Tax Executives Institute--Internal Revenue Service Large and Mid-Size Business Division liaison meeting: February 24, 2003.

On February 24, 2003, Tax Executives Institute met with Larry L. Langdon, Commissioner of the IRS's Large and Mid-Size Business Division, and other representatives of LMSB. TEI President J.A. (Drew) Glennie 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 magazine.

I. Introduction

II. Audit Processes

a. Pre-Filing Initiatives

* LMSB has shown a commendable openness to new and different ways of doing business. More than a year ago, the Division announced several "pre-filing" initiatives, emphasizing the need to resolve issues before a return is filed. This increased attention on "front-end" activities--by the use of pre-filing agreements and industry issue resolution techniques--could potentially reduce contentious audits and prolonged litigation.

* During the liaison meeting, we invite an update on the use of these procedures, including whether LMSB intends to initiate new IIR projects.

b. LIFE Initiative

* TEI is pleased with LMSB's recent announcement of its limited issue focused examination, or "LIFE," initiative. LIFE is an innovative process to focus government and taxpayer resources on the most significant issues on a taxpayer's return by using a risk-based methodology. The new initiative requires the execution of a formal memorandum of understanding between the taxpayer and IRS that will govern key aspects of the examination, including the imposition of a dollar threshold on a case-by-case basis below which both the taxpayer and IRS agree not to raise issues or make claims.

* As the IRS has acknowledged, the new approach represents a major culture shift for LMSB. Critical to its success is the involvement--and training--of IRS field personnel. Without a commitment from the examination team and their supervisors, the new procedure could well be viewed as the latest "flavor of the week," i.e., a mere reworking of other initiatives without an underlying change in philosophy. We understand that LMSB has begun training its agents in the new process. During the liaison meeting, we request an update on the training of agents in the use of the new procedure.

* Although TEI remains hopeful that the LIFE process will succeed in institutionalizing "best practices" for IRS examinations and providing consistency in the treatment of taxpayers, some members have expressed concern about its implementation. The process will succeed, however, only if both taxpayer and the IRS honor the commitments--concerning deadlines, materiality standards, and staffing--set forth in the memorandum of understanding. Providing performance measures based on the use of the process may help resolve this issue.

* A linchpin of the LIFE procedure is the establishment of materiality thresholds that can vary from taxpayer to taxpayer. TEI agrees that a "one-size-fits-all" standard may not be appropriate, but some members have voiced concern that a case-by-case standard may threaten consistency among similarly situated taxpayers. The procedure contemplates that a taxpayer disagreeing with an examiner's assessment of materiality may take the issue up the IRS chain of command, but many taxpayers remain reticent about using that approach for fear of antagonizing the audit team. During the liaison meeting, we invite discussion of how to minimize these concerns.

* LIFE has been described as not a right but a privilege, meaning that participation is not automatic; rather, the decision to use LIFE rests with the IRS examination team and the team manager. Are there taxpayers that, despite a history of cooperation, will not be considered for the LIFE procedure because of size, corporate structure, or involvement in particular types of transactions? The process should be made available to all taxpayers with a track record of cooperation and fair dealing with the IRS. TEI believes that audit teams should be required to discuss the procedure with taxpayers and held accountable for why the process is not used.

c. Record Retention Limitation Agreements

* For several years, TEI and the IRS have discussed the significant burdens imposed on corporate taxpayers relating to the requirement that extensive records be maintained in respect of taxable years subject to audit. Although taxpayers have a responsibility to maintain records to support the positions taken on their tax returns, there is a need to minimize the burden that currently exists (especially for those taxpayers that have many years open for IRS examinations).

* Record retention burdens can best be reduced by increasing the currency of audits; if taxable years are closed in a more timely manner, fewer records will need to be retained.

* Taxpayers and the IRS should make better use of records retention limitation agreements. TEI has long supported the use of agreements that recognize the challenge of constantly changing technology (including limitations on the ability to convert data created on legacy systems) and we continue to believe the rules can be productively revised and streamlined. For example, given the prevalence of ERP systems, guidance should be developed on associated records retention issues, perhaps through a mode] agreement. Another approach would be to use the risk analysis performed for purposes of the LIFE audit as a basis for determining the records to retain.

TEI was recently notified that an LMSB working group has been established to review the current revenue procedure and to seek a more "global" solution, perhaps in the form of additional published guidance. TEI looks forward to working with the agency on this issue.

d. Fast-Track Initiatives

* Two years ago, LMSB announced a fast-track mediation process, which permits an IRS Examination team and an LMSB taxpayer to work with a mediator to resolve audit issues within a 120-day period.

