TEI-IRS Southeast region liaison meeting: December 17, 1996.

December 17, 1996

On December 17, 1996, representatives of TEI's Region V met with officials from the Internal Revenue Service's Southeast Region. TEI's delegation to the annual liaison meeting was chaired by Preston B. Barnett of Cox Enterprises, Inc. the Institute's regional vice president and a member of the Atlanta Chapter, and included the following individuals: T. Norman Bush of James Ricer Corporation (Virginia Chapter), Janet C. Ingle of Ingram Industries, Inc. (Nashville Chapter), Stuart A. Karpel of Turner Broadcasting System, Inc. (Atlanta Chapter), Thomas J. Miller of Providian Corporation (Louisville Chapter), Robert H. Proehl of BellSouth Corporation (Atlanta Chapter), Charles W. Shewbridge, III of BellSouth Corporation (Atlanta Chapter and Institute Treasurer), and Timothy J. McCormally (TEI's General Counsel and Director of Tax Affairs). The Internal Revenue Service was represented at the meeting by Robert Johnson, Regional Commissioner; Daniel L. Black, Regional Director of Appeals; and William C. Roth, Regional CEP Manager.

Reprinted below are the questions that TEI submitted to the IRS in advance of the meeting and the IRS's written responses, which were generally discussed at the meeting. In addition to the topics addressed in the written questions, several other issues were addressed, including: (i) the recent decision to centralize management of the IRS's Appeals function, having the Regional Directors of Appeals report to the National Director of Appeals (rather than the Regional Commissioners); (ii) effective use of the Case Manager as a resource in resolving Service Center problems; (iii) ensuring that members of the examination team have sufficient training and management skills; and (iv) Case Manager oversight of Specialists.

1. Please summarize your recent initiatives to reduce taxpayer burden and what plans you have to achieve further improvements in this area.

A. The following initiatives to resolve issues at the lowest level are being emphasized:

1. Accelerated Issue Resolution (AIR) -- Is a process to advance the resolution of issues from the current examination to any and all filed returns. It involves filed returns and covers only completed transactions.

2. Delegation Order 236 -- is a form of settlement authority that permits the large case manager to settle an issue based on a prior-year appeals settlement.

3. Delegation Order 247 -- Delegates to case manager authority to accept settlement offers, with respect to coordinated issues within the Industry Specialization Program (ISP) and International Field Assistance Specialization Program (IFASP) on which appeals has coordinated issue papers containing settlement guidelines or positions.

4. Advance Pricing Agreement (APA) -- is an agreement between the taxpayer and the IRS regarding the taxpayers pricing policy. This agreed-upon pricing policy would apply to one or more taxable years in the future and can be rolled back to the filed years.

5. Early Referral to Appeals -- Allows the transfer of fully developed unagreed issues on an in-process examination to Appeals while the case remains in Examination for the simultaneous development of other issues.

6. Involving the Taxpayer in the Planning Process -- Is a concept whereby the CEP examination planning process should be conducted to include appropriate taxpayer and IRS personnel; promote the mutual understanding of the taxpayer's systems and IRS's processes; best utilize each parties resources; and generate quality examinations.

B. Other initiatives to reduce taxpayer burden include:

1. Service Centers have had the capability to identify and flag notices to CEP taxpayers. This gives Service Center personnel an opportunity to review all notices prior to mailing and to review offsets prior to transfers being made. Service Center personnel also have the capability to exclude large corporations from the BMF offset program for one full year. This enhancement will address those accounts containing complex processing which require multiple adjustment actions outside the scope of normal processing.

2. Each of the Centers appoints a contact person for most CEP taxpayers. While this process has been in place for a number of years, we now have the capability of locally updating the representatives of large corporate taxpayers. Another enhancement made is the process of sending a notice to the taxpayer prior to offsetting taxes due from filing an original return or from subsequent assessments. This process gives the compliant taxpayer an opportunity to respond to balance due notices without an immediate offset of account overpayments.

3. We currently are in the process of upgrading our CEP equipment and software. As will be discussed in more detail in Question 3, our efforts to become more automated will reduce the audit span while improving the quality of the typical CEP examination.

4. The Southeast Region conducted a study of CEP cases with less than 20 points. Recommendations from this study include the following items:

* Time taken to produce the audit plan should be significantly reduced on the smaller point cases. Part 1 of the CEP plan can be substituted with pre-examination minutes or other appropriate files. Part 2 (Service Management Information Section) can be eliminated.

* Make time tracking optional on smaller point cases.

