TEI-IRS Midstates Liaison Meeting.

February 10, 1999

On February 10, 1999, representatives of Tax Executives Institute met with officials of the Internal Revenue Service's Midstates Region in Dallas, Texas. TEI's delegation to the meeting was led by Kendall D. Coyne of Sprint PCS, Vice President-Region V, and included the following individuals: Steven R. Evans of MidAmerica Energy Company, Frank Calfo, Cynthia A. Rooks of Harley-Davidson, Inc., W. Kurt Meier of Morton International, Inc., Thomas R. Blythe of OwnesIllinois, Inc., Kelley A. Scharosch of Sprint PCS, Madeline R. Schneider of Sprint Corporation, Bill Zornes of PartsAmerica, Jack N. Reif of Dayton Hudson Corporation, Charles B. Tebelius of IMI Group Inc., D. Jeanne Sturges of Citgo Petroleum Corp., Robin M. Fitzpatrick of Citgo Petroleum Corp., Ben J. Clayton of Phillips Petroleum Co. (TEI Vice President-Region VI), Anthony W. Rackley of The Williams Companies, Inc., Gareth S. Glaser of Alcon Laboratories, Inc., William B. Blaylock of Texas Instruments Inc., R. Randall Capps of Electronic Data Systems Corp., Nan E. Smoot of Mary Kay Inc., Janet M. Wilson of Cooper Industries, Inc., Gerard G. Meneilly of Exxon Company, USA, Malcolm E. Calkins of Union Pacific Resources Company, John C. Moore of Tesoro Petroleum Corp., and Mary L. Fahey of TEI's legal staff. In submitting the questions and answers for the meeting for publication, Mr. Coyne wrote the following:

"The meeting began with Bobby Scott, Regional Chief Compliance Officer (Southeast Region), providing a thorough and interesting discussion regarding IRS Restructuring. Mr. Scott is the team leader of the IRS Middle Market/Large Corporate Design Team. After listening to his comments, it was the consensus of TEI participants that the role of the Industry Specialist Program (ISP) will be enhanced in the restructured agency. The Chief Counsel's Office will support the ISP directly. A closer, more controlled approach is likely with ISP and taxpayers at all levels. As the regions and geography take on less importance within the IRS, attention will focus on industry issues. This will include a special focus on training agents in specialized industries. Industry issues and control will emerge from this process. There is concern that the independence of Appeals, though professed with confidence by the IRS, may be compromised in this process.

"Ladd Ellis, Regional Commissioner, prepared TEI members for positive change, including many new faces and responsibilities as the IRS restructuring unfolds. Additionally, he reported that many new system and software upgrades are necessary and underway for delivery in the near future.

"John Buchanan moderated the discussion. Perhaps the response by the IRS that generated the most questions related to capitalization issues. Notwithstanding widespread taxpayer concerns, it is the view of the IRS Regional Officers that there is no evidence of agent indiscretion concerning the utilization of INDOPCO principles outside their expected interpretation.

"Melinda Kurtz did a remarkable job of organizing the questions and answers for the Conference. The region wishes to express its appreciation to her and all those IRS employees who contributed to the overall success of the meeting."

1. How is the IRS applying the global interest netting rule on a retroactive basis? For example, if the statute of limitation has run on an assessment, but claim for refund is pending, can the taxpayer still ask the IRS to do the netting?

There will be forthcoming guidance on the applicable statute of limitations that must be open (and the applicable date of when the statutes must be open) before the taxpayer can take advantage of the retroactive application of the statute. It is anticipated that the revenue procedure will be out by the end of the first quarter of 1999.

2. Recent amendments to section 6662 and other sections of the Internal Revenue Code give the IRS the power to impose penalties for underpayments attributable to tax planning activities simply by characterizing those activities as a tax shelter How can tax professionals engage in legitimate tax planning without the fear of tax penalties under these revised rules?

The revised definition of tax shelter for purposes of the substantial understatement penalty under section 6662 (as well as the new confidential corporate tax shelter registration requirement under section 6111) is intended to discourage taxpayers from entering into transactions that do not comport with the tax laws. The substantial understatement penalty, as revised, is effective with respect to transactions entered into after August 5, 1997. Although currently effective, the penalty provision is not intended to preclude a taxpayer from engaging in a legitimate transaction that furthers a substantive, non-tax business purpose of such taxpayer.

Guidance on the revised definition of tax shelter for purposes of the substantial understatement penalty is not currently planned (although it may be included on the joint IRS and Treasury 1999 business plan. The IRS and the Treasury Department do intend to issue regulations under section 6111, involving the new confidential corporate tax shelter registration requirements, that will provide taxpayers with, among other things, guidance on when a transaction or arrangement involves tax avoidance or tax evasion. The IRS and the Treasury Department welcome comments and suggestions on the manner in which these new penalty provisions can be implemented to achieve their objectives while minimizing the burden on legitimate tax planning activities.

