IRS initiatives to decrease audit cycle times - good ideas that need more work.

Beginning in 2002, the IRS decided to take action to decrease cycle times on examinations of large companies in the Large and Mid Size Business division (LMSB). Initially, the focus was on audits being conducted under the Coordinated Industry Case (CIC) and the Coordinated Examination Case (CEC) programs. These examinations are more structured and there is early involvement by case managers, specialists and counsel's office. Appropriate planning was critical to accomplish the examination goals. Formal examination plans are used to focus on critical areas. There is significant interaction between the examination team and the taxpayers/representatives during the planning and conduct of the examination. This worked well in the largest examinations.

In 2003, the Service initiated a program to expand the principles used in the CIC/CEP examinations to all LMSB cases, and embarked on a strategy aimed at reducing cycle time in the examination process. This required development and use of techniques such as the Limited Issue Focused Examination (LIFE) process; it was hoped that LIFE would help to better manage issues and resolve differences more efficiently during examinations. It was also anticipated that the use of the LIFE process in appropriate cases would help to relieve the strain on limited IRS resources.

The IRS was also active in developing and encouraging other initiatives, such as the use of pre-filing agreements, fast-track resolution alternatives, and the Industry Issue Resolution process, to help accelerate examinations.

In light of the perceived need to increase enforcement due to the proliferation of "abusive tax shelters," the IRS also wanted to create a structured process for use in the information-gathering phase of examinations.

The IDR Process

The issuance of Information Document Requests (IDRs) and their response times have always been an area of differences between the IRS and taxpayers/representatives, as to response times, frequency of the issuance of IDRs during the examination process, adequate responses, etc.

The Service, in January 2002, updated Internal Revenue Manual (IRM) Section 4.45.13.4.10, Individual Document Request Management Process, to formally lay out the IDR process. As part of this management process, the IRS is requiring a 20-day initial response time for IDRs, even though this is not required by new IRM Section 4.45.13.4.10.

15-day delinquency: When a taxpayer's IDR response is 15 days late, IRM Section 4.45.4.13.4.10 (3) requires a follow-up IDR with a "reasonable" response date, but not more than 15 days from the issuance of the follow-up IDR or 30 days from the original response date. The follow-up IDR should be issued after discussion with the taxpayer/representative as to the reasons for the delinquency and how long it will take to accumulate any missing information required for an "adequate" response. The follow-up IDR must carry the same number as the original IDR and in some way incorporate the original IDR request, either as an attachment or wording; see IRM Section 4.45.13.4.10(3)(a).

30-day delinquency: If the taxpayer/representative continues to be delinquent after 15 days, additional follow-up is required if there is insufficient information for the examiner to reach a conclusion on the issue. The examiner should again confer with the taxpayer/representative to resolve the problem.

The examiner should also consider the issuance of an additional follow-up IDR or Form 5701, Notice of Proposed Adjustment. If a follow-up IDR is issued, the response date should he no later than 15 days from the last requested response date or 45 days from the original response date.

45-day delinquency: If the taxpayer continues to be delinquent on the 45th day, the team manager should request to meet with the taxpayer/representative and the examiner to discuss the issues and explain the consequences of continued noncompliance, including the issuance of a summons. Involve ment of higher-level IRS officials (such as the territory manager) and involvement of more senior corporate executives in the process, may also be required.

90-day delinquency: If an IDR response is more than 90 calendar days delinquent, a joint status meeting should be held, involving the territory manager, examiner, the taxpayer's senior tax officer and the taxpayer's representative, to try to resolve the open issues.

Under the new procedures, the issuance of Form 5701 takes on additional importance, because a revenue agent's report (RAR) will not be issued. Form 5701 will have as an attachment a "total" sheet computing the tax on adjustments on unagreed issues. In other words, the RAR response time is significantly reduced.

Procedural Problems

There are a number of problems with these new procedures. The 20-day response time is clearly inadequate, especially when multiple IDRs are issued, requiring significant amounts of information that need detailed analysis.

In large complex examinations, when the requested information is voluminous, it may be impossible to meet the 20-day deadline. When information requested is required to be obtained from foreign subsidiaries, it often takes significant time to accumulate, translate, review and transmit such information.

The complexity of questions posed in an RAR may also prevent adequate responses within the 20-day period. If Form 5701 effectively replaces an (with its decreased timeframe for response), there will probably be many situations in which taxpayers/representatives will take positions that disagree with the proposed adjustments, instead of trying to answer Form 5701 fully. This could have the effect of decreasing, rather than increasing, efficiency in the audit process.

Possible Solutions

Although the new process seems to require more communication between the examination team and a taxpayer/ representative, the rigidity of the time frames and the lack of flexibility actually will, in many cases, work against achieving the stated goal of decreasing cycle time.

For this process to work, there needs to be a great deal more built-in flexibility. There should be a requirement that before an IDR or Form 5701 is issued, an agreement will be reached between the parties as to a reasonable response time, and an "adequate" response to the questions or proposed adjustments. There must also be a method for agreements to extensions of response time without the responses being deemed delinquent (and subject to the attendant consequences and additional procedures). There should also be a method to allow, after discussion between the Service and the taxpayer/representative, an extension of time to adequately respond to Form 5701, so that a protest will not be required.

Conclusion

One of the program's major goals, effective tax administration, requires full cooperation between the Service and the taxpayers, even when there is an agreement to disagree on an issue. This goal will be more difficult to achieve when one or both parties are under rigid and unrealistic timeframes and procedures that work against achievement of the program's goals.

Taxpayers and representatives who find themselves caught up in the shortened timeframes or without the benefit of adequate time to respond to IDRs and/or Form 5701 should not hesitate to take their concerns up the line to area and/or territory managers, in appropriate circumstances.

FROM STEPHEN R. BUSCHEL, CPA, MBA, BDO SEIDMAN, LLP, NEW YORK, NY