Tax Executives Institute-Internal Revenue Service Liaison Meeting Agenda.

On February 23, 2000, a delegation from Tax Executives Institute met with Commissioner Rossotti and other senior officials of the Internal Revenue Service about the IRS modernization initiative and other issues of common concern. The Institute's delegation was led by Charles W. Shewbridge, III of BellSouth Corporation, TEI's International President. The agenda for the meeting, which was submitted in advance of the meeting, is reprinted below. The minutes of the meeting, including a list of the participants, will be published in a future issue of The Tax Executive.

I. Introductory Comments

Tax Executives Institute is pleased to have this opportunity to meet with Commissioner Rossotti, Chief Counsel Brown, and other representatives of the Internal Revenue Service, including officials from Appeals and the Large and Mid-Size Business (LMSB) Division. As an association of corporate tax professionals, TEI is firmly committed to working with the IRS in facilitating the IRS's ongoing modernization efforts, improving the tax guidance system, and generally improving federal tax administration. We look forward to our February 23 liaison meeting and to continuing good relations with the IRS.

II. IRS Modernization

For more than 18 months, Tax Executives Institute has been pleased to have worked with the IRS on its modernization efforts. Our members have contributed to numerous IRS design teams, and the Institute is pleased to have cosponsored the January 13-14 conference "The New IRS Stands Up: What the Modernized Agency Means for You."

During the liaison, we invite a discussion of the IRS's modernization efforts, especially as they relate to taxpayers in the LMSB Division. In particular, we request comments on the following issues:

A. Transition Issues

As the IRS moves closer toward implementation of its new industry-based design, taxpayers represented by TEI's membership have begun to become more and more interested in how the new structure will affect them. Although many members of the Institute's leadership (such as those who attended the Modernization Conference) have a reasonably good understanding of how the LMSB Division will operate, members of TEI's rank-and-file have not devoted significant time to the new structure. They are now concerned with issues as elementary as (1) how will current audits be affected when the LMSB Division "stands up"; (2) what factors will be taken into account in determining the industry group to which particular companies (especially conglomerates or multi-faceted corporations) are assigned and what role taxpayers will play in the assignment decision; (3) what is "the chain of command" in the new IRS (e.g., what are the relative roles of territory managers and directors of field operations); and (4) whether Coordinated Examination Program taxpayers will continue to have access to a designated individual to resolve questions concerning their accounts at IRS Service Centers. There obviously are many, many more questions that particular taxpayers will have as they come face-to-face with the reorganized agency.

We recognize that the IRS (and the LMSB Division in particular) is planning a series of "town meetings" to help explain the new structure to taxpayers. Such a "retail" approach to the implementation is commendable, and we look forward to working with the LMSB Division in scheduling and conducting these sessions. (We also welcome the involvement of the Industry Directors, as well as Division Commissioner Larry Langdon, in TEI's upcoming Midyear Conference, for we assume those introductory sessions will be precursors of regular meetings on an industry-by-industry basis.)We submit, however, that even if these meetings exceed expectations in terms of attendance, there will be major portions of TEI's membership and the LMSB class of taxpayers generally (as well as, perhaps, IRS employees) who will not "get the word" on a timely basis. Accordingly, we recommend that the four operating divisions consider preparing a series of frequently asked questions (FAQs) in respect of both the transition to and the ongoing operation of the division. TEI would be pleased to assist the IRS in the effort, for example, by reviewing proposed questions and their answers and, ultimately, by publishing the final FAQs both in The Tax Executive magazine and on the Institute's Internet site (or at least including a link to the IRS's website on our own).

B. Liaison Activities

Moving from how IRS modernization affects particular taxpayers to the more parochial issue of how organizations such as TEI should interact with the reorganized agency, we invite a discussion of how TEI should interact with the IRS on an ongoing basis. The Institute's concerns relate to national liaison activities as well as local efforts. Indeed, the leaders of TEI's local chapters are becoming more and more anxious over whom they should be meeting with on a liaison basis (i.e., in lieu of their previous liaison meetings with district directors). A similar question also exists in respect of regional liaison efforts.

