IRS Audit Lawyers

Establishing Cost-Basis in Foreign Real Estate | IRS Audit Tax Lawyer & Attorney

One of the most challenging issues during an IRS audit is establishing cost-basis in foreign real estate.  This issue most frequently comes up in the context of real estate that was obtained through inheritance or gift many years ago.  In this article, based on my IRS audit experiences, I would like to discuss the main challenges and case strategies associated with establishing the cost-basis in foreign real estate in a manner that would satisfy the IRS during an audit.

An important note: I will not be discussing this issue in the context of an IRS audit of an offshore voluntary disclosure and how it would affect the calculation of an Offshore Penalty.  This essay is strictly limited to an IRS audit that involves US international tax issues without the taxpayer ever going through a voluntary disclosure.

Another important note: this article is written more for the benefit of other international tax lawyers, not the general public.

Establishing Cost-Basis in Foreign Real Estate: Importance

Before we discuss the problems associated with establishing the cost-basis in foreign real estate, we need to first understand why this issue is so important.  There are three main consequences to establishing cost-basis in the context of an IRS audit. 

First, the income tax impact of failure to establish cost-basis in a foreign property on the audited taxpayer may be truly disastrous.  Obviously, if you cannot prove any cost-basis in a property (or you can only convince the IRS that there was minimal cost-basis), you will have to recognize all proceeds from the sale of this property as capital gains (or potentially subpart F income if you owned a property though a foreign corporation).

Second, there is a very important psychological impact on the entire audit if you have a large unreported gain from sale of foreign real estate.  The IRS agent in charge of an audit is likely to take a more aggressive position not only on this issue, but also on other issues irrespective of whether they are directly related to unreported gain.   The most frequent victims of this hardened attitude of an IRS agent are the legal arguments in support of a reasonable cause.

Finally, a large gain from a sale of foreign real estate is likely to encourage the IRS to dig deeper and even expand the audit to more years.  In one of my audit cases, an IRS agent initially believed that there was a large capital gain and expanded the audit to five prior years; however, he reversed this decision once I was able to show that the sold real property had a much higher cost-basis due to numerous improvements that were made by my client over a number of years.

In other words, establishing cost-basis in a sold real estate property may be one of the most crucial issues in an IRS audit.

Establishing Cost-Basis in Foreign Real Estate: Top 3 Challenges

The challenges to establishing cost-basis in foreign real estate are highly dependent on the facts of the case.  However, there are three main themes that usually appear in one form or another in every IRS audit case.

The first challenge is absence of documentation.  This is by far the most common and most important battleground between the IRS and the taxpayer during the vast majority of IRS audits in this area, especially if the direct documentation is absent due to passage of time.

The second challenge is the potential opposition from the IRS to proving cost-basis indirectly through usage of circumstantial evidence and third-parties.

The third challenge is establishing the credibility of evidence. For example, in one of my cases, the IRS initially refused to accept a valuation report prepared by a local professional valuation expert because the report lacked a proper explanation of how he arrived at the proposed values.

Establishing Cost-Basis in Foreign Real Estate: Top 4 Strategies for Overcoming Challenges

There are numerous strategies to deal with the cost-basis establishment challenges. Your choice among them should depend on the facts and circumstances of your case.  Sometimes, you will even come up with a brand-new strategy tailored specifically to the unique challenges of your case.

Nevertheless, there are four common themes to the strategies used in overcoming the aforementioned challenges.  First, you need to recreate the logical history of the property and capital improvements to the property in order to convince the IRS that the valuation your client supplied is logical and reasonable.

Second, demonstrate to the IRS agent in charge of your client’s audit that you are a reliable source of information.  The more objective you appear (and you actually are), the more the IRS sees that you will not allow false facts or statements to enter the record, the more the IRS sees that your client shares both of these traits, the more likely the IRS agent will accept your position or be willing to achieve a compromise with you (see below).

Third, utilize indirect and circumstantial evidence as well as third-party affidavits/testimony to support the valuation of the property.  In other words, if you have no ability to directly establish the cost-basis of a property, then you need to find creative ways to build the necessary records and establish their credibility through usage of supporting documents and/or testimony. 

