A view from the trenches: a former IRS executive reflects on trends in tax administration.
Shortly after he left the IRS, The Tax Executive sat down with Mr. Brazzil to ask his views on a number of tax administration issues. Excerpts from that interview follow. (Disclaimer: The views expressed in this interview do not constitute tax, legal, or other advice from Deloitte Tax LLP.)
Q: What do you see as the IRS's focus for the next couple years?
A: The IRS is placing a strong focus on its renewed commitment to ensuring taxpayer compliance through a combination of increased customer service and enforcement activities as reflected by the new guiding principle, Service Plus Enforcement Equals Compliance. Areas of emphasis will include case closures, application of planned time in the tax shelter program, resolution strategies, cycle time improvements, and promoter audits.
The IRS will continue to address "abusive" tax shelters and other tax avoidance transactions, possibly by offering additional settlements similar to the "Son of Boss" initiative, which ended earlier this summer. Announced statistics show that a significant number of taxpayers known to the IRS have filed elections under the settlement. The IRS is moving toward increasing audit activity to identify new tax shelters, seek legislation to curb abuses, identify tax shelter promoters and investors, and establish a process for reporting such transactions. Taxpayers may also see changes in penalties and the statute of limitations with regard to tax shelters. The IRS will also be scrutinizing charitable organizations to determine whether they are being used to avoid tax.
The IRS will focus on strengthening its role in corporate governance and its relationship with the Securities and Exchange Commission (SEC) to deal more effectively with corporate ethical breaches and other issues prompting earnings restatements and other compliance concerns. The IRS is also reviewing the professional standards for practitioners and will introduce new guidance in Circular 230 in the near future.
Globally, the IRS is focusing on cross-border transactions and the use of foreign entities to avoid paying taxes. They will work toward establishing cooperative agreements and stronger alliances between countries.
In the Coordinated Industry Case, or large case, community, the IRS will push toward more efficient compliance activity in both scope and depth through more contemporaneous interaction. There will be greater attention paid to listed transactions to determine the propriety of settlement offers and to develop strategies for additional legislation.
Finally, the IRS is focusing on payment compliance and collection. The agency is trying to bridge the gap between what is owed and what is collected. It is evaluating the use of private agencies to assist with collection efforts.
Q: How has the character of large corporate audits changed?
A: Since the restructuring of IRS and the creation of the Large and Mid-Size Business Division, there has been an evolution in the approach taken to conduct large corporate audits. Most noteworthy is the shift from resource-driven plans to an issue-focused approach. The use of risk assessments based partially on industry-specific knowledge has reduced audit scopes and facilitated much more efficient audits. There is much more focus on cycle time and, concomitantly, expected response times for documentation requests; simultaneously, IRS leadership is pressing for proper (likely more frequent) use of enforcement tools such as summonses and penalty administration. Specialists are being brought in at the very early stages of planning and share a heightened sense of urgency. While audit plans might designate fewer issues to examine, complexity will remain and the IRS will need to continue its effort to refine audit techniques.
Tax directors should expect the IRS to continue to identify ways to leverage efforts of other governmental agencies, for example, the SEC, and other oversight bodies, such as the Public Company Accounting Oversight Board, to more quickly identify areas of risk as well as to become dramatically more current.
Q: What challenges lie ahead for the LMSB as an organization?
A: At the top of the list is maintaining, even enhancing, the interaction between the IRS, Practitioner Organizations, and Taxpayers despite significant turnover in the senior executive ranks and in the field. Additionally, the IRS will continue to be tested by the large number of experienced revenue agents who are or will become eligible for retirement in the near future.
The assimilation of new agents hired into the workforce will pose challenges for the IRS as well. The IRS has attempted to address this challenge by hiring experience individuals, including several former TEI members, as revenue agents. My experience with hiring experienced individuals has been a positive one. Hiring highly qualified professionals with both advanced degrees and significant corporate experience has allowed the IRS to increase audit coverage outside the CIC arena. These individuals have been effectively integrated into the audit team.
The IRS may be challenged with handling the influx of Form 8886, Reportable Transactions. The reporting requirements are broad and will produce numerous disclosures being made by taxpayers. The IRS will have the task of sorting through submissions to eliminate unneeded data and add focus on matters of concern. Some of the categories of Reportable Transactions will likely provide disclosures on normal, every-day transactions that the IRS need not and will not wish to scrutinize. Determining the appropriate screening techniques and filtering unessential information will be an ongoing compliance (and resource-management) challenge. The IRS has already made significant improvement to its reporting regime based on taxpayer input. The Schedule M-3, Net Income (Loss) Reconciliation for Corporations with Total Assets of $10 Million or More, may prove to be a viable substitute for disclosing significant book-tax differences on Form 8886.