C. Appeals

On February 16, a TEI delegation will meet with Daniel L. Black, National Director of Appeals, and other representatives of Appeals to discuss several issues relating to IRS modernization. During the February 23 liaison, we anticipate that a report on that Appeals meeting will prompt a further discussion, with particular emphasis on the following issues:

1. Appeals Staffing Levels. There have been several reports recently of significant forthcoming reductions in Appeals staffing. We invite a report on the anticipated level of any such reductions and what steps, if any, the IRS is prepared to take to ensure that the reductions will not adversely affect the ability of Appeals to fulfill its mission.

2. Ex parte Communications by Appeals Personnel with Other IRS Employees. (Note: On December 15, 1999, TEI filed comments on Notice 99-50 with the IRS.) We invite a report on what changes to the proposed revenue procedure are likely in response to the comments filed by TEI and others. In particular, are any changes anticipated in respect of the extent to which the ban on ex parte communications applies to Counsel personnel?

3. Alternative Dispute Resolution Techniques. During the liaison meeting, we invite a discussion of various ADR techniques, including the mediation and the recently announced two-year test on arbitration. Also, are any changes anticipated in the level of approval required before an Appeals officer can settle issues?

D. Pre-Filing Agreements

TEI is pleased to have worked with the IRS design team on the development of a pre-filing agreement procedure. We share the IRS's enthusiasm for the initiative because we agree that pre-filing holds great promise for accelerating the resolution of certain issues to the common benefit of taxpayers and the IRS. We understand that a notice concerning the LMSB initiative will soon be issued. During the liaison meeting, we invite a discussion of the initiative, including the criteria the IRS intends to apply in selecting taxpayers and issues for the pre-filing agreement pilot. In addition, we specifically request comments on whether pre-filing agreements will be subject to disclosure under section 6110 or, alternatively, will be held confidential under section 6103.

E. Balanced Measures

During 1999, TEI was pleased to meet with the IRS to discuss the Institute's comments on regulations establishing the agency's new balanced measures system. During the liaison meeting, we request a report on specific plans to apply the new system to employees associated with the Coordinated Examination Program. TEI stands ready to work with the IRS (or LMSB Division) in implementing this important initiative.

F. Effective Involvement of Specialists

Among the projects that the Institute devoted considerable resources to during the past two years is the IRS's Customer Satisfaction Task Force on Specialists. (Four TEI members and one member of the Institute's staff participated in the task force.) The task force's final report, which was filed in June 1999, includes numerous recommendations for better integrating specialists into CEP examinations, enhancing the taxpayer's interaction with specialists and other members of the audit team in respect of specialist issues, and otherwise improving the effectiveness and involvement of specialists. What steps have been taken to implementing the task force's recommendations?

III. Major Policy Initiatives Affecting Tax Administration

A. Corporate Tax Shelters 

Background -- TEI's Concerns with the Administration's Legislative Proposals

Much has been written and said in the debate over the nature and scope of the tax-shelter problem and approaches to potential solutions.(1) In testimony before the House Ways and Means Committee in November 1999, TEI acknowledged that over-aggressive tax-advantaged products were being marketed and agreed that this poses a challenge to the efficacy of the tax system. But the key to stopping such abuses is effective administration of the law, i.e., "the IRS must do more to challenge and curtail these transactions, including raising practitioner standards, and where appropriate, asserting penalties more frequently." Hence, we applaud the recent IRS announcement that it is creating an internal team to identify, quantify, and develop strategies for addressing tax shelters. Without IRS input on the nature of the problem and the administrative steps that it can and should take under current law, legislative proposals to staunch tax shelter activity ex ante will miss the target and impede legitimate transactions.

Before turning to our questions concerning the IRS initiative, we wish to provide a brief summary of the Institute's major concerns concerning the Administration's legislative proposals. First and foremost, the Institute has consistently urged the Administration and Congress to develop a clear and workable definition for a "tax shelter" transaction. Without such a definition, it will be impossible to craft careful, targeted solutions that do not either adversely affect legitimate business transactions or disrupt the examination process.(2) Thus, TEI remains concerned about the unintended adverse consequences that could flow from overbroad or inadequately drafted proposals. This point was underscored by Thomas J. Smith, Director of the Heavy Manufacturing, Construction, and Transportation Industry, during the recent Modernization Conference. In response to a question, Mr. Smith reported that some IRS employees had erroneously characterized research tax credit claims as "corporate tax shelters."

