Tax Executives Institute - LMSB liaison meeting minutes: February 9, 2005.

On February 9, 2005, Tax Executives Institute met with Deborah M. Nolan, Commissioner of the IRS's Large and Mid-Size Business Division, and other representatives of LMSB. TEI President Judith P. Zelisko led the Institute's delegation to the meeting. The agenda for the meeting was published in the January-February 2005 issue of The Tax Executive. These minutes were prepared by Tax Executives Institute and, although reviewed by LMSB, they have not been formally approved by the agency.

On behalf of the Large and Mid-Size Business (LMSB) Division of the Internal Revenue Service, Commissioner Deborah M. Nolan welcomed TEI President Judith P. Zelisko and the other members of the delegation from Tax Executives Institute to the liaison meeting. LMSB's and TEI's delegations to the liaison meeting are set forth below.

1. Opening Comments

Ms. Zelisko expressed her appreciation to LMSB Commissioner Nolan and other LMSB officials for meeting with TEI. Ms. Nolan expressed regret at missing the meeting with IRS Commissioner Mark Everson the previous day, adding that she had a prior commitment to film Tax Talk Today on the Schedule M-3. She suggested leaving some time available at the end of the meeting for follow-up items from the meeting with the Commissioner.

Ms. Nolan announced that Kurt Meier, formerly LMSB Senior Industry Adviser for Retail, Food, Pharmaceuticals, and Healthcare (and a former member of TEI), has been named a Director of Field Operations for that industry group. She referred to LMSB's new organizational chart, a copy of which is attached to these minutes.

She concluded that LMSB appreciates its open dialogue with TEI.

2. Currency

a. Effect on Appeals. Ms. Zelisko conveyed TEI's ongoing support for LMSB's efforts to reduce audit cycle time, thereby improving audits and permitting an expansion of audit coverage. Mr. Bernard referred to several recent currency initiatives--such as Limited Issue Focused Examination (LIFE), Pre-Filing Agreements, Fast Track Mediation and Settlement, and others--adding that taxpayers are generally pleased with the processes. He noted, however, that anecdotal evidence suggests that the push to become current at the Examination level may in some cases be impairing the resolution of issues at the lowest level as more issues are "punted" to Appeals. Such a result has the potential of overwhelming the Appeals process and prolonging the overall closure of cases. He acknowledged that in discussions with the Commissioner the previous day, Mr. Ungar stated that the IRS's statistics do not show an increase in issues going to Appeals, but suggested that Taxpayers may just be reaching an end to their audit cycles and any trend may not yet be visible. Mr. Bernard emphasized that taxpayers and the IRS benefit if issues are resolved at the Examination level.

Ms. Nolan responded that the division is also concerned about unresolved issues at the Examination level and has been tracking their resolution. She noted that there are currently 239 Coordinated Industry Cases (CIC) and 521 Industry Cases (IC) using the LIFE process. She provided the following information concerning the recent agreed rates:

                 2002   2003   2004

Overall Agreed
Rates            63.1   61.4   62.2

CIC Agreed
Rates            57.9   63.9   63.3

Overall unagreed rates for the same time period are 17.3, 16.2, 15.3, she explained.

Ms. Nolan said that because of initiatives such as LIFE--which looks at the materiality of issues--the complexity of issues going to Appeals has increased. The IRS is looking at the performance metrics for its examining agents and may revise the standards to take into account the entire time it takes to resolve a case, including time spent in Appeals. LMSB wants to look at the cycle time from the taxpayer's perspective, she concluded.

Ms. Zelisko asked whether Team Managers will continue to have the flexibility to resolve issues. Ms. Nolan said that LMSB Team Managers are generally experienced and demonstrate good judgment in resolving issues, including the use of Fast Track procedures. She added that a recent report from the Office of the Treasury Inspector General for Tax Administration was critical of the LIFE process, questioning whether agents are walking away from issues. Ms. Nolan stated that LIFE cases tend to have a higher percentage of no-change cases. She added that there is a higher percentage of tax shelter issues in respect of non-LIFE cases.

b. Compliance Assurance Process. Ms. Jordan referred to LMSB's new Compliance Assurance Process (CAP), which employs real-time issue resolution to improve overall compliance and to enhance customer service. Noting that 18 taxpayers have volunteered to participate in the program, she requested an update on the progress of the new initiative.

