Evaluation of the coordinated examination program and IRS field personnel.

On June 5, 1997, Tax Executives Institute submitted the following comments on the appropriate standards for evaluation IRS agents and districts to Michael P. Dolan, acting Commissioner of Internal Revenue. The comments were prepared under the aegis of TEI's IRS Administrative Affairs Committee, whose chair is Robert L. Ashby of Northern Telecom Inc. John A. Gurovich of US West Inc., a member of the committee, materially participated in the preparation of the Institute's comments, as did Stephen W. Boocock of Allegheny Teledyne, Inc., Ralph J. Coselli of Shell Oil Company, and Robert J. McDonough of Wang Laboratories, Inc.

During TEI's November 1996 liaison meeting with Commissioner Richardson, yourself, and other IRS National Office personnel, the Institute expressed concern that the National Office's concentration on increased production (as measured by "dollars recommended") could impair the overall effectiveness of the Coordinated Examination Program (CEP) by encouraging agents to pursue questionable issues. Thomas W. Wilson, Jr., National Director of Corporate Examinations, and other IRS representatives explained that increased production is only one factor in the evaluation process. Other factors examined include agreed dollars per staff year, currency, and total adjusted revenues (including claims). Mr. Wilson explained that the measurement of individual performance is separate from the IRS's program evaluation. He concluded by inviting the Institute to submit its views on how best to measure agent performance.

On May 19, 1997, TEI met with Mr. Wilson to discuss the Institute's concerns about the emphasis on increased production (as well as other issues). The Institute has also discussed this issue with the National Commission on Restructuring the Internal Revenue Service. We believe it is now appropriate to reiterate our concerns to you.

Evaluation of CEP Program

The adoption of meaningful measures of performance is essential to the long-term success of the IRS's Coordinated Examination Program. Since our November liaison meeting, the IRS has issued its Examination Program Letter for Fiscal Year 1997. That document, issued by the Assistant Commissioner (Examination), sets forth (at page 5) the following guideline for measuring the IRS District Office in respect of its participation in the CEP program:

Quality examinations will be

conducted with the most effective

and efficient use of

resources. This will be

achieved by involving the

taxpayer in the entire planning

process; incorporating

the CEP auditing standards

in every examination; maximizing

the use of specialists

and specialist managers; and

dealing effectively with taxpayer

procrastination using

upper level management and

the available enforcement

techniques including summonses

where appropriate.

Districts are also advised (again at page 5) to:

Strive to develop and resolve

quality issues at the lowest

level. Emphasize the use of

Alternative Dispute Resolution 

techniques including:

Delegation Orders 236 and

247; Accelerated Issue Resolution;

Early Referral; and

Pre-filing Determination.

Practice Risk Analysis on every

examination and involve

the entire examination team

in this practice.

Although we may quarrel with the use of the term "taxpayer procrastination" ("delay" is a less judgmental term) and the use of summonses except in the most serious of cases, TEI wholeheartedly agrees that these standards are a good starting point for evaluation of a District's accomplishments in the CEP program. We have long endorsed the involvement of taxpayers in the planning process and the use of ADR initiatives such as the AIR and early referral revenue procedures. We are pleased that the IRS emphasizes the use of these techniques as an important part of a District's performance evaluation.

We are less sanguine, however, about the mixed signals that the Program Letter sends. Appendix F discusses the measures and target goals to be used in applying resources. Although CEP revenue agents are to be evaluated on the basis of "agreed tax and penalty," the appendix sets forth an "overall examination measure" of "total recommendations" "[proposed additional tax and penalties resulting from an enforcement action by Examination." Thus, it is on this basis that District Offices -- and thus District Directors -- are (at least in part) judged.(1)

This emphasis on dollars recommended -- which has been reflected in the CEP Extra! newsletter -- is troubling, especially in light of the IRS's mission to collect the proper amount of tax (as opposed to the maximum amount of tax). Performance measures drive behavior, and measures for overall programs (or functions) and the individuals who execute them must be in harmony. Evaluating the agents' supervisors on a dollars-recommended basis cannot help but permeate the entire Examination structure. Good employees know the grounds on which their bosses are evaluated -- they know what they need to do "to make the boss look good" -- and under the IRS's current measurements the bosses look good based on the amount of proposed changes. Ironically, the Districts with the most compliant taxpayers -- those whose returns are correct as filed -- would score poorly under this standard because there would be fewer adjustments to recommend. Clearly, it would be counterproductive to rate District Offices negatively for successfully promoting voluntary compliance.

