Tax Executives Institute-Internal Revenue Service liaison meeting: November 19, 1996.

On November 19, 1996, Tax Executives Institute held its annual liaison meeting with the Commissioner of Internal Revenue and other senior officials of the IRS National Office. Reprinted below is the written agenda for the meeting, which was submitted to the IRS in October. The minutes of the liaison meeting will be published in a future issue of The Tax Executive.

I. Introduction: Times of

Challenge and Change

Tax Executives Institute is pleased to have this opportunity to meet with Commissioner Richardson, Chief Counsel Brown, and other senior officials of the Internal Revenue Service. TEI's liaison meetings with the Internal Revenue Service have afforded each organization an opportunity to articulate technical, policy, and process concerns and to explore how these concerns can best be addressed.

As a new millennium approaches, the Internal Revenue Service is facing unparalleled challenges in administering the U.S. tax system, including (1) the ongoing effects of a major reorganization (and realignment of its regions and districts); (2) a proliferation of calls to "end the IRS as we know it" (and "to pull the tax system out by the roots"); (3) Congress's decision to outsource core functions (at least on a test basis) and to reduce funding for the agency (with the attendant possibility of reductions-in-force); and (4) the chartering of a National Commission on Restructuring the Internal Revenue Service.

As an association of tax professionals who deal with the IRS on a daily basis, TEI has long been concerned about the corrosive effect that attacks on the agency's legitimacy can have on the level of voluntary compliance in the United States. We share the view that vigilant oversight of the IRS by Congress and others is absolutely necessary, but also acknowledge that the orderly collection of taxes and the efficient administration of the tax system are in the best interest of the entire country and, further, that adequate funding must be provided for those goals to be attained. Hence, we lament the sometimes virulent attacks that have been launched against the IRS and its employees. To be sure, there are flaws in the current tax system, and there are design and management issues (including those related to tax systems modernization) that must be addressed in order to restore the public's confidence that the tax system is being fairly and efficiently administered. TEI sincerely believes, however, that the focus should remain on correcting the problems, not undermining the basic legitimacy of - and hence the public's confidence in - the IRS.

During the past few months, TEI has voiced these sentiments in statements filed with Congress and comments released to the media, and in mid-november, the Institute will underscore its views in testimony before the National Commission on Restructuring the IRS, while expressing our concerns about areas that need change.(1) During the liaison meeting, TEI requests a report on how the agency is coping with its myriad management and operational challenges. In particular, we invite a discussion of the status of the IRS's reorganization and the steps that are being taken to ensure that the realignment, coupled with recent budget cuts, will not adversely affect either taxpayer relations or the relationships between the IRS and its stakeholders. TEI, in turn, can share the results of its own regional realignment, as well as its members' concerns about the effect of recent changes on the overall performance of the agency.

Finally, we request a report on the IRS's involvement with the Restructuring Commission.

II. Coordinated

Examination Program

A. Implementation of National Office Initiatives in the Field. For the past several years, TEI has actively supported the IRS's initiatives to improve the Coordinated Examination Program. We have been pleased to participate in a wide variety of initiatives, including projects relating to the taxpayer's involvement in the examination planning process, the definition of a successful CEP examination, improving the information-gathering process, and identifying other means to enhance currency. We continue to believe these initiatives hold much promise for improving the examination process to the common benefit of taxpayers and the IRS.

Regrettably, we remain concerned about, and frustrated by, the uneven implementation of various initiatives across the country. It seems that, year after year, officials in the National Office acknowledge the need "to get the word down" to the field and yet, year after year, the "message" seems to get lost in translation. For example, in April several representatives of the Institute participated in a briefing on the IRS's CEP Systems Analysis initiative, which confirmed what TEI had long suspected: discussing the contents of an information document request (IDR) with the taxpayer before the IDR is issued has a positive effect on the taxpayer's response time. Nevertheless, all across the country, overbroad, unfocused, and irrelevant IDRs are issued in a vacuum. Similarly, the longstanding recommendation that all parts of a detailed audit plan be shared early in the process with the taxpayer has still not been uniformly implemented. Finally, even though the National Office repeatedly assures taxpayers that Case Managers control their audits, our members report concerns about Case Managers and Team Coordinators paying undue deference to various specialists (including international examiners, engineers, and economists), who often seem more interested in issuing IDRs and pursuing an independent agenda than in resolving issues and closing the examination.(2)

During the liaison meeting, TEI invites a discussion of the status of various CEP initiatives and how taxpayers and the IRS can work together to ensure the uniform implementation of CEP improvements. For example, are examinations being completed more expeditiously? What are the current statistics on "cycle time" and currency? Are there significant differences among the IRS's regions and districts? Has the National Office established any system to measure the success of CEP initiatives and, hence, to monitor field adherence to National Office initiatives? Has any system of incentives been implemented or is the only "check" on the field the persistence of the taxpayer? Are changes contemplated to ensure consistency in how examining agents are informed of new initiatives and how promptly they receive necessary training?

