Report of the IRS CEP Currency Task Force.

On December 5, 1994, Tax Executives Institute submitted the following comments on a draft report of a special Internal Revenue Service task force on efforts to improve the currency of Coordinated Examination Program (CEP) examinations. The task force, which is chaired by Jack G. Holstein, Chief, Examination Division in the Hartford, Connecticut, District, was charged with -

reviewing ongoing currency improvement efforts in various locations to identify methods and techniques that can be recommended for consideration in other Districts; and

determining whether the "ultimate" currency goal proposed by the Executive Director of CEP (starting an examination within 12 months of its filing and completing the examination within the three-year statute of limitations on assessments) is attainable.

TEI's comments on the task force's draft report were prepared under the aegis of its IRS Administrative Affairs Committee, whose chair is Robert D. Adams of Halliburton Company. Also contributing materially to the comments were Sheldon A. Kimel of Brunswick Corporation, Robert J. McDonough, Jr. of Haemonetics Corp., and Thomas B. Rogers of Apple Computer, Inc. Anyone wishing a copy of the IRS's draft report should send a written request to TEI Headquarters.

On behalf of Tax Executives Institute, I am pleased to submit the following comments on the September 1994 draft report of the Internal Revenue Service's CEP Currency Task Force. The Institute appreciates the opportunity to review the draft report.

TEI's comments were developed following a review of the draft by a number of our members. Specifically, the draft standards were circulated to members of the Institute's IRS Administrative Affairs Committee and Executive Committee, as well as other interested members of the Institute. The views expressed in this letter represent a synthesis of the comments received. In addition, we have noted several typographical and grammatical errors in the draft. Rather than detail those comments in this letter, we enclose a marked-up copy of the draft, on which we have marked our proposed emendations.

General Comments

TEI is pleased that the Internal Revenue Service is reviewing its currency improvement efforts and undertaking to determine whether it is reasonable to adopt the goals of starting an examination within 12 months of a return's filing and of completing that examination within the three-year statute of limitations. We believe the draft report marks a salutary step in reaching those goals and we commend the Task Force for its contribution toward improving audit currency. The draft report reflects a flexibility that we find refreshing. We fear, however, that in certain circumstances the draft report may be too ambitious in the measures it seeks to establish.

TEI agrees with the Task Force that there is no single path to achieving currency. The report should recognize, however, that the use of the various tools available to the IRS and taxpayers depends upon the facts and circumstances of each case. The report should explicitly state that it presents a compendium, or sampling, of commonly used procedures to achieve currency but that the listing is not intended to be exhaustive. If the examination team and the taxpayer are committed to the goal, the means used to achieve currency is limited only by their creativity and initiative; there should be no artificial barriers erected.

TEI believes that there is an overriding need to involve taxpayers in the examination planning process - and in all stages of the process. Indeed, we have some sympathy for the view that the IRS should stop studying and restudying various issues (such as currency) and start insisting that the recommendations set forth in extant reports (most notably, the report on taxpayer involvement) be implemented in the field. At a minimum, we recommend that the Task Force report confirm that, with ongoing staffing constraints on both taxpayers and the IRS, an examination can be completed promptly and efficiently only by establishing and following a plan that the taxpayer was involved in developing. For example, the plan must recognize that in some companies the personnel who are responsible for taxpayer's planning and compliance functions will be involved in the audit and appeals functions. Consequently, advance scheduling and knowledge of the timing and scope of information requests will enable the tax department personnel to better serve all its functions and to provide timely responses to the CEP team. We sincerely believe that delays and attendant problems can be minimized where the taxpayer is intimately involved in the planning process. The IRS, too, is more likely to be thorough and professional in its identification and analysis of possible tax adjustments if the CEP team has a clear conception of the schedule and scope of the audit. Finally, detailed planning should enable both the IRS and the taxpayer to develop a greater variety of techniques for handling requests and issues expeditiously, thereby attaining the currency goals.