In addition to emphasizing the need for a clear definition of "corporate tax shelter" (or, alternatively either "aggressive corporate tax shelter" or "overly aggressive tax shelters," for all three terms have been used), TEI offered the following additional comments and recommendations on corporate tax shelters during its testimony at the November 10, 1999, Ways and Means Committee hearing:

* Adoption of substantive tax provisions with subjective standards (e.g., a so-called super 269 provision or codification of economic substance doctrines) would be counterproductive.

* To facilitate the administration of the law (i.e., the examination of transactions and the publication of timely guidance shutting down abusive transactions), tax shelter promoters and taxpayers should be obliged to provide meaningful disclosure of transactions. An effective early warning disclosure regime (pre-tax return filing) requiring promoters to register their products would likely require new legislation. As for taxpayers, enhanced return disclosure requirements could be implemented by regulation or administrative rule. "Indicators" or "filters" that prompt a requirement to register a transaction or that "trigger" taxpayer penalties for non-disclosure of the transaction should be objective and easy to apply.

* Proposals for a separate attestation of a transaction by a senior corporate officer, especially when accompanied by the imposition of personal liability for the filing of an inaccurate attestation, should be rejected. The proposals could lead to examinations of attestations rather than examinations of transactions, and greatly impair the audit process.

* Proposals to increase the accuracy-related penalty from 20 to 40 percent in respect of tax shelters should be rejected. To the extent a problem exists with the current penalty regime, it lies not in the penalty being too low, but too high, combined with the lack of consistent, meaningful enforcement activity by the IRS in appropriate cases. (To our mind's eye, proposing to reduce the penalty from 40 percent to 20 percent if a position is disclosed provides an inadequate incentive to taxpayers.) Moreover, the "highly confident" standard proposed by the staff of the Joint Committee on Taxation should be rejected because it presumes a greater degree of precision than exists with the current tax law and the proliferation of penalty standards will spawn greater complexity in the administration of the penalty regime.

* In recognition of the complexity of the tax law and to provide an incentive for disclosure of transactions, a reasonable cause exception to the imposition of penalties should be retained. To deter opinion shopping and ensure that opinions are based on the actual facts of a transaction rather than unjustified assumptions, the scope of the current reasonable cause exception should be clarified. In addition, consideration should be given to adopting of a new penalty on tax practitioners and to concomitantly strengthening Circular 230 to increase accountability.

Although the Treasury Department has primary responsibility for developing the Administration's legislative proposals, TEI is interested in the IRS's position with respect to the administrative -- as opposed to the tax policy -- implications of the various tax shelter proposals. We welcome a discussion of this topic during the liaison meeting.

2. Current IRS Tax Shelter Initiative

Last October, Commissioner Rossotti announced an IRS initiative to identify and address the corporate tax shelter issue. During remarks to the IRS Modernization Conference and elsewhere, LMSB Commissioner Langdon and other IRS officials have commented on the scope of the IRS project. According to The Wall Street Journal (on February 2), the IRS is establishing a new office of approximately 15 IRS employees "to better coordinate the network of examiners and specialists responsible for uncovering and closing down illegal tax schemes.... When such a shelter comes to light, the IRS hopes to be able to move swiftly to end the scheme and spread the word among auditors to look for it in tax returns." Moreover, the new office, which "is expected to be running by June," will reported develop "a sort of field guide for tax shelters for examiners." Finally, the Journal reported that the IRS "is likely to announce a pilot project within a few weeks to give corporations more guidance on what constitutes an abusive shelter."

During the liaison meeting, TEI invites a status report on the IRS's initiative. In particular, we wonder whether taxpayers will be given an opportunity to participate in the initiative and to vet the office's conclusions, for example, to guard against the mischaracterization of certain transactions as corporate tax shelters. (See the reference in the previous section to Mr. Smith's comments at the Modernization Conference on the need to carefully define the term "corporate tax shelter" to avoid sweeping in routine business transactions such as the research tax credit.) Further, if the new office is not expected to be operational for several months, what role will it play in supporting the Administration's current legislative proposals? Finally, will the so-called field guide referred to in The Wall Street Journal story be publicly released?

