a timeline of the events and point out the FC’s prompt action and responsible behavior in honoring its U.S. tax commitments. A FC’s attempts to quickly file its delinquent protective tax returns within a reasonable amount of time after learning of its ability to do so demonstrates good faith to the IRS. A taxpayer’s urgency and priority with respect to its tax matters is also a staple of the longstanding reasonable cause criteria.[40] The IRS is more willing to grant clemency in cases where FCs behaved diligently in filing their delinquent protective tax returns.

• Intent of Taxpayer

A FC’s cooperation, prompt action, and diligence, among other factors, can be discussed to provide the IRS a window into such a FC’s mindset. The aim is to highlight evidence suggesting that the FC would have timely filed its prior years’ protective tax returns had it been aware of the option to do so. It is also helpful to mention the FC’s lack of meaningful motive to deliberately not file given the tax-inconsequential nature of protective tax returns. Good faith intentions of applicants surely receive favorable consideration by the IRS.[41]

• Consistency with the Law’s Objectives

The explicit regulatory standard currently required for consideration of a waiver is one of reasonable behavior and good faith.[42] This standard was conclusively prescribed for purposes of Treasury Regulation Section 1.882-4(a)(3)(ii) on March 7, 2003[43] after the revision of the stringent “good cause”[44] under “rare and unusual circumstances” standard contained within the prior regulations.[45] The Department of the Treasury and the IRS had discovered that in practice the old standard was overly restrictive and as such failed to “balance the legislative intent to establish strong compliance measures with respect to required income tax return filing by foreign taxpayers with a means to grant relief from the filing deadlines in appropriate cases.”[46] Resultantly “the [currently applicable] waiver standard provides that the filing deadlines may be waived by the commissioner or his or her delegate [so long as] the non-filer establishes that, based on the facts and circumstances, the non-filer acted reasonably and in good faith in failing to file a U.S. income tax return (including a protective return).”[47] Hence a FC that has acted reasonably and in good faith can assert that the granting of a waiver would be wholly consistent with the law’s stated objectives.

Separately, as protective tax returns do not reflect U.S. taxable income, a denial of a requested waiver would be tantamount to the imposition of the applicable penalties under IRC Section 6651 on taxpayers. If a FC is voluntarily filing its prior years’ protective tax returns without regard to any potentially applicable penalties, the imposition of any such penalties effectively serve a purely punitive instead of a remedial purpose. The Courts have long recognized the concept of penalties being imposed as an inducement towards voluntary compliance rather than as an instrument for punishment.[48] Therefore the granting of a waiver would also be consistent with judicial proclamations.

• Consistency with the IRS’s Policy Objectives

The IRS strives to promote voluntary compliance and to collect income tax returns in the most efficient manner possible.[49] In this regard, a FC’s initiative to file its prior years’ protective tax returns is in alignment with the IRS’s various publicly stated policy objectives. As previously discussed, a denial of a requested waiver is tantamount to the imposition of the applicable penalties under IRC Section 6651 on a given FC. The imposition of such penalties would not only fail to meet the IRS’s policy objectives but would likely undermine them.

Per the IRS, penalties are used to enhance voluntary compliance[50] by increasing the cost of noncompliance[51] and demonstrating the fairness of the tax system to compliant taxpayers.[52] As already discussed, the imposition of penalties on a voluntarily filing FC would serve a punitive instead of a remedial measure. Since protective tax returns are optional in nature, penalties would discourage—not enhance—voluntary compliance by other FCs with similar facts and circumstances. Regarding the IRS’s objective of increasing the cost of noncompliance, the imposition of penalties in such cases would obviously only serve to increase the cost of voluntary compliance, not noncompliance. It would also violate the IRS’s objective of demonstrating fairness of the tax system to compliant taxpayers.[53]

It is also the stated policy of the IRS that “in limited circumstances where doing so will promote sound and efficient tax administration, the Service may approve a reduction of otherwise applicable penalties or penalty waiver for a group or class of taxpayers as part of a Service-wide resolution strategy to encourage efficient and prompt resolution of cases.”[54] As such, the waiver should stress the issuance of the previously discussed LB&I memorandum.[55] The guidelines within this memorandum are obviously designed to foster sound and efficient tax administration and such a FC is undoubtedly a candidate (out of an appropriate “group or class of taxpayers”) for treatment under these guidelines. Therefore a waiver request can rightfully assert that the granting of a waiver will meet several important policy objectives of the IRS.