In addition, the Treasury Department is considering modifications to the substantial understatement penalty and other rules affecting corporate tax shelters in connection with the budget for Fiscal Year 2000.

3. Revenue agents lack adequate training to deal with investment transactions, particularly those involving international investments. As a result, many revenue agents simply make adjustments and force the taxpayer to deal with Appeals or litigate the issue. What is the IRS doing to provide more training in these areas?

In 1993, the IRS established the Financial Products and Transactions Program under the Assistant Commissioner (International). Selected revenue agents received training in domestic and international investment transactions and related financial products. Each year additional Financial Products Specialists (FPSs) are selected and placed in new geographic locations. Also, the International Field Assistance Specialist Program (IFASP) provides assistance to FPSs and International Examiners (IEs) in developing issues.

This is a year of increased emphasis on training for employees. We are expanding our Continuing Professional Education (CPE) to twice the number of hours as in past years. International investments and other complex international transactions are covered at FPSs and IEs CPE and on national teleconferences.

The case manager, along with the International or Financial Products manager, should work with the taxpayer to resolve issues at the Examination level. They should both review proposed issues, prior to issuance to the taxpayer on Form 5701, to ensure the issue is valid and fully developed.

4. With regard to the industry specialist program (ISP), to what degree is the revenue agent required to fully address "coordinated?" How much latitude do agents have on "coordinated" and "not coordinated" issues they seem to rate both sets of issues the same and apply boilerplate ISP write-ups to all transactions without examining the merits and distinctions of each taxpayer position? Will the role of ISPs continue under the new IRS restructuring?

Revenue Agents are required to raise and address "Coordinated Issues." They must develop the facts and apply the Examination position as outlined in the Coordinated Issue Position Paper. If they feel that there is a material difference in their case from the Coordinated Issue Paper, they should contact the Industry Specialist to discuss the situation. Any proposed adjustment that does not conform to the Coordinated Issue paper position must be approved by the Industry Specialist prior to its being proposed to the taxpayer. The purpose of Coordinated Issues is to provide consistency and uniformity on significant issues that impact an industry or large group of taxpayers.

There are a number of significant issues that have not been formally coordinated. Often an Industry Specialist has formulated a tentative position paper on the issue but has not completed the in-depth analysis or Chief Counsel review needed to formally coordinate the issue. In these instances, the tentative position paper is provided to agents to assist them with the development of the issue. While agents are encouraged to follow the tentative or proposed position paper, they are not required to follow it and may develop, propose, and resolve the issue based upon their own interpretation of the facts and applicable law. We strongly urge agents to contact the Industry Specialist whenever they pursue an issue that may have a significant industry-wide effect.

The Middle Market/Large Case Design Team is concentrating on an industry specialization alignment. Under this concept, the current Industry Specialist will be an integral part of the organization. Regardless of the organization structure adopted, the Industry Specialization Program will have a role. We will need to leverage the expertise of these specialists to achieve our customer service objective to provide consistent and equitable treatment for all taxpayers.

5. Rev. Proc. 98-25, which deals with EDP record retention, is viewed both by taxpayers and many IRS Computer Audit Specialists (CAS) agents as impossible to administer. The procedure starts with the idea that every EDP record, which could ever affect an item of income or deduction, must be retained. That list would be never-ending. The "negative" record destruction agreements, which would specifically name those records that could be destroyed, would be a nightmare to negotiate for both taxpayers and the IRS.

Background: Rev. Rul. 71-20 states that all machine sensible data media used for recording, consolidating, and summarizing accounting transactions and records within a taxpayer's ADP system are records within the meaning of section 6001 of the Code and are required to be retained as long as the contents may become material in the administration of any internal revenue law. This is not a new requirement or a requirement of Rev. Proc. 98-25. In the 1970s and 1980s media storage costs were significant. Rev. Proc. 86-19 allowed some relief to the requirements of Rev. Rul. 71-20 through Record Retention Agreements (RRAs). Rev. Proc. 91-59 updated Rev. Proc. 86-19 and, among other things, changed the terminology to Record Retention Limitation Agreements (RRLAs). Many more taxpayers were using computers to process tax return data and we received numerous questions when it was issued. We decided to clarify the revenue procedure and even worked with the National Office of TEI to reorganize it and provide more examples. The result was Rev. Proc. 98-25.

Issue: The issue is whether electronic files are books and records needed by the IRS to conduct examinations, not whether there is a RRLA. We disagree with your statement that taxpayers and CASs believe Rev. Proc. 98-25 is impossible to administer.

Each CEP taxpayer is unique and requires case-by-case decisions. Examples are:

* A RRLA for a taxpayer with a centralized accounting system might be feasible.

