Had General Electric’s e-filed 2006 income tax return been printed, it would have consumed 24,000 pages of paper, the nation’s longest tax return.
No small wonder, then, that the Internal Revenue Service’s (IRS) Large and Midsize Business division (LMSB), which examines business taxpayers with $10 million or more in assets, has a daunting mandate. LMSB taxpayers paid $206 billion in taxes in 2006 and filed 175,862 returns with many running to thousands of pages. “It behooves the IRS to do more with less and to be as efficient as possible,” says
Don Rocen, a partner at Miller & Chevalier and former IRS deputy chief counsel.
The agency’s history is dotted with repeated attempts to be more efficient, with varying measures of success. Its latest endeavor, however, highlighted by the July 2007 launch of the “industry issue focus” (IIF) process, has effected a sea change for taxpayers.
“In less than a year, a whole new environment has developed at the IRS,” says Walter Goldberg, executive director of Grant Thornton’s national tax office in Washington, D.C. “It raises cause for concern, but there are also definite benefits for taxpayers.”
Essentially, IIF is an issue management process aimed at treating specific tax issues consistently across industry lines while improving audit currency. At its core is a focus on prioritizing and centralizing the administration and resolution of important issues.
“Behind the IIF is a desire on the part of the IRS to get as much as it can out of its resources by operating as closely on a business model as it can,” says Ellis Reemer, who leads DLA Piper’s tax controversy and tax disputes group.
To that end, the IRS has designed a tiered system for prioritizing tax compliance issues. After an IRS Compliance Strategy Council identifies the issues, it ranks them based on prevalence and compliance risk. The agency also takes into account visibility and uncertainty due to new legislation and litigation; materiality, in terms of the number of taxpayers affected and the resources required for the audit function; and the potential for abusive conduct.
Tier I issues have the highest strategic importance and most significant impact on one or more industries. Current issues on the Tier I list include abusive foreign tax generators and backdated stock options. See the full list of Tier I transactions at www.irs.gov/businesses/index.html. Tier II issues reflect areas of potential high noncompliance or significant compliance risk to LMSB or an industry.
For Tier I and Tier II issues, the IRS assigns an “issue owner executive” with nationwide jurisdiction to coordinate the relevant examinations. Issue management teams–including counsel, technical advisers, field staff and field representatives–then develop guidance for examiners.
“Under the old system, IRS field offices in different parts of the country could come up with different answers to the same question, meaning that a taxpayer in Oregon with an identical problem to that of a taxpayer in Maine might achieve a more or less favorable settlement than his counterpart across the country,” Goldberg explains.
The most frequent criticism of the IIF to date has been that it removes discretion from examination teams. The degree of discretion that remains varies with the tier ranking of the issue in dispute. Examiners will have no choice but to implement centralized guidance in all Tier I cases. Still, some discretion related to the unique circumstances of each case remains in Tier I and Tier II cases.
“There’s no question that the flexibility of examiners to resolve these issues has been significantly limited,” Goldberg says. The diminution of discretion also means appeals will be harder fought.
“If you have a Tier I issue, the IRS’s centralized approach reduces a taxpayer’s chances of settling at any stage of the process,” Rocen says.
Indeed, any reduction in settlement prospects translates into less certainty and efficiency in a company’s tax and financial reporting. “In many cases, the IRS is auditing three, four or five years back, which makes things uncertain enough,” Rocen says. “Anything that adds to that uncertainty is definitely not welcome.” This may be why so many taxpayers have embraced LMSB’s compliance assurance program (CAP).
CAP began in 2005 as a pilot program to assess a “just-in-time” approach to large corporate tax administration. The IRS wanted to leverage the reporting requirements under the Sarbanes-Oxley Act to encourage participants to work with it to resolve tax controversies before making formal filings. “The process involves examiners looking at a company’s tax treatment of transactions on day one of the taxable year and throughout the current year,” Rocen explains. “In exchange for taxpayers providing information about completed transactions and occurrences in a timely way, they are more likely to achieve tax certainty sooner and with fewer administrative obstacles.”
Through this increased cooperation, the IRS reduces its required resources and enhances its ability to spot emerging issues and risks. Initial indications were that CAP was working. A 2005 IRS survey confirmed that both CAP team members and participant taxpayers were satisfied with the program.
CAP team members confirmed that participants had been transparent, and many had revised internal procedures to accommodate the need to deliver information to the IRS in a timely fashion.
Respondent taxpayers described the IRS’s commitment as strong and their interactions with CAP team members as positive. The majority believed CAP was a satisfactory way of dealing with the IRS in the future. No surprise, then, that CAP continues to generate a great deal of interest in the business community.
“Many of the in-house tax people, especially at large corporations, want access to CAP because of the efficiencies involved in dealing with the facts underlying tax issues before they arise, rather than on a historical basis,” Rocen says. “CAP participation can also reduce the need to carry tax reserves that can affect financial statements.”
From all appearances, the IRS is attempting to accommodate the demand. The 2005 CAP pilot program embraced 17 volunteer corporations, and all agreed to participate for the 2006 tax year. About 20 additional organizations joined the pilot program by invitation in 2007.