Tax Executives Institute - Internal Revenue Service large and mid-size business division liaison meeting: February 7, 2006.

On February 7, 2006, Tax Executives Institute met with Deborah Nolan, Commissioner of the IRS's Large and Mid-Size Business Division, and other repreesntatives of LMSB. TEI President Michael P. Boyle led the Institute's delegation to the meeting. The agenda for the meeting is reprinted below. Minutes of the meeting will be published in a future issue of The Tax Executive.

I. Introductions

U. Transparency-Related Initiatives

A. Schedule M-3.

1. Based on a review of the Forms 8886, Reportable Transaction Disclosure Statement, and Schedules M-3 received during the 2005 filing season, the IRS and Treasury Department recently issued Notice 2006-6, which provides that the book-tax difference category of reportable transactions under Treas. Reg. [section] 1.6011-4 is no longer necessary. As a result, taxpayers who complete Schedule M-3 and adequately disclose their financial and tax accounting reporting differences are no longer required to file Form 8886 and separately report significant book-tax differences. The Notice is effective for transactions occurring on or after January 6, 2006. The IRS and Treasury Department anticipate issuing temporary and proposed regulations under [section] 1.6011-4 to remove from the categories of reportable transactions under [section] 1.6011-4(b)(1) the category of transactions with a significant booktax difference currently set forth in [section] 1.6011-4(b)(6).

TEI commends the IRS and Treasury Department for concluding that the Schedule M-3 supplies substantially all the information that IRS agents require in order to examine significant book-tax accounting differences. Elimination of the duplicative reporting burden of Form 8886 was one of the promised benefits of implementing Schedule M-3. We recommend that the IRS and Treasury consider making the effective date of the coming regulations under Treas. Reg. [section] 1.6011-4 (or a second Notice) be for transactions occurring after December 31, 2005 (or, for taxpayers with 52-53 week fiscal periods, the end of the taxpayer's applicable fiscal period). As long as a taxpayer's tax period and return encompasses the effective date of the change, significant book-tax differences preceding the effective date will be disclosed on the taxpayer's return and Schedule M-3 even without the Form 8886. (1) Hence, the filing of Forms 8886 for significant book-tax difference transactions occurring in the five-day stub period will be redundant and imposes an unnecessary burden on taxpayers to identify and report the items. Indeed, the requirement to file Form 8886 could be eliminated retroactively for all book-tax difference transactions as long as the taxpayer's return includes a Schedule M-3 reporting all significant book-tax differences for the entire taxable period.

2. Beyond the M-3.

Does LMSB believe that the current tools designed to curb tax shelters are working or should be given additional time to work before additional changes are imposed by legislation or regulatory action? We invite a discussion of whether other regulatory initiatives are under consideration to enhance disclosures, curb tax shelter activities, or promote settlement of outstanding disputes. For example, is the IRS or Treasury considering additional tax return disclosures or general reconciliation schedules in addition to schedule M-3 for corporations (1120-C,-S,-PC, or -L) or partnerships (1065)?

3. Sarbanes-Oxley Documentation.

Section 404 of the Sarbanes-Oxley Act of 2002 requires companies to document and support the tax benefits that are reflected in their financial statements.

LMSB has indicated that the increased accountability for tax positions on financial statements will assist in the IRS's efforts to focus on high-risk issues and areas of noncompliance. For example, LMSB Commissioner Nolan recently stated that the division was studying the implications of increased corporate governance under the Act and the effect of accounting changes put in place by the Financial Accounting Standards Board. See Alison Bennett, LMSB Compliance Efforts to Be Focused on High-Risk Deals in 2006, Nolan Says, 2006-04 Daily Tax Report, G-1 (Jan. 6, 2006).

During the liaison meeting, we ask for a status report on whether LMSB anticipates issuing standard information document requests to the field to request taxpayer's documentation prepared for purposes of complying with the Sarbanes-Oxley Act.

B. Circular 230

1. Commendation.

On May 18, 2005, the IRS and Treasury Department released final regulations governing practice before the IRS. The revisions clarify that in-house tax practitioners are to be treated as a distinct category of tax professionals for purposes of Circular 230 and that written advice provided by in-house counsel to the employer for purposes of determining the employer's tax liability is excluded from the definition of a covered opinion under section 10.35 of Circular 230.

TEI commends the IRS and Treasury Department for recognizing that the application of section 10.35 to in-house tax practitioners would have raised numerous issues and might have impaired the provision of sound and timely tax advice to the practitioner's employer. We agree that written advice provided by in-house counsel should be excluded from the definition of a covered opinion under section 10.35 and that the other provisions of Circular 230, especially section 10.37, adequately address the professional responsibility of in-house counsel when providing advice to the employer.