Mr. Ungar said the program is in its early stages, but is going well. LMSB will hold classes for Territory and Team Managers this month, and an implementation plan for participants in the pilot program is being drafted. The goal is to obtain signed Memoranda of Understanding from participants by April 1, 2005. LMSB expects that there will be peaks of concentrated activity around specific events and filing dates, and will not be able to test its ability to handle the peaks until next year. The lessons learned this year will enable LMSB to determine how broadly to expand the program. The agency is committed to making the initiative work, he said, but the quality of examinations cannot be compromised.

Mr. Ungar concluded that there are three types of resolutions available in the CAP program: (i) acceptance of the taxpayer's return as filed; (ii) a partial acceptance of the return with a continued review of unresolved issues past the filing date; or (iii) a determination to examine the taxpayer's return in the normal course of an audit. Mr. McCormally stated that TEI has established a private forum on its website for members involved in the CAP program to permit them to exchange ideas and information.

Ms. Nolan explained that LMSB is considering how to examine the transition years of taxpayers participating in CAP. She added that the program essentially requires audits of different cycles at the same time. The assumption is that once completed, CAP will become a continuous process. Mr. Ungar noted that the program is currently resource intensive, but taxpayers should reap benefits from the process in later years.

Ms. Nolan remarked that the process highlights the need to focus on and eliminate gaps in the examination process because speed is emphasized, for example, there is recognition that the IRS cannot wait on the specialist's schedule to resolve issues. Counsel has been designated for each CAP audit, she said, to assist in resolving legal issues. She added that LMSB appreciates TEI's feedback on the process.

When issues are left unresolved, Ms. Jordan asked, do the IRS and taxpayer continue with the audit or must the taxpayer seek help from Appeals? Ms. Nolan explained that the examination continues after the return is filed, but Appeals may be asked to resolve issues under the Fast Track procedure. Ms. Petronchak noted that LMSB has established an Appeals Advisory Board, which will monitor developments at Appeals to determine whether issues have been fully developed.

c. Appeals. Mr. McDonough referred to the 2004 Annual Report to Congress recently issued by National Taxpayer Advocate Nina Olson, which raises several key questions about the continuing independence of Appeals. Mr. Boyle added that Commissioner Everson disagreed with the report's conclusion and said no changes are contemplated in light of the report.

Ms. Nolan explained that in taxpayer-specific cases, the independence of Appeals is key to a perception of fairness in resolving issues. It was for that reason that the ex parte communications between Examination and Appeals is prohibited. In respect of a broad compliance strategy, it is important for LMSB to use the Appeals settlement guidelines in proposing resolutions. Appeals' advice on the hazards of litigating a particular issue is sought to permit the Examination teams to resolve issues expeditiously and consistently, she concluded, adding the Appeals' involvement in these strategies will not compromise its independence to resolve individual cases.

3. Tax Administration

a. Schedule M-3. Mr. Traubenberg commended the IRS for its collaborative approach in developing the new Schedule M-3. He noted that to permit taxpayers time to comply with the new requirements, the filing of columns (a) and (d) of Parts II and III are optional for the first year. Although taxpayers appreciate the extra time, he said, the burden of providing this information in the future may well outweigh its benefit. He urged the IRS to extend the optional period for at least one year to permit the first year's information to be analyzed to determine whether the information in columns (a) and (d) of Parts II and III is really necessary. Ms. Twinem emphasized that producing the data required in these two columns is the most burdensome aspect of the new schedule, requiring taxpayers to map their systems to two different destinations--a difficult IT process.