* We invite LMSB to provide a status report on the project. More specifically, has there been any move to open the process to docketed cases?

III. Administrative Issues

a. Tax Shelters 

* Settlement Initiatives. Another innovative approach to resolving issues is the IRS's new tax shelter settlement initiatives. In October, the IRS announced proposed settlement options in three groups of cases: corporate-owned life insurance (COLI), 302/318 basis-shifting transactions, and section 351 contingent liability transactions. These cases have the potential for clogging the tax system, consuming significant resources, and preventing LMSB from making progress on other important issues.

* The three initiatives offered taxpayers an opportunity to settle these issues in a timely manner and were intended to bring the cases to a comprehensive resolution, based on the IRS's assessment of the strength and weaknesses of its legal positions.

* During the liaison meeting, we invite a discussion of taxpayers' response to the initiatives and whether further initiatives are anticipated. Is LMSB satisfied with the volume of transactions being disclosed?

* Disclosure Regulations. In October, the Treasury Department and IRS issued temporary and proposed regulations substantially modifying the rules relating to the disclosure and reporting of certain transactions under Temp. Reg. [section] 1.6011-4T and the requirement to maintain investor lists under Temp. Reg. [section] 301.6112-1T.

* TEI has long held that the most effective approach to addressing tax shelter transactions is to enhance tax return disclosures. By identifying and targeting indicia of transactions that are characteristic of "tax shelters" and requiring enhanced disclosure of such transactions, the IRS can properly focus its examination resources on questionable transactions.

* TEI filed extensive comments on the temporary regulations in January. (A copy of those comments is attached.) During the liaison meeting, TEI would like to address several issues in respect of the implementation of the regulations.

* Temp. Reg. [section] 311.6112-1T--which sets forth the rules that organizers and sellers of "potentially abusive tax shelters" and their material advisers must follow in preparing, maintaining, and furnishing lists of investors in such transactions--cross-references Temp. Reg. [section] 1.6011-4T(a) and the list of "reportable transactions" in Temp. Reg. [section] 1.6011-4T(b) for purposes of defining transactions that must be registered as "tax shelters" or have a "potential for tax avoidance or evasion."

Establishing a consistent definition for purposes of all three sections is commendable, for it provides a measure of simplification and clarification for taxpayers and the IRS. This approach, however, increases the concern that unifying the definition of these sections may create the perception that "reportable" transactions are equivalent to "potentially abusive tax shelter" transactions that warrant an automatic adjustment by a revenue agent. We recommend that the IRS reinforce the message that disclosure of "reportable transactions" is not indicative of whether the tax benefits are allowable and emphasize in training materials that the determination of the benefits of a transaction is independent of disclosure.

* In certain circumstances, the temporary regulations require a series of substantially similar transactions to be treated as a single transaction. In such circumstances, it is unclear whether the taxpayer should disclose each transaction in the series on a separate Form 8886, Reportable Transaction Disclosure Statement, or, instead, file a single disclosure statement reflecting aggregate information for the entire series of transactions. We believe taxpayers should be permitted to file a single statement aggregating the series of related transactions and recommend that the regulations be clarified.

* Temp Reg. [section] 1.6011-4T(g) requires taxpayers to retain all documents "that are material to an understanding of the facts of the transaction, the expected tax treatment of the transaction, or the taxpayer's decision to participate in the transaction." Absent an exemption for transactions undertaken in the ordinary course of a taxpayer's business, compliance with this requirement for thousands of potentially reportable recurring transactions will be challenging, if not impossible. It would be impractical for the tax department to suggest that the business people retain all records, correspondence, analyses, etc., relating to routine or recurring transactions until the tax department determines which transactions must be disclosed under the temporary regulations. Accordingly, we recommend that the proposed documentation requirements not apply to recurring transactions. If it is necessary to have a reporting requirement for recurring transactions, taxpayers should be afforded a more streamlined approach for record retention relating to such transactions.

Another documentation issue is the open-ended look-back requirement. If the statute of limitations has closed on a taxable year, a taxpayer may not have records available to determine whether it participated in a transaction "substantially similar" to a newly listed transaction. We urge the Treasury and IRS to establish a time limit and require taxpayers to review no more than, say, three prior taxable years in order to identify and report whether they have engaged in "substantially similar" listed transactions undertaken prior to the date a transaction first becomes reportable. At a minimum, taxpayers should not have to review transactions in years closed to examination.

* Under Temp. Reg. [section] 1.6011-4T(f), if a taxpayer is uncertain whether a transaction must be disclosed it may file a "protective disclosure" statement or "submit a request to the IRS for a ruling ... whether the transaction is subject to the disclosure requirements of this section." TEI believes that both provisions are helpful. In addition, we recommend that the temporary regulations (1) provide examples to illustrate areas where rulings will be granted and (2) permit taxpayers to obtain rulings on a case-by-case basis that provide for no or limited disclosure.