In particular, our members are interested in learning the current status of the following IRS initiatives (including the IRS's assessment of the initiatives' ongoing merits):

* Advance Pricing Agreements (including whether any improvements are planned in the APA process and whether any changes are anticipated in APA staffing levels) - and the possible expansion of the APA program to domestic tax issues.

* Use of Accelerated Issue Resolution (including the types of issues in which AIR agreements are being executed).

* Intangibles Settlement Initiative (including whether the initiative should be made available to resolve valuation issues related to intangibles acquired before July 25, 1991, even where the IRS's examination of such an acquisition did not commence until after April 1, 1994).

* Implementation of expanded Examination settlement authority pursuant to Delegation Order No. 236 (Rev. 2) and Delegation Order No. 247 (including whether any problems have developed that may cause the IRS to reconsider the expansion of settlement authority).(3)

* Earlier referral of issues to Appeals, Appeals' involvement in the Competent Authority process, and the implementation of the Appeals mediation initiative.

B. Scope of the Audit/Materiality of Audit Adjustments. Many members report that, notwithstanding several promising national initiatives, the scope of their examinations have not become more focused, but rather more expansive and intrusive. Hence, the number of information document requests has increased substantially, and many IDRs are open-ended and seem driven not by particularized concerns but by curiosity or the fervent hope of finding some transaction or some expenditure that will somehow generate a substantial adjustment.(4) For example, in connection with taxpayer claims in respect of the research tax credit, boilerplate IDRs are being issued, not on the substance of the taxpayer's research activity or the merits of its claim, but on (1) how the taxpayer became aware of the possibility of filing a claim, (2) whether the taxpayer was approached by a particular consulting firm, and (3) if so, the name of the firm, the content of its promotional materials, and the details of the financial arrangements between the taxpayer and the consulting firm. In other words, the focus of requests is not the legitimacy of the claim but what or who may have prompted it.

More fundamentally, our members have expressed concerns that agents are devoting more time and resources to examining insubstantial or immaterial timing issues. We believe that the IRS's goal of currency is ill-served by efforts to expand the scope of audits unduly and by the practice of applying relatively low thresholds of materiality. To be sure, timing issues can have a significant financial effect (for the taxpayer as well as the government), but TEI wonders whether the IRS's measurement system is properly calibrated in respect of such issues. If an item is merely "flipping" from one year (or cycle) to the next, its value to the government is obviously less than if it is permanent in nature. Often, however, agents spend considerable time effecting such "flips." Has any consideration been given to either adjusting the scope of the audit plan or, more fundamentally, evaluating agent performance on a net present value basis?

C. Appeals. During the meeting, we request a report on the shift of the Appeals organization from the Office of Chief Counsel to "the Commissioner's side of the house." Has the change affected Appeals' ability to resolve cases in an expeditious manner? What is the average lapse time of cases in Appeals (in absolute terms and compared with previous years)? Do the cases that take inordinate amounts of time to resolve share any common characteristics?

Several members have expressed concern about the computation process in Appeals. Specifically, computations that were agreed to during the examination are changed, sometimes without notice to the taxpayer, and frequently the taxpayer does not have an opportunity to discuss the computations with the relevant Appeals personnel. Even where that is not the case, the process seems to take an inordinate amount of time and often merely duplicates what was done during the examination. At last year's liaison meeting, we briefly discussed the efficacy of joint Examination-Appeals computations. Does such an approach hold promise? More generally, does the IRS share TEI's concerns or have others relating to the Appeals computation process?

Finally, we invite a discussion of pending proposals to afford the National Director of Appeals line authority over Appeals field personnel, and to have Appeals team chiefs be "managers" rather than "technicians," which might affect not only the team chiefs' technical competence but also their ability to assess the skills and competence of other members of the team.

