An inside look at LMSB's heavy manufacturing industry group.

Authors' Note: As a result of the Internal Revenue Service Restructuring and Reform Act of 1998, the IRS recently reorganized itself along "customer segments." As part of the reorganization, the Large and Mid-Size Business Division (LMSB) was formed, and within LMSB, five special industry sections have been created including one section devoted to Heavy Manufacturing and Transportation (HM). The director of this section is Thomas C. Smith. During his 32 years with the IRS, Mr. Smith has served as a Revenue Agent, CEP Case Manager, Director of International District Operations, Deputy Assistant Commissioner (International), Assistant Commissioner (Examination), and Organizational Performance Management Executive. Recently, we met with Mr. Smith to discuss the new industry group and the changes that are occurring within the LMSB division.

Taxpayer Characteristics

The Heavy Manufacturing industry group will serve almost 92,000 taxpayers, 1,500 of which are large businesses. This sector includes businesses dealing in the areas of air and ground transportation, the aerospace and automotive industries, shipping, agricultural manufacturing, heavy metals, and real estate. This group originally included the Construction industry, but to better balance the workload of all five industries, Construction was moved to the Natural Resources industry.

Tools and Techniques

Two of HM's main goals are to become a world-class tax administration and to improve the level of customer service. Some of the new programs within LMSB that should help HM achieve these goals are Pre-Filing Agreements (PFA), Comprehensive Case Resolution (CCR), and Industry Issue Resolution (IIR). These new initiatives should improve customer satisfaction by allowing taxpayers to know the answers prior to filing their returns. The new methods will allow taxpayers to achieve certainty regarding the treatment of issues and, in turn, this should eliminate examinations, appeals, and litigation of some issues. Through a cooperative effort, the program is intended to reduce the cost, burden, and delays encountered in post-filing examinations.

In the past, the IRS has employed other types of methods such as Advanced Issue Resolution and Early Referral to Appeals to improve the process, but they have not been used widely since not everyone, internally and externally, buys into them. Tom Smith believes that the new programs will succeed because whereas the case manager initiated the previous processes, the new processes can be initiated by the taxpayer. It is understandable that not everyone will champion the programs, but HM has already had success in closing the 1998 tax year for some Fortune 50 taxpayers. In the past, the average number of years open from filing to ultimate resolution for the very largest corporate taxpayers was 13 years. These new methods will permit the issue resolution process to be completed more quickly.

In addition to the new programs, there have been some changes to existing programs, such as the Industry Specialization Program and the audit planning process, that should improve the issue resolution process.

Pre-Filing Agreements

During 2000, the IRS introduced a pilot program for taxpayers to request examination and resolution of specific issues and to obtain a pre-filing agreement on these issues. In February 2001, the IRS permanently adopted this program.

A PFA is a closing agreement under section 7121 of the Internal Revenue Code. By participating in the PFA program, the taxpayer gains certainty for the current year before the return is filed. The goal of this program is to enable both the taxpayer and the IRS to resolve issues before filing that would otherwise be disputed in post-filing audits. PFAs should increase compliance and reduce the amount of resources used by both the taxpayer and the IRS in exam. In addition, the new approaches to issue resolution should contribute to increased compliance overall. The IRS is working to instill these ideas and change Revenue Agents' mind set to approaching a case. Agents need to approach cases with a view toward getting the correct answer, not the one with the largest tax liability.

Who is eligible for a PFA? For the pilot program, the industry director decided who participated in pre-filing. For the permanent program, in contrast, applications may be submitted to the Team Manager if an audit in currently in process. Otherwise, applications can be submitted to the Office of Pre-Filing and Technical Guidance. Only LMSB taxpayers are eligible to participate in the program. Some of the issues that can be involved in the program are: valuation of assets, expense versus capitalization, reorganization, start-up costs, research and experiment, and certain specified international issues. During our interview, Tom Smith pointed out that there is some motivation for taxpayers who are not in the CEP program to participate in the pre-filing agreement program because about 20 percent of the large non-CEP corporate taxpayers are currently audited. (Approximately 70 percent of all CEP taxpayers are audited.) Therefore, taxpayer must decide how much certainty they want and whether they could benefit from a pre-filing agreement program.

What is the PFA time line for a calendar-year taxpayer?

Peak time of requests:   February and March
Work done:               April, May and June
Answer:                  By mid-August

This time line reflects a dramatic reduction in the normal time frame for resolving such issues.

