Audit plans.

No matter how large or small, every company subject to a field audit should devote time to working with the IRS Compliance Team in developing, a joint audit plan. The key to every successful audit is effective management of the audit process. A successful audit means no surprises. An effective audit plan reduces this and improves the efficiency of the audit and cycle time. By recognizing that every eventuality cannot be anticipated, the audit plan should be flexible enough to accommodate alterations as the audit proceeds.

Sec. 7602 provides that the IRS may examine all records, including those not directly used to prepare the return, that may be "relevant or material" to the investigation into the correctness of the tax return. The basic data retention requirements can be found in Sec. 6001. Regs. Sec. 1.6001-1 requires that taxpayers retain sufficient records to establish the correctness of any income tax liability. Rev. Rul. 71-20 and Rev. Proc. 98-25 further define what records taxpayers must keep when they maintain the records on machine-sensitive data media or on an automatic data processing system. Failure to clearly identify and retain records that support items on the tax return could lead to the imposition of various penalties. Moreover, if the taxpayer fails to comply with the minimum recordkeeping requirements, the IRS could issue a Notice of Inadequate Records pursuant to Regs. Sec. 1.6001-1(d). In addition, penalties can also include, among other things, Sec. 6662 accuracy-related penalties and Sec. 7203 willful-failure criminal penalties.

The only way for a taxpayer to fully understand and circumscribe the scope of an audit is through an audit plan. The concept of an audit plan can be traced to the Service's Examination Technique Guideline Handbook, which is included in the Internal Revenue Manual. The Manual, in chapter(s) 4200, et al. ,discusses various planning and examination techniques for IRS agents' use during an audit examination. The taxpayer's understanding of these and other of the Service's audit procedures, together with an audit plan, can simplify the audit process.

An audit plan begins with the taxpayer's designation of an individual as the focal point for contact with the IRS examination team. The individual (or individuals) could be a company employee or a third-party representative. Third-party representative(s) are required to obtain a power of attorney prior to discussions with the Service by filing Form 2848, Power of Attorney and Declaration of Representative. The taxpayer needs to reach agreement on the physical location of the IRS audit team. Proximity to the company's books and records should be considered. The taxpayer's goal should be to place the audit team close to the company,s records. If records are stored off-site, the examination team should also be off-site. Other important factors to consider include the number of offices, telephones, copy machines and personal computers at the company location.

How the audit team will access the company's financial records and the confidentiality of the data must also be resolved. Questions such as what steps will be taken to protect the security of a company's proprietary information and whether the Service's examination team will be provided access to the taxpayer's computer system must be addressed beforehand. Specific audit techniques, such as statistical sampling and de minimis rules, should be discussed. A successful audit plan should also clarify, among other key roles, who will be receiving Information Document Requests (IDRs) and who will discuss potential issues with the IRS team.

Thereafter, the taxpayer should establish who is going to be working on the examination. In addition, the taxpayer should obtain a complete list of the agents, specialists and managers who will comprise the audit team, and determine whether they will work on a full or part-time basis. The role of the IRS District Counsel should be clarified if the District Counsel will be assigned to the examination. It is also important to establish the official start date of the examination, as the official start date begins the 15-day period (see Rev. Proc. 94-69) under which to file a qualified amended return and potentially avoid substantial underpayment penalties under Sec. 6662.

Once the basic logistical items are established, the key operational items relevant to how the audit will proceed are issue priority, overall scope, IDR process and audit timeline. Issue priority is often based on the taxpayer's prior audit experience and the Service's risk analysis. This part of the audit plan should detail the IRS's Examination program, including its scope. The plan should list the companies being audited, the potential areas to be examined, and which agents are assigned to each area. The plan should also indicate the time allotted to the examining agent for each area to be examined.

The audit timeline is the linchpin of the audit plan. A reasonable timeline provides a measure for both the IRS and the taxpayer to determine whether problems arise, and to determine whether scheduled completion of the audit is likely. The initial timeline will also assist in planning for potential extensions of any applicable statute of limitations.

The audit plan should provide for official opening and closing conferences, as well as interim status meetings. The opening conference is the first formal meeting between the taxpayer and the Service's examination team, and should be attended by the key decision-makers at both the IRS and the company. The closing meeting should function as the final critique of the completed audit. During the interim-status meetings, progress in relation to the established timeline should be discussed.

Along with the timeline process, milestones should be created to keep the audit on target, to make sure that both the Service and the taxpayer can monitor the progress of the audit at any point in time. A discussion of the audit's progress in relation to the pre-determined timeline should be included as part of every meeting between the taxpayer representative and the IRS team manager.

Discussions about the status of IDRs and any proposed adjustments should also be part of the audit plan and included in the status meeting. The taxpayer should take into consideration its prior audit experience, available staff and specific industry issues before agreeing on IDR procedures. Reasonable response times, such as 30, 45 or 60 days for most IDRs, should be established; if international operations are relevant, a longer response time may be needed. The taxpayer should establish whether IDRs would be submitted by entity or by issue. Failure to clearly outline the IDR process is the main reason that examinations get off-target.

Additional items to consider in developing an audit plan are the company's internal controls, peculiarities in the accounting systems, data storage and industry practices.

The audit plan is the only official opportunity, for the taxpayer to have input into how the examination is to be conducted. The audit plan is the taxpayer's only opportunity to plan with the IRS team manager the scope, duration and procedures used during the examination. A thoroughly developed audit plan will improve the overall efficiency of the audit, reduce the overall cycle time and help keep the taxpayer current in its audits. Although development of an audit plan is time-consuming, it will lead to a more efficient audit. In addition, the audit plan can be the start of mutual cooperation and candid communication between the Service and the taxpayer representative.

Editor's note: Mark Ely is former chair of the AICPA Relations with the IRS Committee. Deborah J. Pflieger is the current chair. Ms. Barners, Ms. Hyde and Messrs. DeGeorgio, VanDeveer and Goldstein are members of that committee.

FROM TOM DEGEORGIO, DIRECTOR, FEDERAL INCOME TAX AUDITS & ANALYSIS, SHELL OIL COMPANY, NEW YORK, NY