Definition of Case

Currency Goal

The Currency Task Force recommends (at page 1 of the draft report) that the following "case currency goal" be adopted:

A CEP case will be considered current when an examination is started within twelve months of the filing of the most recently filed return in a cycle and the planned examination span ... for the cycle is less than the cumulative number of months included in the cycle.

The Task Force's stated goal in its Mission Statement (page 1) of completing an examination within the three-year statute of limitations may technically be obtained, however, only if the audit cycle includes a single year. If the audit cycle includes two or more years, the currency goal - almost by definition - will often not be met.

For example, under a one-year audit cycle, the 1994 return of a calendar-year taxpayer (assuming no extensions) will be filed by March 15, 1995. The case will not fall within the proposed case currency goal unless it begins by March 15, 1996, and ends by March 15, 1997. Since the statute of limitations for 1994 will not expire until March 15, 1998, the 'ultimate' currency goal (page 1) could be achieved in such a case. The Mission Statement breaks down, however, where the cycle includes more than one year. Consider the case of a twoyear cycle (1994 and 1995). The examination will have to begin by March 15, 1997, and end by March 15, 1999 - one year beyond the three-year statute of limitations for the 1994 return. Thus, at least a one-year extension of the statute will be required. Inasmuch as this example fits within the definition of case currency but requires a waiver of the statute, the goal stated in the Mission Statement is not attainable.

Audit cycles for CEP taxpayers typically include more than one year. If the Task Force contemplates moving away from multi-year cycles (to rolling one-year cycles), we suggest the report be revised to reflect that thinking. If it is intended that multi-year cycles will continue to be the norm (and, indeed, the draft report devotes considerable attention to the possible benefits four-year cycles), we believe that currency is obtained if the audit examination is completed prior to the close of the normal statute of limitations for the last year in the audit cycle. We recommend that the definition be revised to reflect this fact.

Moreover, TEI believes that the "planned examination span" set forth in the currency goal definition ("less than the cumulative number of months included in the cycle") should be revised. The IRS should not assume that three years are needed to examine three years and that the goal of currency is advanced as long as the audit of three years takes fewer than 36 months. If that is the stated goal, then true currency will never be realized; rather, the IRS will simply be treading water. Stated differently, the IRS should reject (at least as inevitable) the notion of uninterrupted, unending audits; such an approach provides no incentive to get - and stay - current. Although it may take time (and "cultural" changes on both sides), some of our members have suggested (and not just fancifully) that the IRS move toward a goal of auditing each year in three or four months.

Scope and Methodology

The draft report states (at page 3) that "[i]t is essential that timely access to the taxpayer's automated system be obtained to improve [the IRS's! efficiency and effectiveness." The draft report recognizes that improved access to data reduces the cost of record retention and promotes "customer satisfaction" and confidence in the IRS's ability to resolve an examination at minimal cost.

TEI wholeheartedly agrees with these statements. We urge the Task Force to strongly recommend that the revenue procedures revising Rev. Proc. 91-59 and allowing for the retention of records by digital imaging be issued as soon as possible. Release of the digital imaging revenue procedure is particularly important, because the lack of guidance is impeding taxpayers' ability to use new technologies. Taxpayers should not be required to maintain redundant record retention systems, i.e., they should not be required to retain original paper or microfilm reproductions when a digital imaging system (the integrity of which has been established) is in place. Indeed, TEI believes that the IRS's use of digital imaging technology in examining returns will save time and resources for the IRS, as well as being less burdensome for taxpayers. Allowing digital imaging as a replacement to hard-copy retention will also promote 'customer satisfaction" and would likely encourage taxpayers that do not now maintain such systems to implement them.

Four-Year

Examination Cycles

The draft report (at pages 8 and 9) discusses a currency initiative in the Chicago District that employs audit cycles of four taxable years. Although an extended cycle may have benefits in some cases, TEI members expressed concern that, in the absence of the taxpayer's buy in," a four-year cycle may prove too ambitious and burdensome.