Industry Issue Resolution

The pilot program for Industry Issue Resolution (IIR) was announced in December 2000. This program will address longstanding issues within an industry that have been the source of controversy between the IRS and taxpayers. IIR is both a pre-filing and a dispute resolution process. The objective of this program is to resolve an issue common to many taxpayers within an industry. The issues most appropriate for the IIR pilot program will generally have the following characteristics: There is uncertainty about the appropriate tax treatment of a given factual situation; the uncertainty has resulted in frequent, often repetitive examinations of the same issue; the issue affects a significant number of taxpayers within an industry group, many of which are larger businesses (those with gross assets in excess of $10 million); and factual determination is a major component of the issue. Suggestions for issues for the pilot program had to be submitted by February 28, 2001.

Tom Smith believes that the result of an IIR project will be a revenue procedure, such as the one issued a few years ago dealing with LIFO conformity. Other possibilities are a notice or other document setting forth conditions or requirements that the taxpayer must satisfy in order to use it.

Industry Specialization Program

In order to move issues through the Industry Specialization Program (ISP) with more efficiency, LMSB has two new plans. The first is to structurally change the ISP specialist reporting structure. In the past, there were inconsistencies in whom the ISP specialists reported to; e.g., some were assigned to districts, some to regional posts, and some to national headquarters. Under the new structure, they are all part of the Office of Pre-filing and Technical Guidance within the national LMSB headquarters. This change will provide increased consistency for IRS positions and an increased level of coordination with Counsel and Treasury. Incidentally, ISP personnel are now called "technical advisers."

The second change deals with creating a more focused decision-making process. Within LMSB, the Industry Director now has line authority to all of the cases assigned within the industry. For example, Tom Smith is the person who can make decisions in Heavy Manufacturing industry. He has the line authority over every case. This single point of responsibility, with fewer levels of management, should produce better results and a more consistent application. Senior Industry Advisers will also help in the decision-making process by providing insight into industry-related issues.

Audit Plans

In the past, many taxpayers received audit plans one year after the beginning of the audit. With the new structure, the taxpayer will be integrated into the process from the beginning. Many examination teams will utilize a project management approach by using new time-line software to create and monitor the audit plan. The taxpayer will be given a copy of the time-line software file outlining the schedule for the examination. This approach should prove much more successful because both the taxpayer and the examination team will be able to see the effect of their actions (e.g., not answering IDRs immediately or replacing an examiner on a case). In addition, the program triggers dialogue between the IRS and the taxpayer. The taxpayer will also see gains and will be able to assess the effect of each party's actions on the entire examination. This software will be the future of the audit planning process. To be successful, however, both sides must commit to using it.

Another area that needs to be reconfigured is the creation of audit plans. Old examination plans often seemed to be based on the prior year's plans plus or minus five percent. The plans did not account for what the issues were and whether they were already resolved. Therefore, a certain number of hours were spent regardless of the circumstances. Under the new structure, the issues will be identified and a determination will then be made about how long the examination should last.

Challenges

Tom Smith and his fellow LMSB leaders frequently remind us that not all of the work is done yet. It is a continuing learning process. One of the biggest challenges for LMSB will be identifying issues and cases and bring them to resolution in order to convince people that the IRS can break the old paradigms. Another challenge will be to continue to build the teams.

Conclusion

Tom Smith's message to taxpayers is "Don't think of what's happened so far as the reorganization. We are just getting started. The big improvements are yet to come. If you haven't seen a change yet, don't worry it will happen. Give us feedback on the reorganization and pre-filing. Issue resolution will help."

Special thanks to Tom Smith, Industry Director for Heavy Manufacturing and Transportation for his participation in the development of this article.

JAMES A. DOUGHERTY is a Director of Tax Controversy Services in Deloitte & Touche's Washington, D.C., National Tax Office. Mr. Dougherty has more than 30 years' experience with the Internal Revenue Service. Immediately prior to joining Deloitte & Touche, he was the National Director of Appeals, with responsibility for the nationwide settlement of tax disputes. During his government career, he held senior positions in Examination and Appeals.

TRACEY A. FIELMAN is a Manager in Deloitte & Touche's Tax Controversy Services Practice in Washington, D.C. She has a Bachelor's degree from Xavier University and a J.D. degree from Indiana University School of Law - Indianapolis.