For example, in one of my previous audits, the client had no documentation whatsoever except one isolated receipt to prove the substantial improvements made to her foreign real estate over the past almost forty (!) years.  My solution to this problem was to first get an affidavit from my client fully stating all improvements made with approximate cost based purely on her memory.  Then, I obtained additional signed statements from neighbors largely supporting the estimates as well as the fact that these improvements were indeed made. Finally, I obtained a statement from a local construction company owner who stated that he recalled these improvements and confirmed the estimated amounts.  Additionally, all of the improvements were properly explained by the history of how the property was obtained, for what purpose and why so many improvements were needed.  All of these facts and circumstances were explained in a letter to the IRS agent together with the legal basis (i.e., case law) showing how courts have accepted similar evidence in the past. Under the weight of this substantial record (and some other circumstances of this case), the IRS finally agreed to accept all improvements as part of an overall compromise.

Finally, use creative legal strategies to convince the IRS to accept a different cost-basis in a property through operation of tax rules.  This is a very complex strategy, but it is more commonly employed than one may believe.  For example, in one of my prior audit cases, the IRS agreed to disregard the foreign corporation that owned the foreign property allowing the stepped-up basis for this inherited property.

Contact Sherayzen Law office for Professional Help with IRS Audits Involving Foreign Real Estate

If you have foreign assets and you are audited by the IRS, contact Sherayzen Law Office for professional help.  We have helped hundreds of US taxpayers around the world to bring their tax affairs in full compliance with US tax laws, including during IRS audits.  We can help you!

Contact Us Today to Schedule a Confidential Consultation!

Post-OVDP Audits | Offshore Voluntary Disclosure Lawyer & Attorney

A significant number of US taxpayers who went through the OVDP mistakenly believed that they were immune from the IRS post-OVDP audits concerning their post-voluntary disclosure compliance. Sherayzen Law Office has repeatedly warned in the past that these taxpayers were mistaken with respect to their exposure to potential post-OVDP audits. The recent announcement of a new IRS compliance campaign concerning post-OVDP tax compliance confirmed the correctness of Sherayzen Law Office’s analysis.

Post-OVDP Audits: OVDP Background Information

The IRS created the Offshore Voluntary Disclosure Program (“OVDP”) as an incentive for US taxpayers to come forward and disclose their prior willful and non-willful noncompliance with US tax reporting requirements concerning foreign assets and foreign income. In exchange for the voluntary disclosure, the taxpayers paid a significantly lower penalty than what they otherwise could have had to pay outside of the OVDP. Moreover, taxpayers also received protection from IRS criminal prosecution of their prior tax noncompliance.

OVDP is not just one program, but a series of programs. The initial one was created in the early 2000s, but it was a relatively small and unknown program. The first program that became influential was the 2009 OVDP. The 2009 OVDP was created on the heels of the IRS victory in the UBS case and it closed on October 15, 2009.

Then, after the passage of the Foreign Account Tax Compliance Act (“FATCA”) in 2010, the IRS created the 2011 Offshore Voluntary Disclosure Initiative (“2011 OVDI”). The 2011 OVDI was a hugely popular program. Its success led to the creation of 2012 OVDP and, finally, 2014 OVDP.

The implementation of FATCA had materially altered the IRS interest in the OVDP while the number of the OVDP participants precipitously dropped due to the success of the Streamlined Compliance Initiatives (i.e. Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures). The 2014 OVDP program was closed on September 28, 2018.

Post-OVDP Audits: False Sense of Security After OVDP

Some of the OVDP participants have mistakenly treated their OVDP disclosure as a remedy capable of curing not only their past tax noncompliance, but also future compliance issues. In other words, after going through the OVDP, these taxpayers relaxed their commitment to their ongoing annual compliance. Some of them started filing their FBARs irregularly or stopped filing them altogether while others under-reported their foreign income. Still others engaged in a different conduct overseas without realizing that their new way of doing business gave rise to a different set of US reporting requirements.