2. Clarification of Definition of Employer for Purposes of Section 10.35.

Circular 230 omits an express definition of the term "employer." Government representatives have explained that no definition of "employer" is provided in order not to unduly limit the scope of the in-house carve-out. In other words, the government's thinking is that for purposes of Circular 230 "employer" is to be construed broadly to include entities beyond the employee's W-2 employer and even beyond the affiliated group of corporations of which the employee's W-2 employer is a part.

This approach is wholly sensible since company tax department employees often render tax advice and compliance services for many entities beyond their immediate W-2 "employer." Hence, TEI previously recommended that the IRS and Treasury confirm in future guidance that the term employer (i) is to be construed broadly and (ii) encompasses all members of the controlled group of corporations (as defined in section 267(f)(1)(A) without the exclusion of section 267(f)(1)(B)) as well as other controlled entities (e.g., partnerships, which do not pay taxes per se, and controlled foreign and domestic corporations that are owned by any member of the controlled group) for which the in-house counsel is expected to provide tax advice within the scope of his or her employer/employee relationship. The scope of the term employer should also extend to the "employer's" VEBA, charitable foundation, pension or profit sharing plans (as well as other deferred compensation trusts, such as rabbi trusts, established by the employer), and include advising a foreign parent corporation on any U.S. tax obligations or filing requirements.

We ask for a status report on TEI's recommended clarification of the scope of the term "employer" as well as the timing of, and prospects for, additional changes to the Circular 230 regulations.

C. Information Sharing.

During last year's liaison meeting, LMSB reported that IRS officials had met with the Securities and Exchange Commission to discuss initiatives relating to the Compliance Assurance Process (CAP) and tax shelters, as well as the Sarbanes-Oxley Act. As LMSB audits became more current, it was anticipated that the two agencies would share more information. During the liaison meeting, we would appreciate a report on the potential for information sharing between the two agencies.

D. T.D. 9229: Time for Filing Partnership Returns.

In November, the IRS and Treasury Department issued final and temporary regulations providing a simplified procedure for automatically obtaining extensions of time to file certain returns. The regulations permit taxpayers to file a single request to obtain a six-month extension of time in which to file a return. The automatic procedure applies to individuals, partnerships, real estate mortgage investment conduits, and certain trusts. (2) Prior to issuance of the regulations, partnerships were able to obtain an automatic three-month extension of time in which to file the Form 1065; a second three-month extension was available upon request.

TEI commends the IRS and Treasury Department for attempting to simplify the process for obtaining an extension of time. We are, however, concerned about the new rules' potential effect on partners' compliance obligations. Specifically, affording pass-through entities an automatic six-month extension of time may add to the delays in receiving the information necessary for companies to prepare their Forms 1120. In addition, as the preamble to the regulations notes, "the availability of a six-month extension of time to file for pass-through entities may result in taxpayers filing an increased number of amended income tax returns." Companies often file consolidated returns that cover hundreds of subsidiaries and other entities. Partnership returns may cover items--such as contributions, capital gains and losses, and foreign tax credits--that roll up to the corporate return. Perhaps even more important, the partnership return may contain a reportable or listed transaction, the disclosure of which must be filed with the partner's original return to protect the partner from failure-to-disclose penalties.

Finally, we understand that there is a concern that the six-month extension might impair one of the IRS's goals in developing the Schedule M-3. The schedule requires taxpayers to identify each partnership investment and distributive share of partnership income and loss. If corporate partners do not receive their Schedule K-1s in time to include their actual distributive share on the 1120 Schedule M-3, the utility of the form as an audit issue selection (or de-selection) tool may be undermined.

We invite a discussion of the regulations and their effect on large corporate taxpayers' compliance obligations.

III. Currency initiatives

A. Compliance Assurance Process.

One of LMSB's goals is to accelerate the audit process. Last year, LMSB launched the Compliance Assurance Process (CAP), which employs real-time issue resolution to improve overall compliance and to enhance customer service. CAP's overall objectives are to: (i) work with the taxpayer to achieve federal tax compliance; (ii) resolve all or most issues prior to the filing of a tax return; (iii) reach an acceptable level of assurance regarding the accuracy and correctness of filed tax returns; and (iv) eliminate or substantially reduce the need for a post-filing examination.

TEI is pleased that a number of its members volunteered to participate in the CAP program. During the liaison meeting, we invite LMSB to provide an update on the progress of the new initiative. What lessons have been learned from the first year's experience? What would LMSB do differently? (The January-February 2006 issue of THE TAX EXECUTIVE includes an article on CAP for TEI's membership.)

The Institute understands that LMSB has met with certain taxpayers concerning their potential involvement in the 2006 program. Will the program be expanded? What changes, if any, to the process are anticipated?

Finally, during the liaison meeting, TEI requests a status report on the involvement of the Office of Chief Counsel in the CAP process. Have processes been implemented to ensure that advice sought from Counsel is received in a timely fashion?