The issue is, quite simply, resources - a point that the Task Force recognizes (at page 9) with its statement that 'taxpayers may have to enlarge their respective tax staffs in order to service the examination team." We suggest, however, that many companies may be hard pressed to handle a four-year audit cycle, especially since the corporate management trend is continual "downsizing" (or "rightsizing") of the workforce. TEI members are doubtful that they will be permitted to increase their staffs to reach such a goal. We recognize that the report itself acknowledges that taxpayers in some cases may not be able to provide the resources necessary to complete a four-year audit cycle.

Four-year examination cycles are best suited to those situations where the taxpayer and the IRS agree to such a cycle. We also suggest including a statement in the report that, where four-year cycles are considered, IRS personnel need to be sensitive to the reluctance of taxpayers to hire additional staff to assist the IRS in "catching up" where those staff may have to be laid off once currency is attained.

Time-Line Case Planning

and Monitoring

The draft report (at pages 10 and 11) discusses the need to develop a CEP time line for an examination. Although we agree with this concept, we urge the Task Force to clarify that time lines should be developed only after consultation with the taxpayer. Without such input (which should include some room for unexpected contingencies), the time-line target dates may not be realistic.

Accelerated Issue

Resolution

We assume that the report will be revised to reflect the issuance of Rev. Proc. 94-67, relating to accelerated issue resolution.

Peer Review

The draft report (at pages 18 and 19) discusses the CEP peer review program for cases closed during the fiscal years 1991 and 1992. TEI suggests that the following bullet point be included in the recommendations for improvement:

Case Managers should be encouraged to involve the taxpayer in developing the facts that, with District Counsel's assistance, will serve as the basis for field service advice.

Involvement of the taxpayer will ensure that the field service advice given to the field will be based on all the facts, not just the facts as perceived by the examining agent. It will also assuage legitimate taxpayer concerns about the fairness of the field service advice process.(1)

The draft report (at page 19) summarizes several concerns that will require a commitment by taxpayers to address, including response time to information document requests (IDRs) and the emergence of new issues or facts late in the examination period (or even after the case has gone to Appeals). Although we agree that taxpayers need to recommit themselves to addressing these concerns, we believe the draft report in effect presents only one side of the story. With respect to the IDR response time, for example, the draft report gives no consideration to whether the initial response time given in an IDR was realistic and whether the taxpayer committed itself to respond within that time. (Nor does the draft report acknowledge that the vagueness or overbreadth of certain IDRs can impair a taxpayer's ability to respond within the specified time frame.) Seeking taxpayer involvement in the planning process can significantly reduce IDR response time.

We suggest that the draft report's comments on the emergence of new issues or facts during the protest period (i.e., after the issuance of the revenue agent's report) is incomplete. The reason is that the report does not address when during the exainination the Forms 5701 (or IDRs) giving rise to the new facts or issues were issued. Indeed, although the report states that new facts were presented during the protest period in 17 of 18 unagreed cases, it does not correlate that development to any action by the examination team. If the Form 5701 or IDR were not issued until the last minute, or if the issue raised by the team was unanticipated, a delay in the taxpayer's presenting its position (including facts that support its treatment of the issue) may be more defensible (though obviously not optimal).

We acknowledge that many taxpayers wait until the end of the examination to determine which proposed adjustments to protest and, hence, the taxpayers response to the adjustments will not be forthcoming until the protest period. We also recognize that, although the taxpayer may have valid resource management reasons for waiting,(2) the result may be to slow down the audit.

The Task Force recommends that these concerns be aggressively pursued with taxpayers and TEI. We also believe that a dialogue on these issues will be instructive. We simply recommend that the report strike a more balanced tone by acknowledging that the "problem" (the late emergence of facts or issues) may have multiple causes. We also reiterate our willingness to meet with the proper IRS personnel to pursue these concerns.

Advance Pricing

Agreements

The draft report (at pages 20 and 21) discusses the use of advance pricing agreements (APAs). The Task Force recommends the process as a means of taking significant issues "off the table."