* Consider combining post-examination critique from the past cycle with the opening conference of the current cycle.

* Requires documented risk analysis and priority/assignment of SAIN areas at the beginning of the examination.

C. Recommendations from a task force on involving the taxpayer in the planning process will be implemented. These recommendations include:

1. Emphasize the importance of securing an orientation of the taxpayers accounting systems and internal controls.

2. Case managers should coordinate with taxpayers to hold meetings where IRS specialists and their managers can interact with their taxpayer counterparts

3. The IRS team should discuss and work with the taxpayer regarding Notification of Issue Closure.

4. Taxpayers' concerns regarding entities and areas to be examined should be solicited by IRS teams and reviewed with the taxpayer.

5. A copy of the CEP Examination Plan should be given to the taxpayer.

2. In the recent IRS restructuring, new districts have been added to the Southeast Region. Could you comment on the effects of these changes on the new districts that have been added and the taxpayers who are served by these districts?

The aim of the IRS restructuring efforts is to move headquarter positions closer to the front line; thereby, improving the service we are able to provide. In CEP, improvement has been realized in the following areas:

A. Most all of the districts in the Southeast Region now have a pure CEP Branch. In other words, the CEP Branch is made up of only CEP and speciality groups. This permits the CEP Branch Chief to become more specialized and focused. CEP Branch Chiefs have commented that the elimination of general program groups from their branch gives them more time to interact with the CEP taxpayer.

B. The management of specialists under the concept of key and associate districts will be significantly reduced. Instead, many districts will now be able to support a pure speciality group. Decisions on how to proceed on unagreed speciality issues should be improved because the CEP group and speciality group now have the same upper-level management staff.

3. The media have reported extensively on the IRS's problems with outdated technology and its difficulties in upgrading its technology? Could you give a brief status report on significant technology matters in the Region and their expected effect on corporate taxpayers in the Region?

A. Through various applications, we will be able to download the taxpayer's financial information for auditing, thereby reducing the need for individual hard copy requests for information. This process saves the taxpayer time and enables the audit team to better develop issues.

B. Major part of our automation effort will be to transfer taxpayer information between geographical areas in a secure manner. Through encryptic modems we can move data to where the IRS has personnel and expertise. This process reduces taxpayer burden and travel cost while improving the quality of the examination.

C. We intend to purchase time-line software for all audit sites. This tool will improve our ability to manage the span of the examination and minimize cycle time.

D. While working with National Office, we intend to purchase "off the shelf" tax computation software which will allow for increased efficiency in closing examinations.

4. How soon may taxpayers expect updated guidance on recordkeeping requirements? What is the status of the National Office's project to revise Rev. Proc. 91-69 or to issue a revenue procedure on digital imaging pursuant to Notice 96-9? What is the region's philosophy concerning record retention agreements? Should taxpayers be requesting approval of imaging or compute output to laser disc (COLD) record retention system on a case-by-case basis?

A. A project to revise Revenue Procedure 91-59 is currently on this year's business plan of the Office of Chief Counsel. Although work has begun on the proposed revision, it is unlikely that anything will be finalized before the end of this calender year. A proposed Revenue Procedure on the use of imaging technology was published in notice format earlier this year soliciting public comment. Those comments were received and have been reviewed. The Office of Chief Counsel is currently in the stage of finalizing the revenue procedure and its issuance is expected by the end of the calender year.

B. The position in the Southeast Region continues to be that record retention agreements should be entered into on a case-by-case basis, with the primary consideration being the benefit to be derived by both the taxpayer and the IRS from such an effort.

1. Record retention agreements were first initiated more than 15 years ago when taxpayer ADP systems could easily be identified. Over the past decade, taxpayers, as well as their ADP systems, have grown large and very complex. Because of this, taxpayers are often unwilling to devote the resources necessary to draft a record retention agreement. And secondly, the IRS doesn't have the resources to maintain across-the-board record retention agreements.

2. We do believe there may be cases where we need to have agreements. For example, companies that are using the "R/3 Germany based SAP AG" type software for financial records, need to get agreements on our access to the database records we will need for audit purposes. These may not be the exact records required for certified audits. For the normal automated accounting systems, storage space for the entire automated financial records are generally not excessive.

5. During the past several years, TEI has worked with the IRS National Office in developing a number of initiatives to reduce burden, enhance taxpayer involvement in the audit planning process, and to otherwise increase the efficiency of CEP audits. Unfortunately, these initiatives do not appear to be consistently communicated to or adopted by the field. The result is a perception of a significant "disconnect" is correct and, if so, what steps might be taken to redress the situation?