* To the extent the IRS receives promoter information, how will that be used in the field? Will the information be provided to the taxpayer at the beginning of the audit? If a taxpayer is incorrectly included in such a list or there are other inaccuracies, what process will be available to correct or contest the information?

* Announcement 2002-63. On June 17, 2002, the IRS issued Announcement 2002-63, announcing a change in the IRS's policy for requesting production of a taxpayer's tax accrual workpapers. TEI expressed its concerns about the new policy and subsequently met with LMSB representatives to discuss a list of questions and answers to assist the field in administering it. We understand that the IRS is working on refining those Qs&As, including the development of training materials for the field. During the liaison meeting, we request a status report on this project, including the need to clarify that a restatement of earnings unrelated to a tax issue will not automatically result in a request for the workpapers. Have any requests for production of the workpapers been approved?

b. Tax Deposit Requirements for Nonqualified Stock Option Exercises

* Recently, some TEI members have reported that significant late tax deposit penalties are being raised in respect of employment and withholding taxes owed on the exercise of nonqualified stock options. The dispute is not whether the taxes are owed; rather, the issue is when the wages are actually or constructively paid.

* The argument is apparently that the exercise date is the date establishing the employment and withholding tax liability. In some cases, this would require the deposit of the taxes the next business day following the exercise of the option, even though the settlement date for the purchase is normally the trade date plus three days. On the exercise date, the employer will not be in possession of any funds or even know the amount of taxes to deposit.

* TEI submits that this approach is inappropriate. Actual or constructive payment can occur no earlier than the settlement date; that is the first date on which the stock (or cash) is credited to the employee's account and the first date on which the employee may access the account. See Treas. Reg. [subsection] 1.83-1(a)(1) & 1.83-3(a)(1) (section 83 property is not taxable until transfer, which occurs when a person acquires a beneficial ownership interest in the property).

* TEI suggests that an administrative solution to this issue is warranted. Treasury and the IRS should immediately announce a suspension of the imposition of penalties in these circumstances. Guidance should also be issued clarifying the date when the deposit of withholding taxes is due. The guidance must take account not only of the employer/ employee relationship, but also the practical administrative requirements involved with stock option plan administration. The regulations governing employment tax deposits must recognize the business and information needs of all the parties to the stock transfer: employer, employee, stock broker, transfer agent, and perhaps a payroll service provider. Hence, rules of administrative convenience (such as those set forth in Notice 2001-73, relating to the deposit of taxes in respect of the exercise of qualified stock options) should be provided to address the deposit of employment tax liability. Information must be shared among all parties before an employer can initiate an accurate tax deposit transaction. Finally, the guidance should ensure that penalties are not unduly imposed on employers already caught in this trap.

c. Section 482

* In a January 22, 2003, directive, LMSB instructed agents to issue at the joint opening conference for each audit cycle a "written information document request for a copy of any transfer pricing documentation prepared by the taxpayer pursuant to section 6662(e)." The directive also required the agents to "[a]pply the 30-day time frame provided by statute for providing a copy of any documentation prepared pursuant to section 6662(e)," noting that the discretion authorized by the regulations to excuse minor or inadvertent failures is limited and should be exercised sparingly.

TEI suggests that the directive is overbroad and should be revised. Requiring an IDR to be issued for every audit cycle for every taxpayer is onerous for those taxpayers that do not have significant transfer pricing issues. The timing of such a request could be affected by the existence of an advance pricing agreement or the presence of substantial transfer pricing issues in prior audits. The directive recognizes, "[a]n exception should be made only if recent experience with the taxpayer has indicated that examination of some or all transfer pricing issues is unnecessary, and there have been no major changes in the taxpayer's transfer pricing practices." TEI suggests that training will be required to ensure that agents recognize this exception.

Such a boilerplate IDR cannot help but adversely affect the IRS-taxpayer relationship. A better approach would be to issue a request for the documentation only where there are significant transfer pricing issues to be reviewed. During the liaison meeting, we invite a discussion of the directive.

* We understand that the Treasury Department and IRS are nearing completion of a revision of Treas. Reg. [subsection] 1.482-2 and 1.482-7. During the liaison meeting, please provide a status report on the regulations and discussion of proposed changes, if possible.

d. IRS Service Center Issues

* TEI members have been experiencing a diminution of services by IRS Service Centers. Problems include the filing of unjustified liens, the receipt of duplicate notices (some from different service centers), the lack of a contact name on notices, and the length of time it takes to resolve even minor discrepancies. In many cases, the taxpayer has received assistance from its audit team, but this seems an inefficient use of resources.

