Tax Executives Institute -- IRS Midstates Region Annual Liaison Meeting Questions and Responses.

February 11, 2000

The following questions and answers are excerpted from materials prepared in connection with a liaison meeting held between representatives of TEI's Region V and Region VI with representatives of the IRS's Midstates Region. The Institute's delegation to the meeting was chaired by Gareth E. Glaser of the Fort Worth Chapter Vice President-Region VI, and James R. Burkle, Vice President-Region V, and included members from each chapter in the two regions. The IRS's delegation was chaired by Regional Commissioner Dale Hart. Note: A number of questions have been deleted or edited, either for space or because the discussion has been overtaken by events.

IRS Restructuring

1. The IRS is undergoing a significant restructuring of its organization. What is the status of the process?

During the meeting held on February 11, 2000, Paul Cordova, Director of Field Operations for Natural Resources Industry, presented an update of the new Large and Mid-Size Business Division. Susan Graham, Acting Regional Compliance Director (Corporate) presented an update on the Tax Exempt and Government Entities Division. Ronnie Desbrow, Acting Regional Director of Appeals (Large Case) presented an overview of the Appeals restructure.

2. After IRS restructuring how will the role of Chief Counsel change?

Regional Counsel Bill Hammack, Deputy Regional Counsel Gary Benford, and Assistant Regional Counsel (Tax Litigation) Mark O'Leary presented an update on the restructuring of Chief Counsel's office.

3. After IRS restructuring, will CEP taxpayers continue to be assigned a particular individual in the Problem Resolution Group? How will the success of this group be assured to continue?

We are still working this issue, but it is our plan to devote one Service Center to house and service the LMSB tax returns. Right now we are looking at the Brookhaven Service Center, but this may change.

Until we get this issue resolved, it is business as usual. The CEP or LMSB taxpayers will continue to work through the Case Manager assigned to the case who have the primary responsibility for resolving taxpayer problems.

The LMSB taxpayers will also continue to file and deal with the service centers currently assigned.

The Taxpayer Advocates (formerly Problem Resolution Group) currently located at each District Office will be a shared service between all operating divisions and they will continue to help LMSB taxpayers as the need arises.

4. We have heard that Case Managers may not be in the same geographical area as an audit team working on a case. Is this correct? If so, will the Case Managers be required to visit the team on a regular basis? How will the taxpayer have access to the Case Manager?

For the most part, the Case Managers will be located in the same geographical area as the audit team working the case, which is generally the way it is now. We do have a few case managers in the Midstates Region who cover two or more states, i.e., Arkansas-Oklahoma, Kansas-Missouri, and Midwest Districts.

The Territory Manager (similar position to the CEP Branch Chief or Examination Division Chief) may not be in the same geographical area as the case manager and audit team. However, we do not anticipate significant problems or delays in providing service to our customers. Providing excellent Customer Service to our taxpayers is one of our most important goals

5. What roles will e-mail and the Internet play in the new IRS?

Customer Service is currently using the e-mail system to answer some taxpayer questions. All of the CEP audit sites either have received or will be getting new computers and all agents; specialists and managers will have e- mail addresses. We see both e-mail and the Internet as tools which our agents can use in their audits as the need arises and should enable us to better service our customer and employee needs. The e-mail addresses will be made public eventually.

Policy

1. The new IRS Mission Statement, "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." How do the unreasonable positions taken by IRS audit teams (i.e., setting up the maximum possible tax adjustment as opposed to a more reasonable and defendable tax adjustment) comport with this mission statement? Arguably, this practice leads to difficult relations with taxpayers and serves to further the misconception that "IRS appeals gives everything away." Additionally, this practice leads to extended audits and costs to both the taxpayer and the IRS. Will this practice continue or will a more reasonable approach be found?

Over the last few years more and more of our CEP cases are closing agreed or partially agreed with fewer issues going forward to Appeals. This is primarily due to the Alternative Resolution Techniques we are now using, such as: Case Manager Settlement Authority (Delegation Orders 236 and 247), Early Referral to Appeals, Accelerated Issue Resolution, etc.) We are emphasizing resolving issues at the lowest level through these methods.

If there are specific instances where the IRS has taken an unreasonable position, we would appreciate knowing about it so that we could address it outside of this forum.