* Some taxpayers have decentralized accounting systems and the burden on the IRS and the taxpayer resources to identify files for a RRLA is too great. An alternative RRLA has been successfully used which identifies files that do not have to be retained. (Also referred to as negative or exclusion RRLAs). This reduces burden on both the IRS and taxpayer.

* Many taxpayers are changing so rapidly with mergers and spin-offs that any list of files to retain on a RRLA is virtually impossible to keep up-to-date. The alternative RRLAs work better in this instance where the taxpayer asks for specific relief to not retain certain files.

* Many taxpayers are cooperative in always providing any files requested whether or not they are included on a RRLA. The files are kept for other reasons and agencies. To reduce burden on the IRS and the taxpayer, we might revoke an old RRLA, rather than continually update it.

* Some taxpayers used RRLAs as a shield against the IRS by not allowing us access to new files identified for examination. The IRS might revoke these RRLAs to ensure access to files needed for examinations.

If a taxpayer specifically requests a RRLA, it is considered on a case-by-case basis depending on the resources of both the IRS and the taxpayer and how cooperative the taxpayer has been in providing records to meet the needs of the CEP examination team. Alternative RRLAs are considered when appropriate. Section 10 of Rev. Proc. 98-25 does require taxpayers that request a RRLA to identify and describe those records that they propose not to retain and explain why those records will not become material to the administration of any internal revenue law. This was intended to reduce the burden on both the IRS and the taxpayer.

6. It is our understanding that the Illinois District will continue to negotiate "affirmative" record retention agreements, which would specifically name those EDP records that must be retained. Discussions with many local IRS CAS agents indicate that they prefer this approach; certainly taxpayers do. The Illinois District should be commended for this policy. What is the position of the Region on this issue?

The history and background for Rev. Proc. 98-25 are explained in the answer to the previous question. The Illinois District states that since its issuance, Rev. Proc. 98-25 has caused some confusion and concern with respect to whether RRLAs would be continued. The Illinois District will continue to enter into RRLAs. As in the past, the CAS and the taxpayer will work in a bilateral effort to identify the computerized records to be retained. However, during this process of identifying computerized records, problems can arise (e.g., complexities of the taxpayer's corporate structure) that make it difficult to complete an agreement. In those situations where an agreement cannot be completed, the taxpayer will be required to follow Rev. Proc. 98-25. The taxpayer must keep all computerized records as required by Rev. Rul. 71-20 or identify and describe those records they propose not to retain and explain why those records will not become material to the administration of any internal revenue law. We assume the latter situation will be the exception based upon the spirit of cooperation that is present with the taxpayers in the Illinois District.

7. What is the status of Notice 98-31 (IRS-initiated accounting method changes under section 446(b))? Given the outcry of criticism from the tax community, will this proposed revenue procedure be withdrawn or modified?

The IRS has received comments on Notice 98-31 from various groups, including TEI. All comments are being considered. Bonny Dominquez is Examination's Change in Methods of Accounting Issue Specialist. His phone number is [phone].

8. With respect to environmental clean-up costs, can we expect issuance of any additional guidance on issues such as Rev. Rul. 94-38?

We recognize that there are a number of issues in the environmental cleanup area that remain unresolved despite the issuance of Rev. Rul. 94-38. The coordinated issue paper on underground storage tank removal costs that came out about a year ago applied Rev. Rul. 94-38 to the costs incurred to clean up surrounding soil that was contaminated by the leaking tank. Rev. Rul. 98-25 gave a current deduction for the cost of an underground storage tank used to hold toxic waste once the tank was filled, using what has become known as the "garbage bag" analogy. At the moment, Treasury is working on the guidance that will become part of the 1999 Business Plan. There is a possibility that guidance dealing with environmental issues will emerge on the 1999 Business Plan.

9. Can we expect issuance of additional guidance on tax treatment of enterprise-wide software system upgrades?

At the present time there is nothing in the works on this issue.

10. How and when does the IRS plan to implement the provision of the 1998 Restructuring Act concerning ex parte communications? That provision says the IRS should "(4) ensure an independent appeals function within the IRS, including the prohibition in the plan to ex parte communications between appeals officers and other such IRS employees to the extent that such communications appear to compromise the independence of the appeals officers."

There is a draft document on Ex Parte Communications in the clearance process. As soon as the document is approved, an IRS Notice will be issued.

11. What do IRS officials believe will be the role of the National Taxpayer Advocate and Taxpayer Assistance Orders in CEP examinations and IRS processes involving CEP taxpayers?

The redesign or restructuring activities will have no adverse impact to CEP taxpayers. The role of the Advocate will be the same as in the past with more direct involvement in the program. Positive effect will include more involvement in prefiling activities, as well as filing activities (in terms of account and issue resolution). Activities will also include early interaction with taxpayers to identify issues and trends and to address those issues. Advocates will work with taxpayers, associations, and various industry organizations that represent those taxpayers, including TEI, to gain the taxpayer prospective.