D. Technical Advice and Field Service Advice. During the liaison meeting, we request a report on the IRS's field service advice initiative. We recognize that pending litigation about whether field service advice memoranda must be disclosed pursuant to section 6110 of the Internal Revenue Code may preclude a fullscale discussion of this topic. Nevertheless, we hope to receive an update on the frequency with which field service advice is requested, as well as on whether the National Office has developed any formal guidelines on when technical advice (in contrast to field service advice) will be considered the more appropriate vehicle for seeking National Office guidance. (In a previous meeting, we were informed that field service advice frequently resulted in issues being dropped by the field; is this still the case?)

In addition, TEI renews its recommendation that the IRS adopt procedures on when taxpayers will be advised that Counsel is involved in their case, when they can dispute or elaborate on the field's statement of facts, when they can talk or meet with the responsible Counsel personnel (independently or with pertinent members of the audit team), and when they will be informed of pertinent field service advice. We continue to believe that the adoption of such procedures will reduce contentiousness, guard against "false starts" by Examination and Counsel personnel, and expedite the resolution of issues.

III. Distinguishing Between

Capital Expenditures

and Ordinary and

Necessary Expenses: The

Need for More Guidance

TEI does not wish to sound like a broken record, but our members continue to be concerned about the IRS's initiatives in respect of the capitalization of expenditures and, in particular, about the penchant of agents to invoke the Supreme Court's decision in INDOPCO v. United States, 503 U.S. 79 (1992), to justify the capitalization of heretofore currently deductible expenses. We are also concerned about the National Office's apparent decision to let the INDOPCO drama unfold through the private letter ruling and technical advice memorandum process rather than to issue published guidance in this area.

Our concern is grounded in fact. Despite frequent public assurances from the IRS National Office (in Rev. Rul. 94-12, 1994-1 C.B. 36, and elsewhere) that "INDOPCO did not change the law regarding capitalization," agents continue to seize upon that decision's broadest statements to justify novel and distended capitalization theories. In many cases, agents have cast aside well-settled law and practice supporting the deduction of many business expenditures. Regardless what authority the agents cite - whether section 263 or 263A or, more baldly, the INDOPCO decision - the same burden is imposed on taxpayers: the need to defend against unwarranted proposed adjustments.

The latest blip on the INDOPCO radar scope relates to the proper treatment of certain airline maintenance expenditures, which were the subject of Technical Advice Memorandum 9618006. The technical advice memorandum, which held that a taxpayer must capitalize the cost of periodic major inspections, has prompted a firestorm of protests, not only from the airline industry but also from key congressional leaders. Our concern is not so much with the legal conclusion set forth in the technical advice memorandum - though much fault can be found with that conclusion - but with the process the IRS is using to develop post-INDOPCO law.

TEI recognizes that technical advice memoranda and private letter rulings formally have no precedential effect. We also recognize that they technically involve the proper application of law to a taxpayer's specific set of facts. In the absence of published guidance, however, examining agents have imbued such documents with significant weight, and the result is what some have called de facto, secret law that imposes a substantial hidden tax. Hence, while the IRS's National Office attempts to insulate the technical advice memorandum from congressional criticism on the ground it reflects no change in law and affects only a single taxpayer, revenue agents are interpreting the memorandum as a green light to capitalize a whole range of expenses that heretofore have been currently deducted.

In its letter to House Ways and Means Committee Chair Archer, the IRS stated a goal of "providing additional guidance to assist both taxpayers and the Service in resolving these issues and minimizing further controversy." TEI shares that goal. We submit, however, that it can be best attained by the issuance of public, generally applicable guidance. Such guidance can be held up to the light of day, by both taxpayers and the IRS. Such guidance provides a basis for challenge, clarification, or - if need be - congressional oversight. Where the private ruling process is used, however, the facts may be obscured, the legal analysis shielded from scrutiny, and taxpayers as a whole disadvantaged. (Taxpayers are technically denied the ability to rely on favorable rulings, whereas agents are free to apply "the reasoning" of the ruling in other situations.) More fundamentally, the dearth of generally applicable guidance places taxpayers in the position of having to seek clarification of any challenged expense deduction, and may well open the door to Congress's micromanaging the IRS's interpretation of the tax law.(5)

TEI renews its recommendation that the National Office provide more generally applicable guidance on the capitalization issue in order to reduce the number of protracted, and expensive, disputes between taxpayers and the IRS. During the liaison meeting, we invite discussion of the National Office's efforts - through published guidance, technical advice memoranda, or otherwise - to bring clarity to this area. (In this regard, in March of this year the Institute filed comprehensive comments on Notice 96-7, which sets forth the IRS and Treasury Department's request for assistance in identifying approaches to address the expense-versus-capitalization issue.)