Another challenge for the IRS is in achieving its goal of expanding audit coverage to go beyond 1,500 CIC and increase audit consideration for smaller, mid-size companies. To accomplish this audit goal, the IRS may have to seek more resources from Congress.
Q: Pleaser give us your perspective on LMSB's so-called currency or breakthrough initiatives, in general, and in particular, on proposals relating to three topics--document requests, notices of proposed adjustments, and the issuance of summonses.
A: The currency/breakthrough initiatives have focused on reducing the cycle time of an audit and allowing the IRS to audit more current returns. So far, it has been deemed to be effective in accelerating the closure of a large number of cases that contained audit cycles substantially longer than standard. The IRS plans to continue this mindset as LMSB opens new exam activity, scoping audits for maximum efficiency.
Through these initiatives, the IRS is focusing on IDRs and the appropriate response timeline. The IRS has considered various options for setting the response timeline: an absolute timeline (e.g., 15 or 20 days); average response time; or a case-by-case determination based on the facts of the case. The IRS will probably determine that the flexibility at the team level is the most appropriate and practical. Regardless of what approach is adopted, there will still be a strong focus on IDRs and the response timelines. Any delay in responding to the IDR could prompt the issuance of a summons or inadequate records notice.
Another part of the IRS's vision for these initiatives is to improve the quality of, and response time regarding, Form 5701, Notice of Proposed Adjustment (NOPA). The IRS will be issuing NOPAs throughout the examination, as issues are closed. The IRS expects taxpayers to respond timely to these notices and not accumulate them for the end of the audit cycle. A taxpayer's inability to respond timely to NOPAs may reciprocally reduce the IRS's receptivity to granting extensions to respond to 30-day letters.
Q: What is encompassed by compliance reengineering activity?
A: Compliance reengineering is complementary to the breakthrough initiative but is still distinctly different. Compliance reengineering is focused on finding a way to dramatically decrease cycle time, currently averaging 60 months, while moving toward a contemporaneous, or real-time, interaction coupled with the traditional approach to audit activity. Some of the objectives are to (1) identify compliance areas of concern earlier; (2) seek resolution on a broad scale in a timelier manner; and (3) shift the focus to pre-filing interaction.
This activity includes moving toward electronic filing for large companies. In the short-term, the IRS is seeking the capability to scan tax returns and provide them to agents in the field more quickly than the 22 months it now averages. Electronic filing of returns will allow the agents to perform a comparative analysis between years to determine any unusual shifts in accounts.
With the advent of the Schedule M-3, more information will be disclosed on the return, which will enable the agent to better assess the appropriate scope for audit planning.
Keeping pace with the many changes being considered by IRS spells opportunity for tax executives. Both the IRS and taxpayers stand to gain--less burden, less cost, quicker resolution, certainty and, for some taxpayers, less exposure.
Q: We have heard discussions about a pilot claims project. What can you tell us about this program?
A: The focus of pilot claims project is to determine the most appropriate time and method of dealing with claims that are submitted during the examination. Many revenue agents contend that claims filed too late in the audit delay closure and otherwise disrupt the examination. Ideally, if a claim is filed early enough, it will be considered as part of the audit and not delay the planned closure. The Limited Issue Focused Examination (LIFE) program has mitigated many of the concerns around the timing for filing claims. Under the LIFE program, the agent and the taxpayer agree to a date after which claims will not normally be submitted.
Q: What are your observations of the Joint Audit Planning Process and LIFE programs?
A: The Joint Audit Planning Process is a compilation of good practices, effective techniques, and approaches to creating a positive, more efficient working relationship between the Agent and the Taxpayer. It has aided in scope reduction and promoted a joint effort to identify risk factors and determine how to proceed with the audit. It could dramatically reduce audit scope and dramatically increase audit currency. Taxpayers should try to implement these practices on their audits if given the opportunity.
LIFE takes a risk-based approach to conducting an audit to limit the scope of the examination to the areas of greatest risk of noncompliance. It may have a positive effect on determining the scope of the audit and encouraging currency. As part of the process, the taxpayer and the agent discuss and sign a Memorandum of Understanding (MOU) that sets forth (and makes each party accountable for) timeline commitments and materiality factors. While many taxpayers and agents believe the terms of the MOU should be subject to negotiation (based on the circumstances of each particular audit), currently the instructions to the MOU provide that the document is not to be changed or adapted in particular cases. (The rigidity of the process can be tempered by preparing MOU addendums to adjust the methodology for each audit.)