Ms. Nolan acknowledged TEI's assistance in developing the Schedule M-3, noting that it was TEI's comments that caused the IRS to offer the one-year delay in filing the information in columns (a) and (d). The IRS has asked its research branch to determine how this information will be used for risk assessment of a particular return. Our plan now is to stay the course in terms of what will be required next year, she said, but additional discussions will be held about the need for the data. The information will be used to determine which returns will be audited, she concluded.

b. Efiling Mandate. Ms. Zelisko referred to the recent temporary and proposed regulations mandating the electronic filing of large corporate tax returns for taxable years ending on or after December 31, 2005, stating that TEI has significant concerns about the mandate. The regulations presume a level of uniformity and technological sophistication that does not exist, on the part of taxpayers and perhaps also the IRS, she said. Even large companies with internal resources will have difficulty complying with the mandate, she explained, adding that her company's systems are not now on an XML platform--a system that would have to be created to comply with the mandate. She also raised concerns about the ability of the IRS's systems to accept a large volume of data being filed at the same time. Mandatory e-filing cannot help but exacerbate the burdens to corporate information reporting systems posed by the American Jobs Creation Act of 2004, the continuing demands of the Sarbanes-Oxley Act, and other resource-draining mandates, she said.

Mr. Hedgpeth explained that the IRS has been building the systems required to support electronic filing for four years. The issues raised in TEI's agenda have all been considered, he said. The IRS believes that taxpayers will only file electronically if the IRS mandates it. Software vendors have told the IRS that they can be ready, he stated, adding that the IRS recognizes there are some issues remaining to be resolved, but the agency believes the time frame is do-able.

Ms. Nolan remarked that the efiling initiative presents a chicken-and-egg scenario; vendors will not change their software packages unless the IRS makes electronic filing mandatory. She said the required data will be used to perform more efficient risk assessments of returns.

Ms. Zelisko inquired about the possible waiver of penalties for taxpayers that attempt to file but are unable to do so because of system or software failures. Ms. Nolan suggested the issue is premature, explaining that the public hearing to be held the next week will help identify gaps that need to be addressed. She noted, however, that elections that are required to be made on a timely filed return will not be considered timely if the taxpayer does not file electronically. She acknowledged that guidance is needed concerning what form of hardship waivers will be granted, noting that the agency cannot judge the merit of potential waivers until it understands what the barriers to electronically filing may be.

Mr. Ungar commented that the IRS would have no leverage to require efiling unless there were penalties applicable for the failure to file. He noted, however, that the IRS is concerned with deliberate failures, not inadvertent ones.

Ms. Zelisko emphasized that the software systems must be in place by the end of the year. Mr. Hedgpeth stated that the vendors will test their packages before year-end. The IRS believes that the time table is reasonable, he reiterated.

Mr. Bernard asked about a taxpayer's remedy if the vendor his company uses is not ready to efile. Three months is insufficient time in which to acquire and test new software, he said. Referring to the Schedule M-3, Mr. McCormally suggested that the IRS should have begun meeting with taxpayers at least six months ago. Mr. Traubenberg suggested that it is an error to believe the vendors will produce flawless products (and to hold the taxpayer accountable if they do not). He also noted that many fillings--such as agreements relating to mergers and acquisitions--are not technically part of the return but must be included in a taxpayer's filing. Are these documents required to be filed electronically? he asked. Mr. Boyle suggested that the benefit to taxpayers should be identified and publicized.

Ms. Nolan explained that efiling is necessary to decrease the amount of time it takes for the field to have access to a return. The lag time will be reduced from 14-22 months to 32 days, she said. We also expect the process to reduce cycle time, she added.

Ms. Nolan concluded that the technical issues will be discussed during the meeting immediately following the liaison meeting.

c. Circular 230. Mr. McDonough referred to the final and proposed regulations issued in December relating to Circular 230, which governs the practice of attorneys, certified public accountants, enrolled agents, enrolled actuaries, tax return preparers, and other persons representing clients before the IRS. The rules are primarily aimed at practitioners, he stated, expressing concern that their effect on the ability of in-house tax professionals to efficiently provide high-quality tax advice is unclear. In-house professionals may unknowingly run afoul of the rules, he said.

Ms. Gray stated that the intent of the regulations is not to create traps for the unwary. She invited comments on areas where the new rules create problems, adding that the rules technically cover in-house professionals. Section 10.35--which provides rules for issuing "covered opinions"--is not aimed at in-house professionals, she explained, although she acknowledged that the work of in-house tax executives could fall within its purview. Section 10.37--dealing with the requirements for "other written advice"--may be more relevant because it speaks to the scope of the engagement. The IRS wants to be fair-handed, she concluded.