* Many of these problems could be resolved by assigning a permanent account representative for each large-case taxpayer. This approach was used in the past and was well received by taxpayers. At a minimum, a contact name should be included on any notices.

e. Taxpayer Confidentiality

* TEI is concerned about two issues that have the potential to threaten taxpayer confidentiality. First, the Administration is considering the use of private debt collection agencies to collect delinquent taxes. Even though there seems to be no direct effect on LMSB taxpayers, TEI believes that the proposal represents poor tax policy, could imperil taxpayer rights, and would likely erode taxpayer confidence in the fairness of the tax system. We recommend that the proposal not be adopted.

The second issue involves the access to corporate tax returns granted to non-government employees under the Inter-governmental Personnel Act's Mobility Program. (1) See International Tax Reform? Don't Hold Your Breath, Conference Participants Suggest, 2002 TNT 221-3 (Nov. 14, 2002). Under the IPA program, the IRS's Statistics of Income Division contracted with several academics who were permitted to review unexpurgated copies of corporate tax returns to consider whether the domicile of an acquirer affects the post-acquisition taxable income of its target. The resulting paper (2) was publically discussed at a Tax Foundation program in November. Although the researchers signed confidentiality agreements, TEI suggests that the program could undermine taxpayers' confidence in the confidentiality of return information and their willingness to participate in IRS initiatives. How widespread is the distribution of tax returns to non-IRS employees? What safeguards are taken to protect taxpayer confidentiality? For example, are taxpayer names and identifying information removed before the returns are disseminated outside the agency?

* During the liaison meeting, we invite a discussion of this issue.

IV. Status Reports

During the liaison meeting, we request status reports on the following:

a. IRS Budget and Modernization Program

* Whether the promise of the reorganization can be realized depends in large measure on the IRS's securing sufficient funds to do its job. TEI has consistently supported adequate funding for the IRS. TEI is concerned about reports that funding for programs such as the modernization program may be substantially cut back. Other reports have indicated that the modernization program is not proceeding as well as expected; the recent departure of key personnel also raises concern about the completion of the program. Does LMSB anticipate receiving the funding it needs for this program, as well as for the recruitment and training of personnel?

b. Proposed Regulations on Capitalization of Expenditures

* Proposed regulations on the deduction and capitalization of expenditures were issued in December. TEI is still reviewing the proposed rules, but during the liaison meeting we request a status report on what, if any, changes are contemplated in the final regulations.

c. Proposed Regulations on Tax Shelter Disclosures

* TEI has filed extensive technical comments on the proposed and temporary regulations relating to the disclosure of tax shelters. During the liaison meeting we request a status report on what changes are contemplated in the final regulations. In addition, will additional items be added to the so-called angel list of exceptions ? What is the process for identifying additional items for this list after the regulations become final?

d. LMSB Reorganization

* In October, LMSB announced a reorganization to bring a more geographical focus to its division. During the liaison meeting, we request a report on how that process is proceeding, including any taxpayer reaction to the new organization.

e. Revision of Form 5471

* TEI representatives have met with Carol Dunahoo, Director of International Tax Programs, and other IRS and Treasury representatives to discuss the possible revision of the Form 5471, Information Return of U.S. Persons with respect to Certain Foreign Corporations. What is the status of this project?

f. E-Filing

* The business community is interested in utilizing technology to reduce tax compliance and recordkeeping burdens. Thus, TEI is pleased to have met with IRS representatives to discuss the electronic filing of corporate tax returns. We are also pleased with the IRS's permitting taxpayers to utilize technology in their day-to-day business, for example, with respect to the documentation of employee expenses for tax purposes. Electronic filing by itself, however, offers modest relief to taxpayers; the real key to reducing taxpayer burden lies in streamlining the core reporting requirements (whether the information is reported on paper or electronically). What is the status of the IRS's e-filing project for corporate returns?

g. Transition

* During the liaison meeting, we request an update on the transition issues from former Commissioner Rossotti to Commissioner-nominee Everson, as well as plans for executive development and continuity within LMSB.

V. Conclusion

(1) The program permits the temporary assignment of personnel between federal agencies and other organizations including institutions of higher education to permit the sharing of professional, administrative, and technical expertise. See 5 U.S.C. [subsection] 3371-3376.

(2) See Jennifer L. Blouin, July H. Collins, & Douglas A. Shackelford, Does Acquisition by Non-U.S. Shareholders Cause U.S. Firms to Pay Less Tax?, reprinted at http:/ /emlab.berkeley.edu/users/burch/ Shackelford.pdf.