Many of these taxpayers also erroneously believed that, by going through the OVDP, they were taken off the “IRS radar”. This means that they felt that the IRS was highly unlikely to audit them after their voluntary disclosure.

Post-OVDP Audits: IRS Noticed Noncompliance Among OVDP Participants

In reality, as Sherayzen Law Office had suspected, the IRS engaged in extensive analysis of the OVDP participants’ behavior after their voluntary disclosure. Of course, it was not difficult for the IRS to monitor them, because the IRS already had a full list of the OVDP participants at its disposal. Some of the data came from field audits while other information was derived from FATCA and data analysis.

As a result of its analysis, the IRS discovered the aforementioned disturbing noncompliance trends among former OVDP participants.

Post-OVDP Audits: July of 2019 IRS Compliance Campaign

After it uncovered these noncompliance trends among the former OVDP participants, the IRS announced in July of 2019 a campaign to specifically target taxpayers who went through the OVDP. As part of this campaign, the IRS will send out soft letters and conduct post-OVDP audits.

Post-OVDP Audits: Potentially Disastrous Consequences for Noncompliant Taxpayers

The targets of this IRS compliance campaign will be in a particularly difficult legal situation for two main reasons. First, during a post-OVDP audit, the taxpayers are unlikely to be able to claim non-willfulness with respect to their post-OVDP tax noncompliance because of the knowledge of US tax requirements that they acquired during their voluntary disclosures. In fact, it is difficult to see how non-willfulness can be established in any way other than claims based on new and/or extraordinary circumstances.

Second, since it is not likely that they will be able to establish non-willfulness, taxpayers will most likely face willful penalties during an IRS audit, perhaps even civil and criminal fraud penalties. The IRS is unlikely to be lenient with taxpayers who already benefitted from a voluntary disclosure and persisted in their noncompliance afterwards. In other words, a post-OVDP audit may result in disastrous consequences for noncompliant taxpayers.

Contact Sherayzen Law Office for Professional Help With Post-OVDP Audits

Given the particularly dangerous nature of a post-OVDP audit, a taxpayer subject to this type of an IRS audit must retain an experienced international tax attorney as soon as he is notified about the commencement of the audit. Failure to do so may severely damage the taxpayer’s ability to defend against subsequent IRS penalties.

This is why you need to contact Sherayzen Law Office as soon as possible. We are a highly-experienced international tax law firm that has helped hundreds of US taxpayers to resolve their past noncompliance with US tax laws, including in the context of an IRS audit. We Can Help You!

Contact Us Today to Schedule Your Confidential Consultation!

IRS Large Corporate Compliance Program | IRS Lawyer & Attorney

On May 16, 2019, the IRS Large Business and International Division (“LB&I”) announced the creation of a new compliance program for the large corporations – Large Corporate Compliance program.

The Large Corporate Compliance program will cover the oversight of the LB&I’s largest corporate taxpayers. It replaces the existing Coordinated Industry Case program.

The replacement of the Coordinated Industry Case program is not unexpected. Ever since the IRS announced that it would switch to compliance campaigns for case selection purposes, the future of the old program was in doubt. Moreover, the Coordinated Industry Case program used criteria that did not incorporate many of the advancements made by the IRS in the area of data analysis. Hence, it is not surprising that the May 16 announcement came right after the LB&I began on May 15, 2019 a new application of data analytics for determining the population of its largest and most complex corporate taxpayers.

The IRS stated that the Large Corporate Compliance program will determine on a different, automatic basis who should be covered by the program. In fact, the program employs automatic application of the large case pointing criteria to determine the LCC population. For example, pointing criteria include such items as gross assets and gross receipts. In the past, this was done on a manual, localized basis. Automated pointing allows a more objective determination of the taxpayers that should be part of the population.

After the population is determined, data analytics is used to identify the returns that pose the highest compliance risk. The Large Corporate Compliance program further improves LB&I’s ability to efficiently focus its resources on noncompliance.