We also invite your comments on the propriety of IRS districts, in consultation with taxpayer groups such as TEI or otherwise, developing capitalization thresholds.

IV. IRS Efforts to Reduce

Taxpayer Burdens

A. Record Retention Issues. On April 11, 1996, TEI submitted comments to the IRS on Notice 96-10, which requested comments on a proposed revenue procedure relating to the use of digital imaging to satisfy the recordkeeping requirements of the Internal Revenue Code. We request a status report on the draft procedure, as well as on efforts to revise Rev. Proc. 91-59, which sets forth basic record retention requirements.(6)

B. Streamlining Corporate Filing Requirements. In August 1995, TEI submitted comments to the IRS on streamlining corporate filing requirements and developing a business case for electronic filing of Form 1120. We request a status report on the streamlining initiative.

C. Congressional Review of Regulations. In March of this year, President Clinton signed legislation (Public Law No. 104-21) that not only increased the public debt limit (which was the principal purpose of the bill) but also changed the process for developing federal regulations, including those issued by the IRS. Under the legislation, no regulation that constitutes a "major rule" can go into effect until at least 60 days after the regulation is submitted to Congress. Within the 60-day window period, Congress will have the opportunity to review and, if it is so inclined, block the implementation of the regulation by passage of a joint resolution. During the liaison meeting, we invite a report on how the legislation has affected the development, processing, and review of regulatory projects.

D. Retroactive Extension of Section 127. Congress's retroactive extension of the educational assistance exclusion of section 127 left taxpayers (employers and employees alike) who complied with the law in a worse position than taxpayers who disregarded the expiration of the income exclusion. TEI recognizes that it was Congress that made the policy decision to extend section 127 retroactively, and acknowledges that the position set forth in IRS Information Release 96-36 - requiring the filing of amended returns - can be justified under the statute. We continue to believe, however, that it should have been possible to craft a creative solution - such as permitting an adjustment to 1996 wages where the individual remained on the employer's payroll - that had few adverse consequences (for employers, employees, or the fisc) while obviating the burden of filing and processing amended returns.

V. Request for

Status Reports

Time permitting, we request status reports on the following projects.

A. Changes in Method of Accounting. On October 18, TEI submitted comments to the IRS on Notice 96-40, on the possible revision of Rev. Proc. 92-20, relating to changes in method of accounting. During the liaison meeting, we request an update on the IRS's plans to revise the revenue procedure.

B. Interest Netting. On June 28, TEI filed comments on Notice 96-18, relating to issues surrounding the computation of interest where overpayments and underpayments of tax liabilities overlap; the Institute also testified at the IRS's September 4 public hearing on Notice 96-18. During the liaison meeting, we request an update on the interest-netting project, including a projected date for the release of the study.

C. Check-the-box Regime for Entity Classification. On August 9, TEI filed comments with the IRS on proposed regulations under section 7701, relating to the simplification of the Internal Revenue Code's entity classification rules; the Institute also testified at the IRS's August 21 public hearing on the proposed regulations. During the liaison meeting, we request a status report on the regulations, especially on whether there are any open questions that TEI can help resolve.

D. Section 482 Service Regulations. On July 24, TEI issued comments to the IRS on possible changes to the regulations under section 482, relating to intercompany services. During the liaison meeting, we request a status report on when proposed section 482 regulations relating to intercompany services may be issued.

E. CFC GAAP E&P Regulations. On June 30, 1992, the IRS issued proposed regulations under sections 952 and 964, relating to the use of generally accepted accounting principles (GAAP) to compute the earnings and profits of foreign corporations. TEI filed comments on the proposed regulations in October of that year, and in February of 1995 renewed our recommendation that final regulations be issued as soon as possible. During the liaison meeting, TEI requests a report on the status of the GAAP E&P regulations.

VI. Conclusion

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

Important CPE/CLE Accreditation Information

CPE/CLE Accreditation: Boards of Accountancy. TEI is registered with the National Association of State Boards of Accountancy (Sponsor No. 91-00116- 97, Exp. 12/31/96). TEI is also registered with the following Boards of Accountancy: Illinois (#158-000651); Indiana (#CE92000119, Exp. 12/96); New Jersey (#160, Exp. 6/30/97); New York (E93-253, 9/1/93-8/31/96); Ohio (P0087); Pennsylvania (PX613L); and Texas (#3512).