B. Update on Other Currency Initiatives.

Approximately two years ago, TEI and LMSB launched the Joint Audit Planning Process, which compiles the "best practices" for conducting an audit and includes a planning and monitoring tool that lists the steps a taxpayer and audit team can take to enhance the quality and timeliness of tax examinations. A key to the initiative is the delineation of both the individual and the joint responsibilities of all participants--the taxpayer, team manager, audit team, specialists, and Counsel--thereby directing time and resources to the most important areas.

Several other innovative procedures--such as Limited Issue Focused Examination (LIFE), Pre-Filing Agreements, Fast Track Mediation and Settlement, Accelerated Issue Resolution, Advance Pricing Agreements, and Early Referral to Appeals--have sought to improve the examination process and promote currency. LIFE in particular--with its focus on the resolution of material issues--holds great promise in reducing disputes and decreasing cycle time. These procedures all share a common denominator--a collaborative effort to resolve issues at the lowest level.

During last year's liaison meeting, TEI noted that taxpayers are generally pleased with the processes, but suggested that the drive to become current at the Examination level may in some cases be pushing more cases to Appeals. The IRS's statistics did not, however, show an increase in the number of issues going to Appeals. During this year's meeting, we request an update on whether any pattern has emerged concerning the number of un-agreed issues going to Appeals.

C. Potential for Other Initiatives.

For almost a decade, LMSB has shown a commendable interest in seeking out new ways in which to resolve issues as quickly and efficiently as possible. During the liaison meeting, we request an update on whether and what other new initiatives are under consideration.

IV. Office of Appeals

A. Announcement 2005-80.

In comments filed on January 17, 2006, TEI expressed concern about the effect of Announcement 2005-80 on the independence of Appeals. (The announcement sets out concession terms for 21 transactions for which the IRS has determined the accuracy-related penalty to be applicable.) What specific steps are being taken to address TEI's concerns and to reaffirm the independence of Appeals?

B. RAPID Appeals Process.

Last summer, several TEI members participated in an LMSB program in Dallas in which a proposal for a new RAPID Appeals process was discussed. The new process was intended to incorporate some of the Fast-Track Settlement processes to reduce cycle time, provide better taxpayer service, and enhance enforcement. Among the processes to be included in RAPID Appeals were requirements that (i) Appeals accept only cases that were "fit for use," i.e., fully developed; (ii) one issue be resolved in one conference; and (iii) Examination be involved in all Appeals conferences.

The TEI members expressed concern about the process, noting that it might undermine the prohibition on ex parte communications between Examination and Appeals. Moreover, the concept of resolving one issue per conference may not be appropriate for complicated issues and had the potential for reducing the availability of requesting technical advice. Finally, the "fit for use" concept increased the likelihood of sending more cases back to Examination.

TEI understands that the IRS has determined not to implement the RAPID Appeals process as originally proposed. During the liaison meeting, we request an update on the status of the process and what portions of it, if any, may be implemented.

V. Mandated E-Filing

A. Prospect for Phased-In Implementation.

In January 2005, the IRS and Treasury Department issued temporary and proposed regulations mandating the electronic filing of large corporate tax returns for taxable years ending on or after December 31, 2005. TEI supports the goal of increasing the IRS's use of technology, including its ability to effectively process e-filed returns. Further, we agree that a properly designed and implemented e-filing process will advance key IRS objectives, namely, providing the IRS with accurate and timely return information, reducing audit cycle time, and achieving currency in those audits.

The organization has worked with the IRS to help make the e-filing mandate a reality. The Institute has met several times with the IRS, and our members and staff have participated in an IRS task group (styled the "IRS-TEI Forms and Attachments Task Group"). This group has held several day-long sessions and numerous conference calls to review every form and schedule a corporate taxpayer may file in an attempt to determine which forms could be filed in XML format and which could be filed in other formats (such as PDF files and on paper). Meetings have also been held with the major software vendors (CorpTax, InSource, and Vertex) in an effort to identify challenges and work toward acceptable solutions.

In spite of the tremendous efforts of IRS, taxpayers, and the software vendors, significant challenges remain--issues that may not be soluble by the time the returns are due to be filed later this year. One major challenge of the proposal is that to date, no software exists that would permit data from multiple programs to be aggregated in one XML file, as required by the regulations. This means that taxpayers using different programs are "on their own" in satisfying the mandate.

Another challenge relates to the availability of software from third-party vendors. Vendors are just now releasing prototypes of the new software that will be used to facilitate e-filing. Corporate taxpayers are understandably concerned about integrating the new programs into their existing data collection systems. Given the wholesale changes that have to be incorporated in the new software, a significant number of affected taxpayers will be pressed to install, test, and debug the software before their returns must be filed. Further, it is not clear what tools the vendors will provide to allow taxpayers to review data before actual submission.