The Large Corporate Compliance program will coordinate its work with the LB&I agents and examiners who apply their experience and expertise in undertaking compliance actions and determining compliance treatment streams of the biggest and most-complex corporate taxpayers. The IRS happily stated that each enhances the other.

The IRS further shared that the program includes continuous improvement using an agile model principle to continually monitor and improve based on feedback from stakeholders including field teams, practice networks, and data scientists.

Sherayzen Law Office carefully watches the new IRS moves with respect to its compliance programs to determine their impact on the firm’s clients.

Schedule C IRS Audit | Business Tax Lawyer & Attorney

One of the most common types of IRS audits is the Schedule C IRS audit. In this article, I would like to introduce the readers to the Schedule C IRS audit. In particular, I would like to discuss the type of taxpayers who are affected by an IRS audit of Schedule C and the key legal issues associated with such an audit.

Schedule C IRS Audit: Who is Affected?

A Schedule C IRS audit primarily concerns two groups of taxpayers: owners of sole proprietorships and owners of single-member LLCs. These are the taxpayers who conduct business in either unincorporated form (i.e. sole proprietorship) or the incorporation is disregarded by the IRS (i.e. single-member LLC).

Schedule C IRS Audit: the Focus of the Audit

A typical Schedule C IRS audit focuses on two critical areas: full reporting of revenue and substantiation of expenses.

Generally, the reporting of business revenue should not be too difficult as long as there are sufficient records, but there are exceptions. One of such exceptions is the reporting of foreign income earned by the taxpayer because of the issues of income recognition and currency translation.

Unfortunately, a typical Schedule C IRS audit rarely involves a business with well-kept records. In a purely cash-based business, this is most problematic for obvious reasons – absent records of receipt of cash, it is extremely difficult to recreate an accurate picture of the revenue intake by the business. Similarly, a lot of work will be needed to reconstruct the revenue of a business with multiple revenue conduits, constant transfers between accounts, inexplicable cash withdrawals and deposits, disorganized prepayments and other similar complications.

Schedule C IRS Audit: Substantiation of Expenses

The problems associated with the second part of a Schedule C IRS audit (i.e expenses), however, dwarf the difficulties of revenue identification. The substantiation of expenses is by far the most difficult task in a Schedule C IRS audit. Let’s explore the reasons for this problem in more detail.

During a Schedule IRS C audit, the revenue agent in charge of the audit will only allow a business expenses if it satisfies all of the following three requirements:

1. Expense is Incurred by Business Identified on Schedule C

In this context, the primary problem that plagues taxpayers is the commingling of personal and business expenses. Oftentimes, the taxpayers will pay for business expenses using a personal bank account or a personal credit card. Actually, I have had clients who used credit cards of third parties to pay for business expenses. Proving that these expenses were actually incurred by the business, as opposed to the taxpayer or the third party, can be very challenging.

2. Expense is Supported by Records

The IRS will generally require that a business expense is supported by records. If a taxpayer uses only his own memory as the basis for an expense, an IRS agent is likely to disallow such an expense.

Ideally, the taxpayer should have actual receipts for all business expenses, but IRS agents generally accept bank and credit card statements that would allow them to identify the nature of an expense. The generosity of an IRS agent in this aspect often depends on the general “flow” of a Schedule C IRS audit – i.e. cooperation of the taxpayer, his credibility and the non-willfulness of his prior noncompliance.

3. Expense is Allowable Business Deduction from Income

Even if the audited taxpayer has good records in support of a business expense, the expense must still be an allowable business deduction. The critical issue here is whether the law actually allows the taxpayer to reduce his business income by the expense in question.

In order to qualify for being a deductible business expense, the expense must be both ordinary (i.e. common and accepted in the relevant area of trade or business) and necessary (i.e. helpful and appropriate for your trade or business). It is also should be kept in mind that some of the business expenses are either capitalized or added to cost of goods sold. There are also limitations on certain types of business deductions (such as business meals).