Mr. McDonough noted that the new regulations provide more latitude to the IRS Office of Professional Responsibility. Ms. Petronchak said that the IRS is willing to consider revising the rules to address specific situations.

d. Enforcement Efforts. Mr. Penney referred to a January 25, 2005, speech at the University of Southern California Tax Institute, in which IRS Chief Counsel Donald L. Korb discussed the IRS's use of the economic substance doctrine in litigation. The speech came on the heels of IRS losses in Black & Decker, Coltec, and Castle Habour. Mr. Penney asked whether the cases had led the IRS to consider issuing any formal guidance in this area, adding that the issue was discussed with Commissioner Everson the previous day.

Ms. Nolan explained that the IRS does not litigate only cases in which a win is assured. Mr. LaBelle noted that Mr. Korb's speech was intended to provide policy guidance to the field. In the Coltec and Castle Harbour cases, he added, the courts referred to the lack of congressional action as one of the bases for their decisions. The IRS believes that both courts are wrong in their analysis. The Office of Chief Counsel has advised its attorneys to exercise more caution in applying the doctrine to facts that do not fall within its boundaries, he added.

e. Interface with SEC and FASB. Mr. Traubenberg explained that, in light of recent actions by the Financial Accounting Standards Board, the Securities and Exchange Commission, and the Public Company Accounting Oversight Board, TEI has established a financial accounting task force. He noted that the IRS has been meeting with the SEC to discuss ways in which recent corporate governance changes can be used to make audits more efficient.

Ms. Nolan explained that representatives of the SEC have met with Commissioner Everson to discuss initiatives relating to CAP and tax shelters, as well as the Sarbanes-Oxley Act. The meetings have been more in the form of relationship building, she said. Ms. Nolan stated that the data the IRS currently has--which is often four years old--have not been very helpful. As we become more current, she said, we will likely share more information with the SEC.

Ms. Nolan also noted that Donald Thomas of the FASB staff had asked the IRS to provide feedback on proposed changes to FAS 109, Accounting for Income Taxes. Their discussions focused primarily on the subjective nature of the tax law, she added. Ms. Petronchak and IRS Senior Industry Adviser Robert D. Adams have been designated to work with the FASB staff.

Mr. Traubenberg noted that the FASB staff has a learning curve to overcome in understanding the complexity of the tax law and how that complexity affects the reserving process. The law is not black and white, he said, and taxpayers have difficulty with the proposed standard (which requires a finding concerning what the tax treatment of an item "should" be).

f. De Minimis Fringe Benefits--Private Letter Ruling 200437030. Mr. Traubenberg referred to Private Letter Ruling 200437030, relating to the treatment of a coupon (for an item such as a ham or a turkey) as a cash equivalent fringe benefit. TEI disagrees with the conclusion that any type of gift certificate is a cash-equivalent fringe benefit, he said.

Mr. LaBelle noted that the ruling considered the administrative practicability of accounting for the item in a single case. It was not meant to provide broad-based guidance and such guidance is not on the business plan, he stated.

4. 2004 Tax Act Guidance

a. Commendation. Mr. Boyle expressed the Institute's appreciation for the IRS and Treasury Department's outreach in respect of guidance under the American Jobs Creation Act of 2004. In particular, TEI appreciates the efforts made to draw the Institute and its members into the process, he said.

b. Tax Shelters. Mr. Boyle referred to new section 6662A, which carves out certain reportable transactions and creates a stricter accuracy-related penalty. The statute requires the taxpayer to establish that it reasonably believed its treatment of the item was more likely than not the proper treatment. To meet this reasonable belief standard, a taxpayer may not rely on a disqualified opinion or the opinion of a disqualified tax adviser. If a taxpayer filed a return prior to the Act's effective date and relied on an opinion of an adviser who later became disqualified by operation of the new rules, he asked, must the taxpayer obtain another opinion from a different adviser?