These conflicting measurements must be refined and reconciled. It should be emphasized that District Offices will be evaluated on a range of performance criteria. Although dollars recommended may be a factor to review (especially on a short-term basis), it should not be the only factor. Indeed, a wide gap between the dollars recommended and the dollars sustained should have a negative effect on performance measurement. Criteria such as the number of agreed issues, the number of issues sUstained in Appeals, and the currency of audit activity should also be used as a balancing measure, especially in a long-term evaluation of the District Office. Indeed, given the IRS's goal of encouraging voluntary compliance, reducing taxpayer burden, and achieving productivity gains, these measures should be elevated in importance. A "top-down" approach-focusing on the agency's ultimate goals -- is needed to promote the expeditious resolution of cases.

Inappropriate Use of Penalties

Appendix F to the Program Letter also notes that penalties (whether agreed or proposed) are used to evaluate the Examination function as a whole (through "overall examination measures") and individual revenue agents. Taxpayer concerns about the IRS's approach to penalties are heightened by this use of penalties as a measurement tool.

TEI strongly believes that a rational penalty system must recognize that taxpayers who endeavor in good faith to comply with our amorphous body of tax law should not generally be penalized. Penalties should only be used to punish non-compliant behavior. Thus, penalties -- or the threat of penalties -- should not be used as a bargaining chip to compel a settlement of issues. We recognize that the IRS has a responsibility to assert penalties in appropriate cases, but submit that a system that encourages or permits penalties to be used as a weapon borders on the unprofessional and is susceptible to abuse. When used as a measurement tool, penalties can disrupt the relationship between the IRS and the taxpayer. This is especially troubling in respect of the CEP program where good faith dealings are essential to improving the currency and quality of audits. Moreover, the severity of the penalty may not be rationally related to the degree, or purposefulness, of noncompliance (as in the employee benefit area where relatively minor nonoperational defects can trigger the assertion of substantial penalties). Penalties should not be used to evaluate either District Offices or agents.

Evaluation of Field Personnel

The IRS appraisal form that TEI understands is currently used for revenue agents (grades 5 through 13) provides a good starting point for addressing basic agent performance. The form identifies seven job elements that are critical to the successful con duct of an audit: (1) workload management, (2) fact finding, (3) application of accounting/auditing principles, (4) application of the tax law, (5) issue identification, (6) written product, and (7) customer relations. In the ensuing sections, TEI addresses the factors it believes should be taken into account in assessing whether an agent has performed adequately in respect of each job element.

1. Workload Management. This performance measure focuses on whether the revenue agent --

Establishes workload priorities

for assigned cases, compliance

activities, and other

assignments; plans, schedules,

and spends time based

on priorities.

TEI recommends that this factor explicitly include a review of the agent's efforts to include the taxpayer in the planning process and to encourage the appropriate use of ADR techniques. Has the agent suggested the taxpayer apply for an advance pricing agreement, used the accelerated issue resolution or early referral revenue procedure, or effectively and creatively used other available resources available (including industry specialists or National Office personnel)? Utilization of these procedures should be examined as part of a review of the agent's workload management. Indeed, we recommend that consideration be given to requiring an affirmative statement whether these procedures have been utilized and, if not, why not. (We understand that such statements are currently required in respect of particular substantive issues.)

In addition, the IRS should consider whether the agent has attempted to assist the taxpayer in solving problems that may not be directly related to the examination, i.e., providing "one-stop shopping" where the Case Manager or Team Coordinator is the taxpayer's point of contact. Moreover, the evaluation should address whether the agent raises new issues (or proposed adjustments) late in the examination cycle and, if so, why. This performance standard should require that issues be discussed with taxpayers at the earliest opportunity, and that taxpayers be involved in the development of the issues. It should also be applied in a manner that encourages agents to issue proposed adjustments throughout the examination rather than holding them until the end. Finally, the standard should clarify that agents who are efficient and end an audit as early as possible will be favorably reviewed.

2. Fact Finding. This performance measure focuses on whether the revenue agent --

Gathers adequate evidence to

resolve the issues identified

and support the conclusions

reached.

This element is one of the most important performance measures, but we suggest that it should be expanded to emphasize that issues must be well developed. For example, if Appeals returns an issue to Examination for further factual development, that fact should be reflected in the agent's review process. In other words, the content of and the relevance of data in the case file, not its volume, should be reviewed.