A. We have made extensive efforts to get the word down to the first-line field personnel. In addition to instructions and stated positions contained in the Internal Revenue Manual and in widely distributed task force reports, the initiatives have been emphasized during district reviews. These initiatives were discussed in detail at the meeting of all CEP and Speciality Branch Chiefs, held in San Antonio, Texas, in September 1996.

B. Four Branch Chiefs from each region are being trained in January 1997, to instruct case managers and coordinators on the following initiatives:

1. Planning the audit with the taxpayer.

2. Requesting information and developing issues using the concepts of risk analysis.

3. Closing issues at the lowest level in IRS.

C. Other training is planned for early 1997 on the use of project managers software. We have seen good results in reducing cycle time where this software is used in planning and monitoring the examination.

D. We ask that TEI members continue to work with our audit teams to effectively implement these initiatives; such as working to improve the focus and quality of IDRs, being a participant in the drafting of the audit plan and keeping the audit focused on relevant and material issues.

6. Please comment on any efforts the IRS has under taken to encourage the audit process to start at the top as opposed to starting at the bottom (i.e., on encouraging agents to focus on the big picture -- "the forest" -- and not be consumed by extraordinarily detailed auditing -- "the trees").

A. The priority of issues should be established through a process that compares the potential benefits to be derived from examining an area to the resources required to perform the examination. This process, referred to as "risk analysis," is a major area of emphasis in the Southeast Region.

B. Factors to be considered when conducting risk analysis include: compliance considerations; adjustment potential; potential impact on future years; historical examination data; industry issues, practices, and trends; appeals and litigation considerations; financial condition of the company; taxpayer's systems and controls and resources available.

C. Risk analysis is a subjective process even where mathematical models are employed. It should be based on experience, judgement, and objective analysis. Once the potential benefits and resources are considered, priorities can be established. Virtually all the factors discussed above are difficult to estimate and subject to change. Therefore, the risk analysis process should be periodically revisited and updated.

D. We are focusing our Regional CEP reviews with the districts on the work product. We are going onsite to review the audit work. We are looking at identified audit areas to see if there is potential for material tax change and we are looking at the approaches for auditing and developing issue areas.

E. At the CEP Branch Chief meeting in San Antonio, we had the North Florida District give a presentation on the joint IRS/TEI study of the CEP process. There were a number of interesting points resulting from this study. Perhaps most significant is that we spend 71 percent of time on verification issues and get only 15 percent of the tax.

F. North Florida now has an expectation to identify the driving issues, "the critical few." The audit team explains to the taxpayer that they will focus their exam on the critical few as long as the taxpayer supplies the necessary information timely. In other words, pursuit of the non-critical issues will only be made if there is down time. The audit team also explains to the taxpayer that they will cut off the examination upon completion of the critical few.

7. Please comment on whether any guidelines relating to materiality (or the scope of the audit) are being communicated to the field. If so, are the guidelines generally being adhered to? Are field agents being evaluated on, among other things, their adherence to such guidelines?

A. We stress and encourage our CEP managers and examiners to raise significant issues and limit raising non-material timing adjustments. The district examination teams are relied upon to set the scope and identify the issues in their respective audits. They are in the best position to determine the appropriateness of their issues.

B. We do not encourage short term timing adjustments that are not significant. However, the examination team is in the best position to determine, relative to each specific audit, what is considered material and/or significant. We believe that as our initiative to involve the taxpayer in the CEP planning process gains greater momentum, this and other potential concerns will be reduced.

C. Yes, field examiners are evaluated on adherence to a materiality standard. Field agents are evaluated on their critical elements. One of these elements is "Issue Identification." This requires the examiner to: select for examination returns with significant tax potential; identify issues for examination that have significant tax potential, and revise the scope, as appropriate based upon the degree of taxpayer compliance.

8. Taxpayers continue to be concerned about excessive or unfocused information document requests. Does the region believe it is generally appropriate for the team to inquire about alternative forms of a transaction -- i.e., forms that were considered but not followed? Taxpayers question the relevance of such hypothetically-based IDRs to an agent's analysis of the transaction that the taxpayer did undertake.

A. Yes, we believe team members should be allowed to ask questions regarding alternative transactions considered. This coincides with involving CEP taxpayers in the planning process and with appropriate procedures for the information/fact finding process. By providing this information taxpayers can assist in disposing of the issues at the earliest possible time.