Continuing Legal Education. The Institute is registered in the following states as a sponsor of continuing legal education programs: California: Approved Provider status from September 1, 1996, to August 31, 1998 - provider number 2080; Iowa; Kentucky: 1996 46th Midyear Conference - 24.5 credit hours [Ethics credits are included], 1995 50th Annual Conference - 25 credit hours [Program Number 36198]); Minnesota: 1996 46th Midyear Conference - 26.25 20.5 credit hours, 1995 50th Annual Conference - 19.50 credit hours; Ohio: 1996 46th Midyear Conference - 26.25 credit hours, 1995 50th Annual Conference - 27.25 credit hours, 1996 International Tax Seminar: Section 482 Compliance (2/22-23/96) - 11.5 credit hours, IRS Audits and Appeals Seminar (4/18-19/96) - 12.25 credit hours, 1996 Federal Tax Course - Level I (4/28-5/3/96) - 30 credit hours [including 0.0 for ethics and 0.0 for substance abuse], State and Local Tax Course (7/14-19/96) - 28.75 credit hours [including 2.5 for ethics and 0.0 for substance abuse]); Oklahoma: 1996 46th Midyear Conference - 31.5 credit hours, 1995 50th Annual Conference - 25.0 credit hours; Pennsylvania: 1995 50th Annual Conference - 20.5 substantive; Wisconsin: 1996 46th Midyear Conference - 26.0 hours; 1995 50th Annual Conference - 31.50 hours. The Institute is also an accredited sponsor of educational programs for enrolled agents.

Note: Several states, as Wisconsin and Georgia, require the individual to submit conference materials directly to the CLE board. TEI provides a continuing professional education form for each registrant at its conferences, courses, and seminars, which should be completed at the end conclusion of the program and returned to the TEI Registration Desk for verification and signature. A copy of the form is retained and filed at TEI headquarters.

Tax Executives Institute and TEI Education Fund accord to participants of any race, color, creed, sex, or national ethnic origin all the rights, privileges, programs, and activities generally accorded or made available to participants at their programs, courses, and other activities.

Please note: TEI and TEI Education Fund programs are presented for the benefit of TEI members and others who work in corporate tax departments; private practitioners may not register for the programs listed above. (1) This agenda is being prepared before the Institute appears at the National Commission's November 8 public hearing, but the liaison meeting is scheduled to follow that hearing. (2) One member put it this way: "The biggest issue is Case Manager control of the specialist, like the IEs and the economists. The IRS always advises us to work up the chain to fix these things. But it does not work. For example, the Team Coordinator says he knows nothing about international. The Case Manager defers to the International Manager. The International Manager always backs up the IE. The Branch Chief always supports the International Manager. Who's next in line? Each time you go up the chain of command, you create nothing but more animosity between you and the IE." (3) We note that the final report of the IRS's Task Force on Examination Settlement Authority proposed that the IRS provide adequate, timely training on the recommended changes to the Examination function's settlement authority; that the IRS reach out to stakeholders through appropriate publications, speeches, and meetings; and that the IRS define performance measurements to show the effect of the recommendations on increasing voluntary compliance, reducing taxpayer burdens, and increasing customer satisfaction. During the liaison meeting, we invite discussion on the implementation of the Task Force's recommendations, especially in respect of the IRS's training initiatives and its outreach to the affected taxpayers through TEI and other means. (4) Regrettably, the gold at the end of the rainbow often turns out to be nothing more than pyrite, and the cost of the journey - to both taxpayers and the IRS - can be substantial. More fundamentally, there is a better way. Taxpayers report (and we understand the IRS's own data confirm) that progress is being made when the examining agent discusses an area of inquiry with the taxpayer before the IDR is issued; this process permits the agent to narrow the scope of the IDR, thereby reducing not only the burden on the taxpayer but also the volume of documents that the (5) See, e.g., "Omnibus Funding Bill Contains Clarification that SAIF Fee Is Fully Tax Deductible," BNA Daily Tax Report, DTR No. 191 (Oct. 2, 1996), at G-3. (6) Almost from the issuance of Rev. Proc. 91-59, TEI worked with IRS representatives to develop a revised revenue procedure, which minimized taxpayer burden while assuring the IRS's access to sufficient information to conduct its examinations. Following a series of meetings, TEI submitted a proposal to the Commissioner in July 1993, which in turn prompted additional meetings between TEI representatives and both National Office and field personnel. The outgrowth of these additional meetings was yet another, collaboratively developed proposal, which was submitted to the IRS for its consideration in November 1993. TEI remains supportive of efforts to revise Rev. Proc. 91-59 (as well as to issue a digital imaging procedure) and invites the IRS's suggestions on how the Institute can facilitate the issuance of a revised revenue procedure.