• No Prejudice to the Interests of the Government

Tax-inconsequential protective tax returns serve information reporting rather than income tax remittance purposes. Thus the granting of relief cannot possibly result in a given FC enjoying lower tax liabilities for the tax years for which such a FC requests a waiver. Additionally, the granting of a waiver usually in no way affects (i.e., does not lower) the U.S. tax consequences of other taxpayers for those (or any other) years.

• INTERVENING EVENTS BEYOND ITS CONTROL

This factor is most suitably invoked in situations wherein a FC knew of its ability to file a protective tax return by the due date but nonetheless failed to do so. In assessing this claim the IRS considers whether such a FC could have reasonably anticipated the event that caused the non-filing. Central to this factor is the idea that “The [FC’s] obligation to meet the tax law requirements is ongoing. Ordinary business care and prudence requires that the [FC] continue to attempt to meet the requirements, even though late.”[56] This factor cozily coincides with the longstanding reasonable cause standard.[57] Common events beyond a FC’s control that can contribute to noncompliance include, but are not limited to:

• Death, serious illness, or unavoidable absence;[58]
• Fire, casualty, natural disaster, or other disturbances;[59] and
• Inability to obtain records.[60]

There is abundant tax literature available on these reasonable cause standards and thus we will not explore these in detail.

• COOPERATION IN DETERMINING ITS U.S. INCOME TAX LIABILITY

As tangentially discussed above, there is a strong likelihood that adjudicators will perform their waiver summary analyses by mechanically following the guidelines given to them. Hence even though protective tax returns are tax-inconsequential, to avoid unnecessary problems the waiver request should unambiguously describe the FC’s satisfaction of its requirement of “[cooperating] in the process of determining its income tax liability for the taxable year for which the return was not filed” in order to be granted a waiver.[61] On this score, the waiver request should emphasize that in the absence of a USTB and any non-ECI income, the FC is not subject to U.S. income taxation and has therefore correctly determined a nil (i.e., zero) U.S. income tax liability for the years for which it seeks a waiver. The narrative should ideally mention the FC’s provision of complete, true, and accurate information regarding its business activities to an international tax specialist for making the appropriate determination.

• FINAL THOUGHTS

FCs with U.S. business connections require special care and expertise. Depending on the situation, simply advising such FCs on their U.S. tax return filing obligations and options requires specialized knowledge. FCs with limited U.S. business activities that have never filed protective tax returns are often unknowingly in a precarious position vis-à-vis the IRS. This is particularly so now more than ever before considering the IRS’s new audit campaign targeting non-filing FCs. Such FCs should consider promptly requesting a waiver pursuant to Treasury Regulation Section 1.882-4(a)(3)(ii) and filing their prior years’ protective tax returns to safeguard their interests in the event of a dispute with the IRS.

ENDNOTES

[1] Anthony (“Tony”) Malik is Principal Consultant and owner of Point Square Consulting in Atlanta. He is an international tax specialist and non-attorney taxpayer advocate (Enrolled Agent). Tony represents clients in international tax controversies and amnesty procedures before the IRS and other tax authorities. He also provides a wide range of international tax compliance, planning, and research services. He is a member of the National Association of Enrolled Agents and the Georgia Society of CPAs. He can be reached at tony@pointsquaretax.com. Tony would like to thank Randall Brody of Tax Samaritan for sparking the idea to write this paper.

[2] Form 1120-F, U.S. Income Tax Return of a Foreign Corporation, filed pursuant to Treas. Reg. § 1.882-4(a)(3)(vi).

[3] FCs’ protective tax return filing deadlines depend on their degree of U.S. connection, whether the current taxable year is the first taxable year for which they will file a protective tax return, whether they filed a protective tax return for the immediately preceding taxable year, and whether they did not file a protective tax return for the immediately preceding taxable year and the current taxable year is not the first taxable year for which they will file a protective tax return. See IRC § 6072 and Treas. Reg. § 1.882-4(a)(3)(i).

[4] See IRC § 882(c).

[5] Treas. Reg. § 1.882-4(a)(3)(i).

[6] Within the meaning of IRC § 882(a)(1) and Treas. Reg. § 1.882-1(b)(2).

[7] This is the legal threshold by which FCs become subject to U.S. taxation under the Code. See IRC § 864(b) and the regulations thereunder.

[8] See Treas. Reg. § 1.882-4(a)(3)(vi).

[9] On February 1, 2018 the Large Business and International Division (“LB&I”) of the IRS issued a memorandum to its employees with guidance on this matter. See LB&I-04-0218-007.