B. Penalty and Interest Provisions

In 1999, both the Treasury Department and the Joint Committee on Taxation released studies on the penalty and interest provisions of the Code,(3) and a hearing on this subject was held last month by the Oversight Subcommittee of the House Ways and Means Committee. Although the Treasury Department and Joint Committee staff agree on some issues -- such as the need to harmonize the standards under the accuracy-related penalty for taxpayers and practitioners -- in other cases, there is wide disagreement. The differences include whether the interest-rate differential should be eliminated, whether the estimated tax penalty should be converted into an interest charge, and whether a "dispute reserve account" regime should be adopted to supplant the procedures set forth in Rev. Proc. 84-58, relating to deposits in the nature of a cash bond. (Under a proposal set forth by the Joint Committee staff, taxpayers in disputes with the IRS would be able to make deposits, which would earn interest even in the event the taxpayer subsequently withdrew the funds; under current law, no interest is paid if the taxpayer revokes a cash bond.) TEI believes the proposal has great promise, not only because it would advance the principle that interest should be paid for the use or forbearance of money but because it would encourage the early payment of amounts in dispute. Accordingly, the Institute was disappointed that W. Val Oveson, the National Taxpayer Advocate, against the dispute-reserve account proposal, essentially on the ground that it would be too difficult for the IRS to keep track of the amounts deposited. This position is regrettably reminiscent of the IRS's views in respect of interest netting, where the IRS's administrative burden became the justification for not implementing clear congressional intent.

During the liaison meeting, we invite a discussion of the IRS's views on the dispute reserve account proposal as well as other issues relating to the ongoing review of the Code's interest and penalty studies. In addition, we request comments on the following issues:

* The IRS's implementation of the interest netting provisions of the IRS Restructuring and Reform Act of 1998. For example, has a procedure been established for taxpayers to inquire about the status of their interest-netting claims?

* The requirement in the IRS Restructuring Act that individual taxpayers be provided copies of their interest calculations, and whether the IRS has any plans to implement that provision ahead of schedule or to extend it to all taxpayers.

C. Confidentiality

On January 28, 2000, the staff of the Joint Committee on Taxation released its study of the confidentiality provisions of the Code.(4) The Joint Committee staff's recommendations are extensive, particularly in respect of exempt organizations. It is our understanding that a Treasury Department study on this subject will be released soon.

As the Joint Committee report recognizes, determining whether to allow disclosure of returns and return information "involves a balancing of sometimes competing objectives." The report makes several recommendations concerning the general disclosure provisions including --

* All provisions authorizing access to returns and return information should be contained in the Internal Revenue Code. In addition, section 6103 would preempt the Freedom of Information Act. Thus, section 6103 would be the sole means by which returns and return information may be requested.

* All final written legal interpretations issued to IRS employees should be made publicly available to the extent such interpretations (i) affect a member of the public, and (ii) are issued by the IRS or Chief Counsel.

* The law should be clarified that tax treaties qualify for exemption under FOIA and section 6103. Tax information exchange agreements would be included within this exemption.

* When nonparty tax returns and return information are to be disclosed under section 6103(h)(4)(A)-(C) (relating to disclosures in the context of a judicial or administrative proceeding), the taxpayer should be given notice prior to the disclosure and only the portions of the nonparty return that directly relate to the resolution of an issue in the proceeding should be disclosed. The nonparty would also be given an opportunity to participate in the redaction process.

Although we anticipate a more extensive discussion with officials of the Treasury Department's Office of Tax Policy, we invite the IRS's reactions to the Joint Committee's proposals.

IV. Tax Simplification

The Internal Revenue Code today is hopelessly complex. Indeed, complexity of the tax law has long been cited as the number one problem facing taxpayers. In his most recent report to Congress, W. Val Oveson, the National Taxpayer Advocate, confirmed that complexity of the tax law "continues to be the most serious and burdensome problem facing America's taxpayers." National Taxpayer Advocate, Annual Report to Congress for Fiscal Year 1999, I-3.