Moreover, the agent should be encouraged to work with the taxpayer to develop IDRs that reflect an understanding of the taxpayer's business operations and are designed to determine whether a "quality" issue exists. Has the agent expeditiously determined whether to develop or drop an inquiry? The performance standard should reflect these considerations.

3. Application of Accounting/ Auditing Principles and Tax Law. These performance measures focus on whether the revenue agent --

During the examination, applies

tax and financial accounting

principles to understand,

reconcile, and analyze

taxpayer's books and records;

assesses internal control.

Researches and applies tax

law during the course of the

examination to resolue issues

of consequence.

TEI believes that these criteria should also look at the utilization of National Office initiatives by the field. Although the National Office has developed programs to reduce taxpayer burden and enhance the management and conduct of CEP cases, there has been an inconsistent implementation of these initiatives by field personnel. More training is needed in the field to educate agents about the benefits of these initiatives to taxpayers and the IRS and to encourage them to use them on a regular basis. The IRS can emphasize the need to apply these techniques by including their use as part of an agent's evaluation.

4. Issue Identification. This measurement performance focuses on whether the revenue agent --

Identifies issues with the

most significant tax and compliance

potential.

TEI agrees that the materiality of issues raised should be a critical factor in evaluating an agent's performance. Although development of an operative definition of materiality may prove to be problematic, we recommend that the evaluation measure be clarified to include an assessment of how well the agent distinguishes between material and immaterial issues and how well he or she handles the material issues.

Similarly, we believe the evaluation process should address those situations where the agent raises issues that, while entailing costly and time consuming documentation efforts, ultimately (or even potentially) involve very little revenue. Even if a particular approach is legally sustainable, it may impose inordinate costs on the taxpayer that, when viewed from either a policy or revenue perspective, should reflect negatively on the agent's conduct of the audit. By focusing on the materiality of the issues raised, the evaluation process would encourage agents to balance the IRS's legal right to demand precise documentation (even in respect of minor issues) against the practical need for, as well as the taxpayer burdens attendant to, providing such documentation. We suggest, moreover, that striking such a balance would diminish the instances of perceived "taxpayer procrastination" and generally improve taxpayer-IRS relations.

5. Written Product. This performance measure focuses on whether the revenue agent --

Prepares and organizes workpapers

and reports in accordance

with national, regional,

and local requirements.

This factor narrowly focuses on written communications within the IRS. TEI believes that it should also encompass communications with taxpayers. Some TEI members continue to receive extraordinarily large numbers of specific information document requests (IDRs) that sometimes bear little relation to the taxpayer's business. We believe that agents should be evaluated on the written quality of IDRs, notices of proposed adjustments, etc., to determine whether these documents are poorly drafted or are too broad in scope.

6. Customer Relations. This performance measure focuses on whether the revenue agent --

Uses communication skills to

facilitate audit completion

and to provide customer service.

TEI believes that this factor should include an evaluation by the taxpayers who are under audit by the agent. Obviously, a corporate taxpayer's perspective needs to be weighed in evaluating the significance of its comments. The possibility of bias, however, should not preclude the IRS from seeking the "customer's" opinion. Although there may be differences over specific issues, the IRS and the taxpayer have the same objective: a well-run, well-respected agency that efficiently conducts its examinations without imposing undue burdens on taxpayers. The taxpayer's views -- together with any ameliorating factors -- should be considered by the agents' supervisors.

Conclusion

In these comments, TEI has discussed the factors it believes should be taken into account in assessing whether an agent has performed adequately. There are, of course, other approaches to refining the IRS's appraisal system. For example, additional job elements (complementing the seven discussed above) could be identified, and the critical success factors for each element (old and new) could be defined or realigned. Or, more dramatically, the IRS's current appraisal system could be abandoned and the IRS, with the assistance of its internal managers and external consultants, could develop an entirely new system. The key, of course, is to ensure that whatever system the IRS utilizes rewards good performance, discourages poor performance, and accordingly advances the IRS's overall objectives by driving agent behavior. Whichever approach the IRS decides upon, Tax Executives Institute will be pleased to lend its support.

TEI appreciates the opportunity to comment on the appropriate measurement of IRS programs and field personnel. If you have any questions or want to discuss these comments, please do not hesitate to call Timothy J. McCormally of the Institute's professional staff at [phone].

(1) The other overall examination measures are "total recommendations per FTE [full time equivalent]," "total revenue protected," and "percent of Examination dollars collected presecond notice.