[10] To keep the topic manageable, this paper will limit the discussion to a pure (as opposed to a partial) protective tax return by a FC, claiming the complete absence of both a USTB and any non-business U.S. source income, thereby reflecting a $0 U.S. income tax liability. Furthermore, to achieve the same end, it will also not delve into the modifications to the rules discussed herein due to the impact of treaty-based positions on protective tax returns.

[11] Treas. Reg. § 1.882-4(a)(3)(ii)(B).

[12] Treas. Reg. § 1.882-4(a)(3)(ii)(C).

[13] Treas. Reg. § 1.882-4(a)(3)(ii)(A).

[14] Treas. Reg. § 1.882-4(a)(3)(ii)(F).

[15] Treas. Reg. § 1.882-4(a)(3)(ii)(E).

[16] Treas. Reg. § 1.882-4(a)(3)(ii).

[17] Consider that this paper foregoes specifically discussing the factor handed by Treas. Reg. § 1.882-4(a)(3)(ii)(D) due to its substantial overlap with the factor handed by Treas. Reg. § 1.882-4(a)(3)(ii)(B). Additionally, the factor handed by Treas. Reg. § 1.882-4(a)(3)(ii)(B) explicitly relates to protective tax returns while the factor handed by Treas. Reg. § 1.882-4(a)(3)(ii)(D), due to its verbiage, seems more germane to FCs’ regular income tax returns and protective tax returns required to disclose treaty-based return positions.

[18] Technically, reasonable cause is not coterminous with the “acted reasonably and in good faith” standard of Treas. Reg. § 1.882-4(a)(3)(ii). Nonetheless there is documented support that reasonable cause is relevant to the standard of Treas. Reg. § 1.882-4(a)(3)(ii). Per CCA 200028030 (May 8, 2000), “While there is no legal precedent that sets forth the level of action required by a taxpayer in order to establish “good cause” under Treas. Reg. § 1.882-4(a)(3)(ii), certain penalty provisions of the Internal Revenue Code do include “reasonable cause” exceptions. It is our view that the precedent that has been developed with respect to these penalty provisions is relevant to the determination of whether a taxpayer satisfies the “good cause” requirement under Treas. Reg. § 1.882-4(a)(3)(ii). It should be noted, however, that the “good cause” threshold involves a higher standard of proof than that required to establish “reasonable cause.”” We will discuss both “good cause” and the “acted reasonably and in good faith” standard of Treas. Reg. § 1.882-4(a)(3)(ii) in more detail further ahead in this paper.

[19] See IRM, pt. 20.1.1.3.2.2.6(4)(B).

[20] United States v. Boyle, 469 U.S. 241 (1985).

[21] Consider James v. USA, No. 8:2011cv00271 (M.D. Fla. 2012), wherein the IRS requested summary judgment using in part Boyle (the IRS contended that James delegated the actual filing of Form 3520 to his tax preparer). James argued that his tax preparer’s mistake was a failure to advise him of the requirement to file Form 3520, not his failure to file the return. In other words, James did not delegate the filing of Form 3520 to his tax preparer—he was abjectly unaware of the filing requirement in the first place. The judge referenced both IRM, pts. 20.1.1.3.2.2.6 (Ignorance of the Law) and 20.1.1.3.3.4.3 (Advice from a Tax Advisor) and denied the IRS’s motion for summary judgment.

[22] This is a facts and circumstances based threshold articulated in most bilateral income tax treaties by which nonresident corporations chartered in a treaty-contracting country, because of their level of cross-border economic activity in the other treaty-contracting country, become taxable there.

[23] On this score too, the foreign tax advisors will most always fail in advising the FC regarding its duty to disclose its determination of the absence of its PE to the IRS on Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b). This is an infraction that carries with it a $10,000 penalty. See. Treas. Reg. §§ 301.6114-1 and 301.6712-1.

[24] Treas. Reg. § 1.882-4(a)(3)(ii)(B).

[25] See the pre-July 31, 1990 rendition of Treas. Reg. § 1.882-4(b)(1). Also see § 233 of the Revenue Act of 1928 and § 882(c) of the Internal Revenue Code of 1954.

[26] For example Circ. 230 §§ 10.34(c)(1), 10.34(c)(2), 10.34(d), 10.35(a) and 10.37(a)(2)(ii)-(iii).

[27] IRM, pt. 20.1.1.3.3.4.3.

[28] Not to be confused with “non-filers.” In the case of individual taxpayers, IRM, pt. 5.19.2.3 classifies persons who filed tax returns in previous years but not in subsequent ones as “stop-filers” (there is no precisely equivalent IRS classification for foreign corporations). The IRS has, now for years, been administering The Individual Master File Return Delinquency Program targeting stop-filers. See IRM, pt. 5.19.2. The point to absorb is that the IRS views stop-filers, whether individual or corporate, as an enforcement priority.