Although the Institute has supported the APA process since its inception, TEI members have expressed concern that the process is now taking substantially longer to complete than when APAs were initially made available.(3) Some of the delay stems from a high turnover rate in the National Office. Other delays appear, in part, to result from the "near-audit intensity" level of investigations being conducted by Examination personnel and District Counsel who are involved in the APA process.

TEI appreciates that the IRS does not want to create an independent staff to deal solely with APAS. We are concerned, however, that the specificity and particularity involved in Examination's role in the process are adding seemingly unnecessary time to the APA process. We suggest that the report remind IRS personnel that there is no "perfect" pricing policy and that some "rough justice" may be neeessary to keep the process viable. We also urge the Task Force to recommend initiation of a "small APA" procedure for smaller companies that may be unable to bear the substantial costs (in some cases, approaching $500,000) for obtaining an APA. Stated differently, the IRS should take steps to ensure that it does not price itself out of the APA market.

Case Manager Settlement

Authority: Delegation Order

No. 236

The draft report (at page 22) states that four factors must be present before exercising Delegation Order No. 236, including Appeals must have settled the issue on [thel merit[s], independent of other issues." We suggest that the Task Force expand the discussion of the latter point and should develop recommendations to enhance the consistent application of the delegation order across districts. Specifically, the term "merits" should be expanded to include settlements based on the "hazards of litigation" (as opposed to "horse trading" of issues); in other words, if Appeals settles an issue because it concludes there is a 75-percent likelihood that the taxpayer would prevail if the issue were litigated, the resolution of that issue in future years by Examination personnel should in our view be subject to Delegation Order No. 236.(4) In addition, we believe Appeals personnel should be instructed to specify whether or not its resolution of particular issues is merit based.

Early Referral Procedure

The draft report (at page 23) discusses Announcement 94-41, relating to the procedures for early referral of issues to Appeals. There has been some suggestion recently that the early referral procedure may be impeding the resolution of some cases at the examination level, perhaps because taxpayers are not utilizing the procedure early enough in the audit process.

TEI suggests that the early referral procedure will be most effective where the taxpayer and the IRS strive in their planning sessions to identify issues that may be susceptible of early referral treatment. The early identification of issues will permit their settlement prior to the completion of the remainder of the audit.

The Task Force should specifically encourage Case Managers to identify in each case a particularized list of the types of issues possibly warranting early referral, which should then be discussed with the taxpayer as soon as possible. The Case Manager should also remind taxpayers of the availability of the procedure during the opening conference or the audit planning sessions.

Pre-Filing Determinations

The draft report (at page 24) discusses the use of a pre-filing determination procedure. The report anticipates that requests will be made at the end of the taxable year, leaving some 8-1/2 months available for the determination process to be concluded before the return is filed.

TEI believes that the use of the procedure should not be limited to seeking determinations after the close of the year. Taxpayers may complete transactions early in the taxable year that will be good candidates for the use of the procedure. TEI recommends the IRS remain open to considering pre-filing determinations not only before filing the return but also before the end of the taxable year.(5)

Systems Analysis

The draft report (at page 26) intimates that major changes in the Coordinated Examination Program are necessary. Thus, the report states that, while the currency initiatives set forth in the report have application in other cases, they do not for the most part change the CEP process in general. It then posits the Task Force's belief that "fundamental changes to these processes are essential to achieving real long term improvement in the currency of CEP examinations."

TEI is waiting, with some trepidation, for the other shoe to drop. It may well be that changes are necessary and, indeed, change has been the watchword over the last several years. We suggest, however, that the report be revised to clarify what types of changes are being contemplated. If the Task Force believes drastic changes are necessary, we request some elaboration of their scope and content; if not, it may be appropriate to temper the language in the report.