One of the most frequent problems that arise during a Schedule C IRS audit is the issue of personal expenses paid by the business. Personal expenses are never deductible as a business expense. I already described this problem above in the context of business expenses paid through personal accounts or by a third party; here, I am discussing the opposite situation – personal expenses paid using a business bank account or credit card.

It is important to understand that the fact that an expense is paid by a business, does not automatically mean that this is a deductible business expense. An expense still needs to comply with the “ordinary and necessary” requirement and be separated from personal expenses.

Sometimes, it is fairly easy to identify personal expenses, but this is not always the case; on the contrary, a vast number of expenses can be interpreted either as a business expense or a personal expense. For example, if a business owner buys tickets to a baseball game for himself, his family, potential clients and their families, how much of it is deductible? How about a personal membership at a gold club to which the business owner often invites his prospective clients and pays for their games?

The answers to these questions should not be left to the judgment of the IRS agent in charge of the question; instead, the attorney who represents the audited taxpayer should look at the precise facts, IRS revenue rulings and similar cases to promote the argument that will benefit his client.

Contact Sherayzen Law Office for Professional Help with a Schedule C IRS Audit

If the IRS is auditing the Schedule C of your tax return, contact Sherayzen Law Office. Our professional audit team, headed by attorney Eugene Sherayzen, is highly experienced in the IRS audits of Schedule C, especially with respect to upper middle-class and high net-worth clients. We can Help You!

Contact Us Today to Schedule Your Confidential Consultation!

Streamlined Domestic Offshore Procedures Audits | SDOP Tax Lawyer

The great majority of offshore voluntary disclosures are currently done through Streamlined Filing Compliance Procedures. Hence, the majority of IRS audits concerning offshore voluntary disclosures are focused on Streamlined Filing Compliance Procedures – the most common type is the Streamlined Domestic Offshore Procedures Audit. This article discusses the main stages of the Streamlined Domestic Offshore Procedures Audit and provides some suggestions to attorneys who handle this type of an IRS audit.

Streamlined Domestic Offshore Procedures Audits: SDOP Background Information

Streamlined Domestic Offshore Procedures (“SDOP”) is an offshore voluntary disclosure option that has existed since June of 2014. It is extremely popular due the fact that it is the most convenient and the least expensive voluntary disclosure option (except the Reasonable Cause/Noisy Disclosure option) for taxpayers whose prior tax noncompliance was non-willful and who otherwise meet the SDOP eligibility requirements.

Under the SDOP, a taxpayer or tax professional prepares a voluntary disclosure package and mails it to the IRS. The voluntary disclosure package usually consists of amended tax returns for the past three years, copies of e-filed FBARs for the past six years, any required international information returns which do not form part of a tax return (such as Forms 3520), the payments of additional tax with interest, the payment of the Miscellaneous Offshore Penalty and Non-Willfulness Certification form (Form 14654) with a detailed explanation. Certain additional items may need to be included in the package.

Once the package arrives to its destination, it is processed by the IRS. Assuming that all of the SDOP submission requirements are met, the IRS reserves the right to audit the taxpayer(s) at any point within three years after the submission of the original SDOP voluntary disclosure package.

The exact process of a Streamlined Domestic Offshore Procedures Audit varies from case to case, but it usually contains all of the stages listed below.

Streamlined Domestic Offshore Procedures Audits: the Initiation Stage

All Streamlined Domestic Offshore Procedures Audits start in the same way. Once an IRS revenue agent is assigned to the case, the agent will send an initial letter to the taxpayer informing the taxpayer about the fact that his SDOP is being audited. Generally, the initial audit letter will explain that the IRS decided to examine certain tax returns and ask for all worksheets and supporting documents that were used to prepare the amended returns. The letter is likely to also contain a request for the taxpayer to contact the agent to schedule the initial meeting, which would usually include an interview of the taxpayer.

At this point, you should contact an international tax lawyer who specializes in Streamlined Domestic Offshore Procedures Audits. I strongly discourage you from even trying to represent yourself or to have your accountant represent you. It is very easy to get into trouble during an IRS audit and it is very hard and expensive to get out of such a situation afterwards.