B. The IDR process is probably the most important aspect in a CEP examination. Over the years it has attracted a great deal of attention and discussion. Most recently, a national task force conducted a process analysis project to identify problems in the IDR process and formulate solutions. Recommendations from this study include:

1. IDR contents and objective should be discussed with the taxpayer prior to issuance.

2. Conduct follow-up meetings with the taxpayer on a monthly basis.

3. Issue fewer IDRs by first discussing with the taxpayer the kinds of information being sought.

4. Conduct bi-weekly meetings with team to discuss status of IDRs.

9. Please comment on the propriety of generalized requests for taxpayer workpapers without a specific issue or need being identified by the agent. TEI had understood that requests were to be targeted. Is this understanding incorrect'

A. Whether seeking accountant's workpapers or other collateral source documentation, it is a long standing policy of the IRS that we should be cautious not to issue overly broad IDRs, rather, IDRs should focus on specific information that is needed to examine the areas that have been identified. Case managers and examiners are in the best position to determine what information is needed. The IDR should be focused for a specific reason or for specific issue The case manager should discuss with the taxpayer the reasons for requesting the documents. These discussions can result in the issuance of fewer and more concise IDRs, as well as generate a more timely response to those IDRs that are issued.

B. Often the best source of explanation for balance sheet M-1 adjustments between books and return are the accountant's workpapers. Many unusual transactions are found in the accountants workpapers rather than records for usual business transactions. Consequently, we view the accountant's workpapers (except for tax accrual workpapers) as part of the records necessary to substantiate what is reported on the return.

10. TEI understands that the National Office has recommended that the audit team share all parts of its audit plan with the taxpayer. Does the region subscribe to this recommendation? Do circumstances exist where the audit plan will not be shared or is it up to the team, on a case-by-case basis, to decide to share the plan?

The Region subscribes to the position that the audit team share all parts of the plan. Since the plan is actually the product of the case manager, the taxpayer and the team members, it naturally reflects three individual sections. Where, in the judgment of the case manager, a taxpayer has fully cooperated in the planning process, all three parts of the plan may be provided to the taxpayer. When requested by the taxpayer, the audit plan will be provided to the taxpayer subject to the limitations below.

A. Part I -- Taxpayer Information Section (Examination Arrangements). In effect this section is the overall plan of examination. It contains information extremely important to both the taxpayer and the team. A copy is to be furnished to the taxpayer.

B. Part II -- Service Management Information Section (Examination Program). This section is essentially the case manager's instructions to team members and contains information of a general management nature. This information can be shared with the taxpayer.

Part III -- Examination Procedures Section. This section contains each team member's assignment and plan for the procedures to be used in accomplishing the assignment. This information can be shared with the taxpayer, except for information that will impair tax administration such as LEM, Official Use Only documents, and some specialized audit compliance techniques.

11. Please comment on the region's activities to promote more timely and expeditious resolution of the issues, such as Advance Pricing Agreements (APAs), Accelerated Issue Resolution, early referral to appeals, Appeals mediation, and field service advice. How often are these tools being used, What is being done to promote the wide use of these procedures at the regional level?

A. Primary emphasis in the CEP in the last five years has been the Total Issue Resolution Concept. Our objective is to resolve issues at the lowest level without sacrificing quality or integrity of the examinations.

B. As stated earlier, we have made extensive effort to get the word down to the first-line field personnel. In addition to instructions and stated positions contained in the Internal Revenue Manual and in widely distributed task force reports, the initiatives have been emphasized during district reviews. These initiatives were discussed in detail at the meeting of all CEP and Speciality Branch Chiefs, held in San Antonio, Texas, in September.

C. How often are these tools being used?

            FY 95 AIR Amount      FY 96 AIR Amount
            {millions}            {millions}
Southeast     5.9                  49.6
National    267.7                 314.1

           FY 95 DO 236 Amount   FY 96 DO 236 Amount
            {millions}            {millions}
Southeast     0.0                  0.3
National    246.1                 42.8

            Number of APA's       Number of APAs
            Issued                Pending
National    72                    142

Field Service Advices: We are not at liberty to disclose the volume of activity in this area.

Early Referrals to Appeals: Activity is low; however, there have been a few occurrences.

12. Taxpayers perceive that case managers often either lack, or fail to exercise, control over engineers. Please comment on the appropriate level of oversight that is to be exercised by the case manager. Now does the region gauge whether that level of oversight is provided? Also, taxpayers are growing increasingly concerned about the adequacy of specialist training. We invite comments on the level of training received by engineers, economists, and other specialists, as well as whether there are plans to enhance this training.