Agreement of Commitment:

IRS Commitments

The proposed agreement (at pages 31 and 32) lists commitments to be made by the IRS. TEI has the following comments on the specific items:

Information Document Requests. The provision covering IDRs (item 6) should state that the IRS will generally make only one specific request per IDR. Discrete requests for information will focus the taxpayer's efforts. Moreover, it will obviate the perception problem that occurs where the taxpayer can comply with one part of an IDR and not another and, as a result, the entire IDR remains categorized as "unfulfilled." To guard against overbroad, multi-part, or duplicative IDRs, we believe the Case Manager or Team Coordinator should review all IDRs before they are issued.

Monthly Meetings. Item 10 provides that the Case Manager or Team Coordinator will meet with the taxpayer on a monthly basis to monitor progress. Optimally, the taxpayer's interaction with the Team Coordinator will be continual (and certainly no less than monthly). We also believe that periodic meetings (or at least monthly telephone conversations) are desirable between the Case Manager and the taxpayer.

In addition, TEI believes that the following issues should be covered in the agreement:

Field Service Advice. We understand that the National Office is considering possible changes in the field service advice process. Thus, the Task Force may have to remain somewhat flexible pending the release of any National Office guidance. We do believe, however, that the report should recommend that the agreement address when and how taxpayers will be brought into the process, especially in respect of the development of factual issues. For example, we believe Case Managers should be encouraged to advise taxpayers of significant issues on which field service advice is being requested, to work with taxpayers in ensuring that such advice is rendered upon an agreed set of facts, and to brief taxpayers on pertinent field service advice; these issues can all be addressed in the agreement.

Computer Audit Specialists. TEI believes that the agreement should commit the IRS (through its computer audit specialists) to work with the taxpayer to identify those records that are not pertinent to the correct determination of tax liabilities and may be deleted from taxpayer's storage systems. Again, we recognize that the IRS's policy in respect of record retention agreements is in a state of flux (and, also, that a revision of Rev. Proc. 91-59 is in the works). Regardless of whether the IRS moves away from entering into formal retention agreements, we believe the IRS examination team should assist the taxpayer in identifying redundant or unnecessary records.

Prompt Consideration. TEI believes that the IRS should commit in the agreement to expeditiously consider requests for the use of outside experts or ISP personnel, for accelerated issue resolution, and for use of the Case Manager's roll-over settlement authority under Delegation Order No. 236. In addition, the report should confirm the requirement that a taxpayer's request for early referral to Appeals must be acted upon within 30 days.

Materiality and Timing Issues. TEI recommends that the agreement contain a concept of materiality or a minimal adjustment level, as well as the general scope of the examination. The Task Force report could provide that taxpayers and the IRS could agree to a materiality threshold, which would prevent the expenditure (by both the IRS and taxpayer) of scarce resources on relatively insignificant items. The agreement could separately address timing differences or the question of foreign tax receipts. Hence, if it can be determined that a particular issue will "turn around" within a short period of time, a higher materiality threshold should be specified. TEI believes that the specific dollar levels should be agreed to by the IRS and the taxpayer during the planning sessions, with a view toward minimizing the expenditure of time and effort on relatively minor items.

Use of Personnel and Facilities. The agreement should also designate the taxpayer representative(s) with whom the IRS is to discuss audit issues. The IRS should agree to contact only the designated individuals unless otherwise authorized by the taxpayer's representative. In this regard, TEI believes that the examination team should be cautioned that interviews of taxpayer personnel should be conducted only in extraordinary circumstances (since interviews disrupt taxpayer operations) or when volunteered by the taxpayer as the most expeditious means of communicating information or supporting a return position. Alternatives to interviews (such as the submission of written questions, which could, in return, be answered in writing) should be pursued with the taxpayer's representative (again, during the planning sessions).(6)

Finally, the agreement should address issues such as the agents' wearing of identification badges and limitations on the IRS's access to the taxpayer's premises and functions. We also recommend that the agreements confirm that in conducting the examination IRS personnel will conform to the taxpayer's work hours.