2. What efforts will be pursued to educate both appellate conferees and agents about (1) ex parte communications, and (2) field service advice? (There seems to be an inconsistency between the law and actual practice.)

(1) Pursuant to Notice 99-50, 1999-40 I.R.B. 444 (October 4, 1999), which released for public comment a proposed revenue procedure on the ex parte communication prohibition, the prohibition on ex parte communications between Appeals officers and other IRS employees that appear to compromise the independence of appeals officers will not take effect until the revenue procedure is issued in final form. In the interim, existing procedures relating to communications in the course of Appeals' consideration of disputes remain in effect. Since the final revenue procedure has not been issued, the ex parte communication prohibition is not currently in effect. Thus, there is no need for detailed training regarding this provision at this time.

Several comments were received in response to the Notice, including comments from TEI. Treasury and the IRS are in the process of carefully considering those comments. No decisions have been made to date concerning what, if any, changes will be made to the proposed revenue procedure when it is issued in final form. Hence, it would be inappropriate for the IRS to comment on, or engage in a dialogue concerning, any potential changes to the revenue procedure with a single interested group.

TEI can be assured, however, that the IRS intends to provide appropriate training to all affected employees once the revenue procedure is finalized and the ex parte communication prohibition goes into effect.

(2) At Chief Counsel's urging, most requests for Field Service Advice (FSA) are submitted by district counsel, even in nondocketed cases. In addition, the procedures for requesting Field Service advice are set forth in the CCDM and are fairly well known. Consequently, we do not perceive a need for training with respect to this matter.

The procedures and timing for the release of FSAs to the public are governed by section 6110(I) and the Tax Analysts case. Inasmuch as this task is primarily handled by the National Office, there is little need to train Appeals and Examination personnel, except perhaps familiarizing them with the basic requirements and limitations imposed by the statute. In Counsel, this topic was covered in the CLE this summer.

Counsel has discussed many times the difference between an FSA and a TAM. At least in some districts, local counsel has discussed this with the client as well. There are no plans for formal training on this topic with Exam or Appeals to the best of our knowledge.

3. Many tax professionals did not see INDOPCO as a change in the tax law but merely as a clarification of a longstanding tax law. Nevertheless, IRS examiners are raising more and more challenges and citing this case. Is there any review of this at National? Are there any new directives being put forth to capitalize expenses?

The National Office has been involved in the review of many capitalization v. deduction issues through the various guidance mechanisms, including the technical advice procedures and the revenue ruling process. Through these types of guidance, the National Office has affirmed that, while the INDOPCO decision clarifies that the creation or enhancement of a separate and distinct asset is not a prerequisite to capitalization, this decision does not change the fundamental legal principles for determining whether a particular expenditure may be deducted or capitalized. (Revenue Ruling 94-12, 1994-1 C.B. 36.) In fact, the National Office has issued several revenue rulings confirming that INDOPCO did not change the tax treatment of many items, including advertising costs (Revenue Ruling 92-80, 1992-2 C.B. 57), incidental repair costs (Revenue Ruling 94-12, 1994-1 C.B. 36), severance pay (Revenue Ruling 94-77, 1994-2 C.B. 19), and training costs (Revenue Ruling 96-62, 1996-1 C.B. 359). In addition, over the past few years, the National Office has issued additional guidance permitting deductions for certain other items, including demand-side management costs (Revenue Ruling 95-32, 1995-1 C.B. 8), environmental cleanup costs (Revenue Ruling 94-38, 1994-1 C.B. 35), the costs of removing and replacing certain underground waste storage tanks (Revenue Ruling 98-25, 1998-19 I.R.B. 4), and most recently, ISO 9000 costs (Revenue Ruling 2000-4, 2000-4 I.R.B. 1). We are not aware of any other directives being put forth to capitalize costs as a result of the INDOPCO decision.

4. Please discuss agent measurement/evaluation procedures. Specifically, will taxpayers be able to provide input into the evaluation of members of the audit team? Will taxpayers have input into the evaluation of all members, including specialists, or just the team coordinator? What weight will this input carry in the overall evaluation?

We have an evaluation system in place, which fairly evaluates the employees of Internal Revenue Service. The Customer Satisfaction surveys we send out on every CEP case when it closes are the proper place for taxpayers to address how well the agents and specialists performed their jobs. In fact, we have very favorable feedback on most of the team members. However, taxpayers are always welcome to contact the manager of the team members.

