Adjustment Process in US Tax Audits
The United States Internal Revenue Service (IRS) is responsible for enforcing tax laws and regulations in the country. One of the primary tools at its disposal is conducting audits to ensure that taxpayers are accurately reporting their income and paying the correct amount of tax. In the course of these audits, the IRS may propose adjustments to a taxpayer’s reported income or tax liability. This article will discuss the adjustment process in US tax audits, with a particular focus on transfer pricing adjustments.
Notice of Proposed Adjustment
At the conclusion of an audit, if the IRS proposes an adjustment to a taxpayer’s reported income or tax liability, it will issue a Notice of Proposed Adjustment, also known as a “30-day letter.” This notice provides a detailed description of the proposed adjustment and the reasons why the IRS believes it is necessary. The taxpayer has the opportunity to respond to the notice by providing additional information to persuade the IRS to reconsider its position.
Protesting the Adjustment
If the taxpayer disagrees with the proposed adjustment, they can protest it within 30 days, subject to an extension. The taxpayer can request that the IRS Appeals Office consider the protest or request competent authority consideration of an adjustment under the mutual agreement procedure in a relevant tax treaty. Alternatively, the taxpayer can request the issuance of a Statutory Notice of Deficiency and challenge the adjustment through litigation.
Transfer Pricing Adjustments
One area where the IRS frequently proposes adjustments is transfer pricing. Transfer pricing refers to the pricing of goods and services that are transferred between related parties, such as a parent company and its subsidiaries. The IRS is concerned that related parties may manipulate transfer prices to shift income to lower-tax jurisdictions or reduce taxable income in higher-tax jurisdictions.
Collateral Adjustments
Where a transfer pricing adjustment is made, the regulations also provide for collateral adjustments. These adjustments may include correlative allocations, conforming adjustments, or set-offs. If an adjustment is made to one member of a group, correlative adjustments are made in respect of any other member of the group affected by the transfer pricing allocation. The IRS gives the taxpayer notice of the amount and nature of these adjustments, and they must be reflected in the documentation of the other members of the group for US tax purposes.
Accounting Adjustments
The taxpayer must also make adjustments in its accounting records reflecting the transfer pricing adjustments. Conforming adjustments may treat the allocated amount as a dividend or a capital contribution. In suitable cases, the allocated amount may be repaid between the group members without further income tax consequences.
Reducing Compliance Burden
In February 2019, the IRS issued a notice requesting feedback on how to reduce the compliance burden imposed by tax regulations on transfer pricing documentation. The notice referred to the final regulations in TD 8656, which set out guidance on the imposition of the accuracy-related penalty for net transfer price adjustments. Comments were invited on related issues, including the information that needs to be collected, how to enhance its quality and utility, and how to minimize the compliance burden for the taxpayer, for example, by the use of automated collection techniques.
Conclusion
The adjustment process in US tax audits is a complex and detailed one, and taxpayers need to be aware of their rights and obligations. The transfer pricing adjustments are one area where the IRS frequently proposes adjustments, and taxpayers must ensure that they comply with the regulations and make the necessary accounting adjustments. The IRS’s request for feedback on how to reduce the compliance burden is an indication that it recognizes the challenges faced by taxpayers and is willing to consider ways to make the process less burdensome.