Agreement of Commitment:

Taxpayer Commitments

The agreement of commitment contains (at page 32) certain commitments to be made by the taxpayer. TEI has the following comments on the specific items:

Access to Tax Return Preparation Files. Item 4 provides that the taxpayer will provide certain documents at the beginning of the examination. It states, "As part of the process, the Computer Audit Specialist will be provided upon request all tax return preparation files and be allowed to perform the application."

The clause "be allowed to perform the application" should be qualified to take into account cost considerations and the taxpayer's own circumstances. For example, some taxpayers may not be willing or able to allow the IRS to use its own computer facilities without limitation because of cost constraints. Alternatively, a taxpayer's computer function may be handled by an outside consultant, in which case every "computer run" will cost the taxpayer money. (Even when the computer function is kept in-house, the taxpayer's cost allocation policies may create an issue of "who pays for it.") We believe the agreement should address the desirability of the taxpayer and Computer Audit Specialist's working together to pare down the number (and extent) of requested computer runs, as well as how the cost of such runs are to be shared or limited. Indeed, we are aware that in some instances the IRS has worked with taxpayers to set up systems susceptible of being audited; we believe such innovative steps should be encouraged.

Item 4 also uses the term 'tax workpapers," which is potentially quite broad. TEI recommends that the term "Schedule M workpapers" or "tax return workpapers" be substituted for the term currently in the draft. In addition, we recommend that the examination team be reminded that they should request tax accrual workpapers only in accordance with the narrow standards prescribed in the Internal Revenue Manual.

Response to Proposed Adjustments. Item 8 requires taxpayers to make every effort to respond to proposed adjustments within 60 days. Although a 60-day response period may be reasonable in many situations, we recommend that the agreement acknowledge that a longer (or shorter) period may be more proper, depending on the facts and circumstances.

Statute of Limitations. Item 9 (at page 33) deals with the effect of the statute of limitations. The report should clarify that the waiver of the statute of limitations will be the subject of negotiation between the taxpayer and the IRS and that the results of the negotiation should be set forth in the agreement, with the projected completion of the examination being a critical factor.

Conclusion

TEI appreciates the opportunity to provide its comments on the draft report of the CEP Currency Task Force. If you should have any questions about our comments, please do not hesitate to call either Robert D. Adams of Halliburton Company, chair of the Institute's IRS Administrative Affairs Committee, at [phone], or Timothy J. McCormally of TEI's legal staff at [phone].

(1) By involving taxpayers more consistently in the field service advice process (e.g., by adopting procedures on advising taxpayers when Counsel becomes involved in the case, when they can dispute or elaborate on the field's statement of facts, when they can meet with the responsible Counsel personnel), the IRS can remove some of the contentiousness from particular cases, guard against "false starts" by Examination and Counsel personnel, and expedite the resolution of issues (and, ultimately, entire cases). (2) We understand that one of the objectives of Announcement 94-41 (relating to the early referral of issues to Appeals) is to make small issues "disappear" once the bigger ones are resolved. (That is to say, if the biggest issues can be resolved, the taxpayer may choose - just as the Case Manager may choose - not to pursue less significant issues.) The initiative hence implicitly recognizes the validity of waiting until the whole audit (or most of the audit) is completed before deciding what issues to protest. (3) TEI also believes that the IRS should be open to applying APAs retroactively to open years. Such an approach would clearly advance the goal of currency. (4) We understand from Commissioner Richardson's address to TEI's October 1994 Annual Conference that a national task force is considering the whole issue of settlement authority and we hope to have an opportunity to respond to that task force's findings and recommendations. (5) The draft report states that "[i]f a determination is made prior to, and incorporated in the filing of the return, the taxpayer will have a high degree of assurance that the issue will be accepted on audit." TEI does not understand why the pre-filing determination should not be dispositive, baring fraud or a material misrepresentation - the same factors that can "undo" a closing agreement or cause a private letter ruling not to have binding effect. If taxpayers have no assurance that pre-filing determinations will be accepted on audit, they will be less likely to seek such determinations. (6) TEI believes that the taxpayer's written comments will usually provide a better, more complete record than an agent's interview notes.