For this reason, TEI has undertaken a joint simplification project with the American Bar Association's Section of Taxation and the American Institute of Certified Public Accountants' Tax Division. The report of these three organizations will be released later this month and will include suggestions for reform of provisions affecting both individual and business taxpayers. High on the list of priorities is a call for repeal of the alternative minimum tax and enactment of a rational estimated tax safe harbor for all taxpayers, individuals and corporations. The report also notes that the on-again, off-again nature of the so-called extenders (such as the research tax credit and the work opportunity tax credit) creates its own complexity and recommends the enactment of these provisions on a permanent basis.

During the liaison meeting, we invite a discussion of the IRS's initiatives to simplify the tax law. For example, has the IRS established, or have plans to establish, any task forces to develop both individual and corporate simplification proposals? We recognize that the Treasury Department will necessarily take the lead in presenting any simplification measures to Congress, but we urge the IRS not to abdicate its role in the simplification effort. Indeed, since IRS agents deal with the administrative fallout of the tax laws on a much more intimate basis than Treasury officials or congressional aides, they are particularly well suited to assist in, if not lead, the effort,

V. The Guidance Process -- And Priorities

A. General

TEI is heartened by the IRS and Treasury's commitment to expedite and improve the tax guidance process. We remain strong supporters of the view that by devoting more time to providing guidance (especially on a pre-filing, or assistance, basis), the IRS and Treasury can reduce the resources consumed by post-filing activities while nevertheless enhancing compliance. TEI is also very appreciative of the request for the Institute's views on what the Treasury and IRS's guidance priorities should be. We are in the process of soliciting the views of our members and intend to submit our suggestions very shortly.

During the liaison meeting, we request a report on the IRS and Treasury's efforts to improve the guidance process, including the establishment of the Published Guidance Advisory Committee. In particular, does the IRS anticipate changes in the "mix" of guidance vehicles (e.g., field service advice, private rulings and technical advice memoranda, notices, revenue rulings, and regulations)?

B. Capitalization 

For nearly a decade, the issue of the proper standard for distinguishing between expenses that could be currently deducted and expenses that should be capitalized has bedeviled taxpayers and, we daresay, the IRS. And for just as long, the question of how the Supreme Court's 1992 decision in INDOPCO v. United States, 503 U.S. 79 (1992), applies has been a topic of discussion at IRS-TEI liaison meetings. As this year's meeting approaches, there is both good news and bad. The good news is that guidance on the treatment of the costs of obtaining ISO 9000 certification, which has been discussed at the last several liaison meetings, was addressed in Rev. Rul. 2000-4. Moreover, the lines drawn in that ruling -- clarifying that incidental future benefits of training, advertising, and quality control process improvements arising from the self-study, certification, and audit process are deductible whereas the more enduring benefits of a printed quality control manual or new tangible equipment acquired to facilitate compliance with ISO 9000 standards are capital -- are technically sound and administratively workable. Further good news came on February 8, when the IRS issued Rev. Rul. 2000-7, generally permitting a deduction for the costs of removing property that is replaced with other property.

The bad news is that the nebulous future benefit standard announced in INDOPCO remains a source of frustration for taxpayers as agents seek to capitalize expenses long treated as currently deductible. In this respect, several items of expense were identified as priorities for the issuance of guidance on the 1999 Treasury/IRS Priority Guidance Business Plan. The outstanding items, which we encourage the IRS to roll over to its 2000 Business Plan, include cyclical maintenance costs, sales commissions paid to obtain new customers, and mutual fund launch costs.

In addition, on February 8 and 9, representatives of the Treasury Department and the IRS participated in a conference sponsored by the Tax Council Policy Institute entitled "INDOPCO: Past, Present & Future." The objective of that symposium was to consider different approaches to resolving capitalization issues, specifically, by establishing a framework for considering capitalization issues. As demonstrated by the discussions at the conference, the ever-expanding list of controversies in which INDOPCO is cited suggests that the standard in the decision (i) is unadministrable and (ii) will continue to be a source of controversy. Moreover, several participants suggested that it may be a propitious time to seek a generic, or global, solution to capitalization issues, whether by regulation or legislation. We invite a discussion of the prospects for a global resolution of capitalization issues.