Finally, it is unclear at this stage whether the IRS will have the capabilities--both human and technological--in place to effectively analyze the electronically transmitted tax return information. For example, taxpayers will still be required to file paper copies of the Form 8886 with the Office of Tax Shelter Analysis because that office cannot access the e-filed material.

TEI questions whether the software vendors, taxpayers, and even the IRS will be ready for e-filing the entire 2005 corporate income tax return. The Internal Revenue Service Advisory Committee recommended that the implementation of the mandate be deferred at least one year, but that suggestion has been rejected.

TEI reiterates its recommendation that the e-filing mandate be phased in over a period of filing seasons. Under a phased approach, those taxpayers prepared to e-file during this upcoming filing season will do so. For the overwhelming majority still confronting myriad challenges, phasing-in the mandate will facilitate the orderly internal migration and transformation of taxpayer data systems, processes, and procedures and at the same time enable the IRS to fully develop its internal capabilities to analyze the received data. In this way, both IRS and taxpayer objectives will be satisfied.

B. Status of Additional Guidance on Waivers.

On November 10, 2005, the IRS issued Notice 2005-88, relating to the procedures for requesting a waiver of the requirement to e-file a corporate income tax return. The notices sets forth the elements of a waiver request, but provides few details concerning what circumstances will warrant the grant of a waiver. The notice provides that the IRS will approve or deny requests for a waiver based on the taxpayer's specific "facts and circumstances," considering the taxpayer's efforts to timely file the return without incurring an undue economic hardship. Although the lack of details is generally disappointing, the notice does provide that "[m]indful of the software and technological issues in filing electronically, the Service will also generally grant waivers where technology issues prevent the taxpayer from filing the return electronically."

Has LMSB issued any guidelines concerning what "facts and circumstances" may qualify for a waiver?

Is additional guidance, perhaps in the area of mergers and acquisitions, planned?

C. Registration Process.

The IRS has said that corporate taxpayers wishing to electronically file their own tax returns should not use Form 8633 (Application to Participate in IRS E-File 7/03). Rather, taxpayers should follow the instructions set forth in IRS E-File for Large Taxpayers Filing Their Own Corporate Tax Returns (released August 31, 2005). Although we commend the IRS for eliminating many of the "suitability" checks for corporate tilers, there appears to be a great deal of confusion among taxpayers concerning the registration process for e-filing. What steps is LMSB taking to ensure that taxpayers understand the registration process? How can TEI help in reducing the level of confusion?

D. Data Warehousing.

As an offshoot of the e-filing process, two government officials recently discussed the prospects for a central "data warehouse" to store taxpayer information from IRS forms (such as the Forms 1098, 1099, and W-2) in a single repository that could be shared with other government agencies. See Dustin Stamper, IRS Progressing Toward Development of Data Clearinghouse, 2006 TNT 11-1 (Jan. 18, 2006). During the liaison meeting, we request a status report on this warehousing concept, including who is driving the initiative and what steps will be taken to assure compliance with section 6103.

VI. International Tax Issues

A. Advance Pricing Agreement Program.

Last February, the IRS held a hearing on the Advance Pricing Agreement Program (APA) at which TEI testified. In the wake of that hearing, the IRS issued new case management procedures that were designed to speed up the process and increase consistency. In December, the IRS issued Rev. Proc. 2006-9, which updated the procedures for obtaining an APA.

During the liaison meeting, we request an update on whether additional changes to the program are planned. We also request a status report on when the final report of the Senate Finance Committee on the program is expected to be released.

B. Cost Sharing Agreements.

TEI understands that cost sharing agreements (CSAs), particularly the buy-in payments associated with those agreements, represent a significant portion of the cases under review in Competent Authority. LMSB's Office of International Programs has been surveying these cases, seeking to identify commonality factors, with a view toward the issuance of Appeals guidelines for settling CSA cases. During the liaison meeting, we request a report on the status of these guidelines.

C. Globalization.

In September 2005, several TEI members participated in a meeting on globalization issues. The meeting focused on the business drivers of globalization and the strategies companies have developed in response. During the liaison meeting, we invite a status report on this initiative.

D. Cross-Licensing Agreements.

TEI understands that the IRS may be considering issuing a technical advice memorandum or private letter ruling addressing the tax consequences that flow from cross-license agreements (CLAs). A CLA is generally an exchange of covenants that affords each party to the agreement with a measure of "freedom to operate" in a particular area without fear of being sued. The longstanding and well-settled treatment of cross-licensing agreements is that they constitute a netting arrangement that does not result in the recognition of income to the extent the rights exchanged are of equal value. (See, e.g., Private Letter Ruling 7739073 (July 1, 1977)). During the liaison meeting, we invite a status report on whether the IRS is considering issuing additional guidance on CLAs and whether the IRS anticipates potentially modifying the longstanding treatment of CLAs.

VII. Conclusion