Q: In your opinion, what is the most successful LMSB initiative?
A: There are two very successful LMSB initiatives--Pre-Filing Agreements (PFA) and Fast-Track Settlement. Both programs have received favorable reviews by users and provide a promising approach to resolving issues. Nevertheless, both programs are underutilized, either because of a lack of familiarity with the programs or because taxpayers taking a "wait-and-see" approach.
The PFA program allows taxpayers to resolve factual issues before filing their return. This program has enjoyed a lot of success since its inception. The biggest challenge for taxpayers using the PFA process is getting accepted into the program. The average time to complete the process has increased over the past couple of years, largely because of the increased complexity of the issues that are being accepted into the program.
Fast-Track Settlement is a non-binding process of negotiation between the taxpayer and IRS agent (or team manager), with an Appeals officer serving as a neutral facilitator. Fast-Track Settlement has provided a staggering reduction in the timeline to close cases. Most recently, the IRS announced that 142 taxpayers were accepted into the 17-month pilot program for Fast-Track Settlement, and approximately $6.7 billion of recommended tax adjustments under dispute were resolved within the 120-day time period established by the program. Through these programs, LMSB is trying to deliver on three expectations: timeliness, fairness/consistency, and reliability.
Q: What do you see as the future for requests related to Tax Accrual Workpapers? Do you foresee IRS requests for Internal Control workpapers in the future?
A: Recently, LMSB Commissioner Deborah Nolan issued guidance revising Part 4 of the Internal Revenue Manual to reflect changes in the policy for requesting tax accrual workpapers. Taxpayers should expect to see an increase in those requests related to transactions considered abusive by the IRS. These changes are consistent with earlier direction as outlined in Announcement 2002-63, but now serve to refocus the field. Internal controls workpapers may be requested in the future to assist the Agent in performing risk analyses to determine the scope of the examination.
Q: Do you see a continued focus by the IRS on transfer pricing?
A: Yes, taxpayers should expect to see more focus by agents on transfer pricing. Taxpayers should expect to see increased activity related to whether pricing studies are contemporaneous and meet the specific requirements laid out in the regulations. Taxpayers can also expect to see an increased willingness by the IRS to recommend penalties.
Q: With the new focus on enforcement, can taxpayers expect to see more penalties being assessed?
A: Penalty consideration will become a routine part of an examination. If penalty thresholds are met, the agent will be expected to develop a clear position on whether a penalty should be asserted. Once an agent recommendation has been developed, it will be reviewed. In LMSB, it is the Director of Field Operations who will provide the review for the penalty decisions. The examiner must justify why they are not recommending a penalty if the exam would normally dictate its application. The review is intended to provide an objective, fair, and consistent application of the penalties.
Q: Do you have any general advice on managing an effective audit?
A: In my opinion, taxpayers should begin to plan for an audit at the time of the transaction. Taxpayers need to anticipate, anticipate, anticipate! Taxpayers should focus on capturing and retaining data and on establishing effective communication with the audit team. A history of cooperation and open communication will be crucial when problems occur in the audit, for example, when the tax department has difficulty obtaining requested documents.
Q: What are the "rules of engagement" and how are they used?
A: The rules of engagement are intended to provide guidance on when and how to escalate issues through appropriate channels. Designed to govern case interactions and involvement by LMSB executives and senior leaders, the rules of engagement are focused on ensuring that decisions are made by the IRS as an overall team not just the top managers. The guidelines differentiate roles and stress that involvement by executives and senior management must be value-added and can be triggered by either the needs of the taxpayer or members of the audit team. They dictates that if an issue is raised too high (too fast), it will be moved back to the appropriate level for resolution. Taxpayers should be cognizant of these rules so they can effectively and efficiently resolve any disputes with the IRS. This approach is well understood within LMSB and should provide comfort to taxpayers concerned about possible backlash by agents for "going over their heads." They also set forth the protocol for handling industry specific issues when an audit is conducted outside the aligned industry.
Q: Any final thoughts?
A: First, the last five years as an Industry Director have been some of the most challenging and rewarding of my entire career, and I've had some great assignments. Getting involved as an Industry Director with professionals from many of the largest companies in the world was a rare opportunity to gain true insights into professional tax administration. I am excited at being able to continue my involvement in tax administration, albeit from a different perspective. The multitude of changes occurring now as well as those on the drawing board will pose a rich mix of challenges and opportunities for corporate taxpayers. I intend to be involved and to contribute where possible and to have a positive influence on reducing burden, cost, and timeliness.
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|Title Annotation:||Robert Brazzil|
|Date:||Jul 1, 2004|
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