Streamlined Domestic Offshore Procedures Audits: Initial Meeting and Interview Stage

Prior to the initial meeting, the taxpayer’s attorney should review all documents to make sure that they support the information on the tax returns. All supporting documents and worksheets should be neatly organized by subject and year. If the audited tax returns are incorrect, the attorney should make the decision on whether amended tax returns should be prepared prior to the initial meeting.

Additionally, the attorney should conduct an extensive preparation of his client for the interview. Read this article for more information on the IRS audit interview preparation specifically for Streamlined Domestic Offshore Procedures Audits.

The initial meeting usually commences with the interview of the taxpayer in the presence of his attorney. It is the attorney’s job to protect his client during the interview, including by making sure that the IRS questions are clear, explaining any confusing answers of the taxpayer, correcting the record based on available evidence and so on.

After the interview, the IRS agent will want to review with the attorney (and, sometimes, the client as well) the documents supplied on a very general level – i.e. he will want to know what is being submitted to him. The attorney should discuss with the agent any confusing parts of the case and familiarize the agent with the client’s story. If a case is very small, it is possible for an agent to cover everything in the first meeting, but it is very rare.

Streamlined Domestic Offshore Procedures Audits: Follow-Up IRS Requests

After the initial meeting, the IRS agent will take some time to review submitted documents, interview third parties where relevant (for example, the accountant who prepared the original tax returns), analyze the tax returns and the Non-Willfulness Certification.

Most likely, the agent will have additional follow-up questions. It is the job of the attorney to address them. Where necessary, the attorney should secure his client’s participation in order to answer the questions. In certain cases, additional meetings with the IRS agent may be required to increase the efficiency of the audit. Continuous cooperation with the IRS while promoting the client’s position is the key to long-term success.

One of the most problematic areas for the IRS agents in Streamlined Domestic Offshore Procedures Audits are PFIC calculations. A lot of agents simply do not know how to properly do PFIC calculations. In my practice, very often I have to go through the entire PFIC calculations with the agent in order to make sure that their calculations match mine.

Streamlined Domestic Offshore Procedures Audits: Conclusion of the IRS Audit

Once the IRS agent completes his review process, he will submit the preliminary results to the taxpayer and his attorney. The attorney needs to review carefully the final results and contact the agent in case he finds mistakes in the agent’s conclusions. The taxpayers’ attorney will also need to build a strategy with respect to the taxpayer’s response to the audit results depending on whether the taxpayer agrees or disagrees with the results of the audit.

The biggest issue in the Streamlined Domestic Offshore Procedures Audits is making sure that the Non-Willfulness Certification is not challenged by the IRS, because such a challenge may result in highly unfavorable consequences to the taxpayer, including a potential referral to the Tax Division of the US Department of Justice for a criminal investigation.

It should be mentioned that, even if the taxpayer agrees with the audit results, the Audit is not immediately over. The IRS agent will need to submit his conclusions to his technical advisor, his manager and the IRS National Office in Washington D.C. for the their approval of these conclusions before the audit can be officially completed.

Contact Sherayzen Law Office for Professional Help With Streamlined Domestic Offshore Procedures Audits

An IRS audit of an offshore voluntary disclosure completed through Streamlined Domestic Offshore Procedures is one of the most important events in a taxpayer’s life. A lot is at stake during such an audit – financial stability, immigration status and, in exceptional circumstances, even personal freedom.

This is why it is so important for a taxpayer subject to an IRS audit of his Streamlined Domestic Offshore Procedures voluntary disclosure to retain the services of an experienced international tax lawyer to handle the audit professionally.

Sherayzen Law Office is a leader in the area of offshore voluntary disclosures and IRS audits of offshore voluntary disclosures. The firm’s owner, Mr. Eugene Sherayzen, is one of the most experienced international tax lawyers in this area, including IRS audits of a Streamlined Domestic Offshore Procedures submission. He can help You!

Contact Sherayzen Law Office Today to Schedule Your Confidential Consultation!