C. Proposed Research Tax Credit Regulations

TEI, and many other groups, submitted comments in March 1999 relating to the proposed regulations on the definition of qualified research for purposes of the research tax credit. To avoid vitiating the credit by adopting rules that are more restrictive than Congress intended, TEI's comments urged the government to: (1) modify the statement of basic principles in the regulations; (2) abandon the "common knowledge" standard of the discovery test; (3) clarify the process of experimentation rule so that it more clearly addresses applied research; (4) ameliorate the stringent recordkeeping requirements for documenting the process of experimentation; (5) include safe harbors for qualified research activities; (6) adopt a simpler definition of gross receipts; (7) modify the rules relating to nonqualified activities and adaptation; and (8) consider revising the proposed rules along the lines of TEI's proposed draft regulations.

The Conference Agreement to the 1999 Tax Relief Extension Act urges the Secretary of the Treasury to carefully consider the comments he has and may receive regarding the definition of qualified research, especially those relating to the "common knowledge" standard. The Conference Agreement expresses other concerns about the scope of the proposed regulations. In particular, it questions whether the regulations may unduly limit the qualification of "internal use software" developed to support the provision of services. It also emphasizes that the discovery of "new" information of a technological nature that is new for the taxpayer qualifies for the credit, and it reaffirms that eligibility for the credit is not contingent on meeting unreasonable recordkeeping requirements.(5)

During the liaison meeting, we invite a discussion of the proposed regulations relating to qualifying research activities, including any modifications, simplifications, or additional rules that the IRS and the Treasury Department are considering.

In addition, we invite comment on efforts to ensure that the research tax credit is interpreted and administered consistently among taxpayers (those in the same industry and otherwise), including what steps the IRS may have already taken to ensure that agents are aware of the concerns Congress expressed in 1999 about unreasonable recordkeeping requirements. The absence of final regulations that provide meaningful guidance has contributed to the situation where some agents will apply the statute in a very reasonable manner, whereas others -- perhaps presuming that the research tax credit is subject to abuse -- will adopt an over-rigorous interpretation of the rules (for example, in respect of internal use software). Will the LMSB Division establish a research tax credit coordinating committee or other body to promote the uniform application of the rules across and within the five industry groupings?

VI. Conclusion

TEI appreciates the opportunity to present its views and looks forward to its liaison meeting with Internal Revenue Service.

(1) In July 1999, the Treasury Department released its report on tax shelters. Office of Tax Policy, U.S. Department of the Treasury, The Problem of Corporate Tax Shelters: Discussion Analysis and Legislative Proposals (July 1999). The staff of the Joint Committee on Taxation also addressed corporate tax shelters in its study. Staff of the Joint Committee on Taxation, Study of Present-Law Penalty and Interest Provisions as Required by Section 3801 of the Internal Revenue Service Restructuring and Reform Act of 1998 (Including Provisions Relating to Corporate Tax Shelters) (JCS-3-99) (July 22, 1999). Hearings on the subject were held in March and November 1999 by the House Ways and Means Committee and in April 1999 by the Senate Finance Committee. TEI presented testimony at the April and November hearings.

(2) This is true whether the definition relates to a substantive proposal, such as the proposed codification of the economic substance test; to a penalty provision; or "merely" to a provision requiring registration or disclosure of "reportable transactions" where one or more factors (nee indicators or filters) are present.

(3) Office of Tax Policy, U.S. Department of the Treasury, Report to the Congress on Penalty and Interest Provisions of the Internal Revenue Code (October 1999); Staff of the Joint Committee on Taxation, Study of Present-Law Penalty and Interest Provisions as Required by Section 3801 of the Internal Revenue Service Restructuring and Reform Act of 1998 (Including Provisions Relating to Corporate Tax Shelters) (JCS-3-99) (July 22, 1999).

(4) Staff of the Joint Committee on Taxation, Study of Present-Law Taxpayer Confidentiality and Disclosure Provisions as Required by Section 3802 of the Internal Revenue Service Restructuring and Reform Act of 1998 (Volume I: Study of General Disclosure Provisions; Volume II: Study of Disclosure Provisions Relating to Tax-Exempt Organizations) (JCS-1-00).

(5) Statement of Managers on Revenue Provisions Contained in the Conference Report (H. Rept. 106-478) to Accompany H.R. 1180 Relating to Extension of Expired and Expiring Tax Provisions, and Other Tax Provisions (November 17, 1999).