[29] Notice 2003-38, 2003-27 IRB 9

[30] LB&I-04-0218-007.

[31] The subject title of LB&I-04-0218-007.

[32] Item C, Attachment A of LB&I-04-0218-007.

[33] In the absence of statutory filing deadlines, prior to July 31, 1990, the Courts had held that there was a “terminal point” after which a FC could no longer claim the benefit of deductions by filing a return. See Taylor Securities, Inc. v. Commissioner, 40 B.T.A. 696, 703 (1939); Blenheim Co., Ltd. v. Commissioner, 125 F.2d 906 (4^th Cir. 1942), affg. 42 B.T.A. 1248 (1940).

[34] Ibid.

[35] Ibid.

[36] See T.D. 8322, 55 FR 50830 (December 11, 1990). The amendments were first published as proposed regulations. See § 1.882-4, Proposed Income Tax Regs., 54 FR 31547 (July 31, 1989).

[37] See 1120-F Delinquent Returns Campaign available online at https://www.irs.gov/businesses/irs-announces-the-identification-and-selection-of-five-large-business-and-international-compliance-campaigns-1

[38] Treas. Reg. § 1.864-4.

[39] IRC § 881.

[40] See IRM, pt. 20.1.1.3.2(4)-(6).

[41] Taxpayer intent is certainly an extant determinative in court cases. In administrative procedure there is at least one noteworthy instance where taxpayer intent was listed as one of the main good cause factors for purposes of requesting extensions of time for making elections or applications for relief. See prior Treas. Reg. § 1.9100-1 and Rev. Proc. 79-63, 1979-2 C.B. 578.

[42] Treas. Reg. § 1.882-4(a)(3)(ii).

[43] See T.D. 9043, 68 FR 11314 (March 7, 2003).

[44] Taxpayers must typically demonstrate “reasonable cause” to avail of clemency mandated by the Code. On the other hand, they must often demonstrate “good cause” to avail of clemency not mandated by the Code. Good cause requires an extraordinary showing of reasonable cause.

[45] See T.D. 8322, 55 FR 50830 (December 11, 1990).

[46] Preamble, T.D. 8981, 67 FR 4173-4177 (January 29, 2002).

[47] Ibid.

[48] See Helvering v. Mitchell, 303 U.S. 391, 58 S. Ct. 630, 82 L. Ed. 917 (1938); Little v. Commissioner, 106 F.3d. 1445 (9^th Cir. 1997); Gorra v. Commissioner, 106 T.C.M. (CCH) 523, T.C. Memo. 2013-254 (November 12, 2013).

[49] IRM, pt. 1.2.20.1.1(2).

[50] IRM, pt. 1.2.20.1.1(1).

[51] IRM, pt. 1.2.20.1.1(3)(b).

[52] IRM, pt. 1.2.20.1.1(3)(a).

[53] Ibid.

[54] IRM, pt. 1.2.20.1.1(7).

[55] LB&I-04-0218-007.

[56] IRM, pt. 20.1.1.3.2.2(d).

[57] Ibid.

[58] IRM, pt. 20.1.1.3.2.2.1

[59] IRM, pt. 20.1.1.3.2.2.2

[60] IRM, pt. 20.1.1.3.2.2.3

[61] Treas. Reg. § 1.882-4(a)(3)(ii).

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• Expanding the rights of taxpayers appointing legal representatives.
• Defining realistic goals for the IRS in light of recent tax reform and budget cuts.
• Passing Senate Bill No. 1074 and House Bill No. 3153 into law thereby reducing inefficiencies in the IRS’s Centralized Authorization File Unit.

The syncretic agenda is designed to improve U.S. tax administration while protecting taxpayers. Point Square Consulting is a member of the nation’s top tax experts and is continually active in the tax legislative process.

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• Interpreting U.S. tax law
• Tax preparer ethics, responsibilities, and engagements
• Substantive and procedural issues pertaining to excess depreciation

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• Elimination of severe international tax penalties imposed on taxpayers for minor instances of noncompliance with various tax laws.
• Electronic delivery of the Taxpayer Bill of Rights to taxpayers in the IRS’s future electronic interaction platform.
• The passage of Senate Bill No. 1074 into law thereby allowing taxpayers to electronically sign a Power of Attorney and Declaration of Representative.

Accomplishing the aforementioned objectives would be monumentally beneficial for the U.S. taxpaying public. Point Square Consulting is a central member of the nation’s top tax experts and is continually active in the tax legislative process.

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