Ms. Petronchak stated that the IRS will review the penalty assertion on a case-by-case basis. LMSB will work with the Office of Chief Counsel concerning the needed guidance, reviewing the steps taken by taxpayers to comply. Mr. LaBelle noted that additional guidance is in the works.

S. Status Reports

a. Executive Audits. Ms. Norton referred to guidance issued last year to the field concerning the inspection of tax returns of corporate officers and key executives. The August 23, 2004, memorandum states that the team should "requisition the returns of corporate officer/key executives using the ERCS/AIMS system during the planning stage of the examination." She noted that there is still some confusion in the field concerning the role of the tax department in obtaining a copy of the executive returns.

Ms. Nolan asked TEI to keep her advised if audit teams continue to approach the tax department for a copy of executive returns.

b. Withholding on Stock Options. Ms. Twinem referred to a March 14, 2003, Field Directive in which IRS examiners were instructed, solely for penalty purposes, not to challenge the timeliness of employment and withholding tax deposits exceeding $100,000 that arise from the exercise of the stock options, as long as the deposits are made within one day of the settlement date of the option. She asked whether further guidance is contemplated.

Mr. LaBelle noted that the issue is not on the business plan. He suggested that TEI keep the IRS informed if serious problems arise in this area.

c. Tax Accrual Workpapers. Mr. Bernard requested an update concerning agents' requests for tax accrual workpapers. Ms. Nolan emphasized that the IRS continues to stress that requests should only be made in certain well-defined circumstances. Ms. Petronchak added that there have been only 22 requests made for the workpapers, all but one of which involved listed transactions. The increase in the number of disclosure forms filed may increase the number of requests, she stated, noting that the number of protective disclosures has also increased.

d. Cost-Sharing Regulations. Ms. Norton requested a report on the status of the cost-sharing regulations. Mr. Hedgpeth confirmed that the cost-sharing regulations will be issued before the section 482 services regulations.

e. Advance Pricing Agreements. Mr. Maggin asked whether the IRS has identified any potential changes to the Advance Pricing Agreement program, in light of the hearings scheduled for February. Mr. Hedgpeth said that the review of the program is continuing; the hearings have been helpful in identifying ways in which the process can be simplified.

6. Conclusion

Ms. Zelisko thanked Ms. Nolan and the LMSB representatives for their participation in the meeting. Ms. Nolan thanked TEI for its preparation for the meeting.

IRS Delegation

Deborah M. Nolan, LMSB Commissioner

Peter J. LaBelle, LMSB Acting Division Counsel

Bruce B. Ungar, LMSB Deputy Commissioner

Elvin T. Hedgpeth, Deputy Director, International

Kathy K. Petronchak, Director, Pre-Filing and Technical Guidance

Andrew Zuckerman, Assistant to the Director, Pre-Filing and Technical Guidance

Carolyn Gray, Office of Professional Responsibility

Kevin Murray, Liaison Program Manager, National Public Liaison

Christopher Johnson, Director, LMSB Communications & Liaison

Matthew Beaulieu, Manager, LMSB Legislative Affairs and Liaison

Marlene Crooks, Office of LMSB Communications & Liaison

TEI Delegation

Judith P. Zelisko, Brunswick Corporation, TEI President

Michael P. Boyle, Microsoft Corporation, TEI Senior Vice President

David L. Bernard, Kimberly-Clark Corporation, TEI Secretary

Robert J. McDonough, Potoroid Corporation, TEI Treasurer

Lynn B. Jordan, Susquehanna Pfaltzgraff Co., TEI Executive Committee

Bruce Maggin, IBM Corporation, TEI Executive Committee

Lisa Norton, Amazon.com, Inc., TEI Executive Committee

David M. Penney, General Motors of Canada Limited, TEI Executive Committee

Carita R. Twinem, Briggs & Stratton Corporation, TEI Executive Committee

Neil D. Traubenberg, Storage Technology Corporation, Chair, TEI Federal Tax Committee

Timothy J. McCormally, TEI Executive Director

Mary L. Fahey, TEI General Counsel

Gregory S. Matson, TEI Tax Counsel

Jeffery P. Rasmussen, TEI Tax Counsel