5. A recurring concern is disagreements between the specialist's manager and the case manager. Presumably the case manager has the ultimate authority. If this is true, is there a citation in the manual or elsewhere that confirms this authority? If not, will guidance be issued that clarifies this authority?

Citation: Case Manager Handbook, IRM 4.3.11 Chapters 13.2, 13.3, and 15.6

Although the Case Manager is primarily responsible for directing all activities necessary to examine and close a CEP case, the specialty manager shares in the responsibility of managing the activities of the specialist. (IRM 4.3.11 Chapter 13.2)

The specialty manager also participates with the case manager and the specialists in meetings with the taxpayer to discuss and resolve proposed issues, which are complex or have substantial tax or compliance impact. (IRM 4.3.11 Chapter 13.3)

If after a complete discussion of the matter the team member is still in disagreement with the case manager's decision, it must nevertheless be followed. (IRM 4.3.11 Chapter 15.6)

6. What are the major audit issues coming up currently on Large Case Audits? In which areas does the IRS believe corporate taxpayers are incorrectly interpreting the law or, alternatively, being excessively aggressive?

There are a number of issues that are currently being examined on our Large Case audits, for instance, COLI, IRC section 1341, research and developmental credits, IRC section 475 Mark to Market, trader vs. investor, etc.

Administrative

1. Has the practice of entering into records retention limitation agreements increased or decreased in the last year? Approximately how many have been requested and how many signed?

Our policy is to follow Revenue Procedure 98-25. Section 10 requires that taxpayers who request Record Retention Limitation Agreements (RRLAs) 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. Most Districts indicated that they had had no requests from taxpayers for RRLAs under the provisions of this Revenue Procedure last year.

Most Districts have rescinded old out-of-date agreements and notified the taxpayer that they are covered by the provisions of Revenue Procedure 98-25. A few Districts issued RRLAs and updated existing ones upon request. 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. Alternative RRLAs are considered when appropriate.

Overall, the number of RRLAs has decreased over the last year. We only maintain listings of current RRLAs, not the changes from year to year.

2. In the IRS's view, do TEI's continued efforts in jointly trying to establish records retention rules with which taxpayers can comply at a reasonable cost have any prospect of producing meaningful results? This question presupposes that taxpayer's cannot comply with current rules. Based on the IRS's responses on this issue at the last meeting, there is disagreement over whether that taxpayers can comply at reasonable cost. Would it be helpful to make efforts to establish, based on an investigation that is nonthreatening to the taxpayer, whether or not substantial compliance with existing rules has been accomplished by "any" taxpayers of significant size?

In a June 18, 1999, letter to IRS Chief Counsel Stuart Brown, TEI elevated several concerns about Revenue Procedure 98-25 (Record Retention Requirements for Automatic Data Processing Systems). Although both the National Office Computer Assisted Audit Program (CAAP) and TEI have expressed a willingness to meet to discuss and identify which areas of concern joint TEI/IRS work groups could address and produce meaningful results, no meeting has yet taken place.

We have also elevated TEI's concerns to the Commissioner and Deputy Commissioner of the new Large and Mid-Size Business (LMSB) Division.

3. Why are yearly penalty notices automatically issued for Forms 1099 mismatches even though the taxpayer has demonstrated in prior years that a procedure has been installed that supports abatement of the penalty and has resulted in a reduction of mismatches?

Code Sections 6721-6724 deal with the penalties and reasonable cause. An error rate of one-half of one percent is perfectly acceptable and the IRS abides by that tolerance. If there are more than 10 errors, however, the taxpayer is sent a penalty notice. We have elevated this issue to the Commissioner and Deputy Commissioner of the LMSB Division.

4. During the past 12 months how many early referrals to Appeals have been requested? Does the IRS view this program as successful?

For the past 12 months nationwide, we has 8 cases with a total of 13 issues that were referred to Appeals under the Early Referral process. The IRS does not view this program as successful as it could be, and we are encouraging both taxpayers and CEP management to consider this process as appropriate. The new LMSB Operating Division will continue to look for ways to improve customer service and reduce cycle time on our cases.

5. What is the current status of the interest netting claims that have already been filed? When can we expect the claims to be acted upon?

Through December 31, 1999, the Complex Interest Units received 474 cases with 4,137 tax periods. They received an additional 1,754 by January 6, 2000, and we are expecting more.