12. Many taxpayers perceive that one of the significant tax administration issues with the IRS is a gap between IRS policy as announced by the National Office and the practice of local IRS personnel. (E.g., the National Office has consistently stated that INDOPCO did not change the fundamental principals of capitalization; however, field agents continue to cite INDOPCO as authority for capitalization of all types of costs from scheduled maintenance and repair costs to certain types of marketing costs). Does the IRS recognize this to be an issue? Are there any programs to address this perceived gap?

The IRS National Office does not recognize this to be an issue. They continue to emphasize that INDOPCO did not change the fundamental principles of capitalization. There are no efforts currently to address this perceived gap. Address any specific examples of revenue agents inappropriately citing INDOPCO with the case manager.

13. If you could look ahead over the next ten years, what do you think would be the most significant developments and changes in tax policy and tax administration that will affect business? Possible discussion areas:

* Impact of electronic commerce?

* Information technology? Proprietary information?

* Will there be a corporate tax return as we know it today? Will examinations and administrative processes still are conducted by local IRS offices?

* Any new compliance problems? Any old compliance problems that would have vanished?

* Will the IRS acquire a mission in areas outside of tax administration?

* Trends in human resources at the IRS, in corporate tax departments, with tax advisers?

* Transborder issues? Combined operations / tax systems of two or more governments?

Our new mission statement reflects where we are heading: "Provide America's taxpayers top quality service by helping them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all."

More emphasis will be placed on pre-filing education to assist taxpayers to correectly file their returns rather than relying so heavily on enforcement activities. The restructuring of Middle Market/Large Case will identify non-compliant areas in a particular industry and identify ways to gain more compliance (e.g., regulations, revenue rulings, revenue procedures, etc.).

Susan H. Graham, Coordinated Examination Program and Specialty Branch Chief for the South Texas District, was selected in mid-November as the National Project Manager for the electronic filing of corporate returns. She will be gathering a team to address this task as soon as possible. This effort is a joint project by the offices of Electronic Tax Administration and the National Director Corporate Examination Programs. Outside and inside stakeholders will be interviewed and consulted throughout the process. The Electronic Tax Administration team members will be based in the Austin Service Center.

A question was raised regarding provisions in the draft FY 2000 budget presented recently by President Clinton. A forum of presenting your concerns is through the TEI National Office and their congressional contacts. While we can not comment on proposed legislation, we will forward any comments or concerns through our MSR Communications Office to our Legislative Affairs Office in Washington, DC.

We have included information on the IRS Corporate Partnership Program. More than 2000 companies are signed up to help the IRS make tax materials more accessible to taxpayers. Participating businesses encourage their employees to obtain tax materials at work via electronic means such as the Internet or by photocopying forms and instructions from a set of materials that are kept at a centralized location in the business.

14. At last year's Midstates liaison meeting, there was considerable discussion about IRS audits of qualified pension and benefit plans. There was a major concern on the part of taxpayers that significant penalties could be proposed for relatively minor ministerial mistakes or omissions. Since that meeting, the National Office has made some public announcements trying to respond to some of these same taxpayer concerns. Given our earlier discussion, and later developments, has the Midstates Region modified its use of proposed penalties in this area?

The Midstates Region Employee Plans/Exempt Organizations Division remains committed to providing support on Coordinated Examination Program (CEP) Examinations. This support includes operational reviews of plans and assistance in determining the proper deductions for plan contributions. Operational reviews may uncover plan defects that vary from minor ministerial mistakes and omissions to significant problems that require extensive correction to maintain the qualified status of the plan. We consider many factors to determine the preferred course of action with respect to the examination results. Included in this analysis is our goal to insure that plans operate in accordance with their terms and that plans designed to qualify under section 401(a) of the Code do so in operation as well as form. The protection of participant's and beneficiaries rights under these plans is an important aspect of examination.

Rev. Proc. 98-22 provides specific guidance and insight into the direction the IRS is taking with regard to continued qualification of deferred compensation plans. Guidelines with respect to "sanctions" are designed to respect the seriousness of the situation but not to be punitive in nature so as to discourage the continuation of such plans by their sponsor. The number of participants affected by the situation and the type of correction necessary to rectify it are also important factors used to determine how best to proceed on a case.

Penalties are a very real aspect of any examination and deserve consideration. It is our practice to consider the statutory requirements of the Code and build them into closing agreements, when practicable. Waiving filing requirements of returns is not part of our settlement programs. Once factual determinations are made the IRS does consider reasonable cause and mitigating circumstances in applying penalties and crafting final closing agreements.

A regional coordinator reviews closing agreements before they are submitted to the Chief, Employee Plans Branch for approval.