A. The case manager remains the central, key control point in all ongoing examinations. While engineering managers are required to approve issues proposed by the engineer, the case manager has overall responsibility for inclusion of these issues in the RAR.

B. Training has been curtailed by budget and we are hopeful that the appropriate level of training can be achieved in the future. For FY 1997, we have $10 million in compliance training with some designation for specialty training.

C. Computer Audit Specialist (CAS) Training:

* CAS Phase I, II, III & IV

* CAS Phase I, II & III (On-the-job)

* Continuing Professional Education (Yearly)

* Statistical Sampling (Basic and Advanced)

D. Economist Training:

* Introductory Course for Economist-Section 482

* International Phase 1

* Continuing Professional Education (Yearly)

E. Engineer Training:

* Basic Income Tax Law Training

* Principles and Income Approach to Appraisal of Real Estate

* Advanced Engineer Training (In-house course on selected topics)

* Natural Resource Engineers attend a Colorado School of Mines class on Investment Analysis

* Continuing Professional Education (Yearly)

* Currently developing a in-house course on business valuations.

F. International Training:

* International Phase I, II & III

* International Phase I & II (On-the-job)

* Continuing Professional Education (Yearly)

G. Note: Specialists also attend various outside courses depending on need and funding restrictions.

13. What steps are being taken to reduce the time between the completion of an examination cycle and the first meaningful contact with the Appeals staff? Taxpayers perceive that the interval is growing longer. Is this perception accurate'

A. Because of hiring freezes, rightsizing, and heavy workloads, the interval of time may be increasing in some offices. In order to improve customer service, the Region is taking the following steps:

B. On September 9, 1996, the Regional Compliance Office issued a complete revision to RC-SE Memorandum 44-33 which establishes clear time lines for processing cases at the conclusion of an examination. Times were established in which the field groups in the Region are expected to close the cases to Appeals.

C. To improve quality, the RC-SE Memorandum emphasizes steps to be taken by examiners when new information is submitted with protests or if there is a need for a rebuttal to the protest. This type of additional action generally increases the time required to get cases to Appeals. However, the benefits of perfecting files warrant the increased time.

D. Compliance and Appeals are involved in cross-functional studies in the North Florida and Georgia Districts to identify ways to shorten the period of time between the request for an Appeals conference and the time the conference is held. Results of the studies will be shared with other offices.

E. Using process analysis techniques, Compliance and Appeals are analyzing current procedures in both offices to identify improvement opportunities which should shorten the time required to move cases to Appeals and to hold the first conference.

F. Local Appeals offices are establishing goals to improve on the time required to hold initial conferences.

14. Please comment on the propriety of an issue that was won by the taxpayer in a prior cycle being raised in the next cycle by the Examination team (assuming no significant change in facts). Will these situations become less prevalent as field agents become more familiar with the expansion of Examination settlement authority?

A. Our response to this question would depend on the definition of "won." Sometimes issues are traded by Appeals and certain concessions are made without independent consideration of the issue at hand.

B. Delegation Order 236 was issued giving case managers limited settlement authority with respect to certain rollover and recurring issues. No settlement can be reached unless, among other restrictions, the underlying issue was settled on its merits independently of other issues. Many CEP issues are unable to meet this strict definition, so Examination will need to raise the same issue in the subsequent cycle. Appeals is responsible for identifying issues that are conducive to DO 236 resolution.

16. TEI member continue to be concerned about the increased breadth and scope of proposed audit adjustments related to the capitalization of expenses that had previously been deducted by the taxpayer (without challenge). Please comment on the training of and discussions with field personnel concerning the expansive application of Indopco to areas in which a question has not been raised.

A. The Indopco decision is not a new body of law. Instead, it only reinforced existing expense v. capitalization law.

B. The determination of whether an expenditure should be capitalized is a very fact intensive issue. Different factual situations may have different tax consequences. Developing generalized guidance interpreting this legal standard is not an easy matter. The IRS has been in the process of providing guidance in this area. Some examples include:

* Rev. Rul. 92-80-advertising expenses

* Rev. Rul. 94-12-incidental repair costs

* Rev. Rul. 94-77-severance pay

* Rev. Rul. 94-38-land redemption

* Rev. Rul. 95-34-demand-side management costs

C. Notice 96-7 requesting comments on the need for further capitalization guidance was issued in an effort to be responsive to your continued concern for misapplication of the Indopco decision. Comments, which included those from TEI, are under consideration by the National Office.