To date, more than one half of the cases worked have been associated with open TEFRA, Exam, or Appeals cases.

Technical

1. Rev. Rul. 99-40 sets forth reasonable rules for interest netting. What is the IRS policy regarding interest dates for deficiencies when an overpayment credited to the subsequent tax year is involved?

The IRS's policy on the May Department Stores issue is currently set forth in Revenue Ruling 99-40 and Chief Counsel Notice N (35) 000-168. Assuming that the question relates to the so-called "Sequa" situation. The IRS's policy on se qua is, as follows:

If it is determined that the reported overpayment, or a portion thereof, is not needed to avoid an addition to tax for failure to pay estimated tax (the credit elect or portion thereof that is not used against an estimated tax installment payment), then the credit elect overpayment is a payment of the succeeding year's income tax liability as of the due date of the succeeding year's return, determined without regard to extensions. If it is determined that the overpayment was a payment of the succeeding year's tax, then interest on the underpayment for the year that generated the credit elect (up to the amount of the credit elect) begins on the due date of the return for the succeeding year.

2. Realizing that the IRS will be focusing on the activity underlying expenditures that a taxpayer claims for R&D credit, what type of documentation will be adequate for the IRS in proving that the "discover," "Technological in Nature" "process of experimentation" and "business component' requirements are satisfied?

The research credit under I.R.C. [sections] 44 is available to all taxpayers, which are in retail, manufacturing, financial matters, communications, computer, energy, chemical, pharmaceutical, and other businesses. The types of research activities that these various taxpayers are undertaking are widely divergent. Thus, there can be no simple documentation test that will be sufficient for all taxpayers.

Section 41(d) provides that the term "qualified research" means research with respect to which expenditures may be treated as expenses under section 174, which is undertaken for the purpose of discovering information which is technological in nature, and the application of which intended to be useful in the development of a new or improved business component of the taxpayer, and substantially all of the activities of which constitute elements of a process of experimentation.

On December 2, 1998, the IRS and Treasury published in the Federal Register (963 FR 66503) a notice of proposed rulemaking (REG-105170-97, 1998-50 I.R.B. 10), which addressed in part, the definition of "qualified research" under section 41(d). Final regulations have not been issued, but are expected shortly. Taxpayers, including TEI, have made comments that are receiving full consideration, and we expect that the final regulations will give further guidance on the questions posed.

The current service position with respect to discovering information that is technological in nature requires that the taxpayer seek to exceed, expand, or refine the common knowledge of skilled professionals in a particular field of technology or science. The position has been upheld by the courts in Norwest v. Commissioner, 110 T.C. 454 (1998), appeal docketed sub. nom, Wells Fargo v. Commissioner, Nos. 99-3878 and 99-3883 (8th Cir.), and United Stationers v. United States, 163 F. 3d 44 (7th Cir. 1998). Such discovery can be evolutionary and does not need to be revolutionary.

The Seventh Circuit in United Stationers agreed with the IRS and stated, "The process of experimentation means a process involving the evaluation of more than one alternative designed to achieve a result where the means of achieving that result is uncertain at the outset."

In general, taxpayers must comply with the general recordkeeping requirements of section 6100. In addition, to comply with or document that they have met the requirements of section 41(d), we recommend that taxpayers keep detailed records, prior to or during the early stages of the research project in question, that show how these requirements are met. Information that demonstrates that this information is new to the taxpayer and that it is not widely available to other skilled professionals in that field is important. Failure to keep such records does not preclude the taxpayer from later establishing that it is entitled to the credit, but good recordkeeping should make the examination process much easier and less time consuming.

3. With the increase of e-commerce and website design, has there been a determination as to whether associated design and development costs are to be capitalized or expensed?

The technical issue whether associated design and development costs of e- commerce and websites are to be capitalized or expensed is currently before Chief Counsel's Office. We expect some feedback soon. As mentioned in Question 3 above, once the executive and staff have been named for this new section of LMSB, we will share that information with TEI and the other external stakeholders.

4. What are the IRS experiences with their audit of TxT FSC calculations?

There are a wide range of issues that have been raised during examinations. These issues involve late filing of refund claims, qualifications as export property, and the computation of combined taxable income, including expense allocation and grouping issues.

Some issues have been resolved at the Examination level while others have proceeded on to Appeals.