LMSB's Compliance Assurance Program (CAP): one year later.
The Large and Mid-Size Business Division is one of four primary operating divisions of the IRS and serves corporations, subchapter S corporations, and partnerships with assets greater than $10 million. LMSB taxpayers include the nation's largest corporate employers, many with workforces numbering in the hundreds of thousands. LMSB taxpayers conduct their businesses in an increasingly global environment, routinely dealing with highly intricate legal, accounting, and tax law issues. Their tax returns tend to be complex and voluminous, and LMSB's examinations of those returns can take months or years to complete. LMSB's business operations are structured to support the IRS's overall goals of improving taxpayer service, enhancing enforcement of tax laws, and modernizing the agency through its people, processes, and technologies.
Within LMSB, the goal of improving service to taxpayers generally means completing audit work faster and more efficiently; achieving high standards of performance," ensuring that personnel are well trained and equipped to do their jobs; and reducing administrative burdens placed on taxpayers to the greatest extent possible. The goal of enhancing enforcement means identifying and addressing areas of high compliance risk through examinations and other means; it also means encouraging non-compliant taxpayers to follow the law and meet their tax obligations. The modernization goal generally means finding ways to streamline the tools, systems, and processes LMSB employees use every day to do their jobs.
LMSB tracks its ongoing performance through a variety of business measures and indicators, including taxpayer and employee satisfaction, and examination coverage, timeliness, duration, and quality.
In March 2005, the Internal Revenue Service's Large and Mid-Size Business (LMSB) division launched a small pilot program to assess the viability of a new, alternative approach to large corporate tax administration. This approach--known as the Compliance Assurance Process (CAP)--has attracted growing interest, particularly from corporate taxpayers intrigued about its potential to simplify and streamline corporate tax examinations.
The CAP approach is structured to leverage new corporate governance and financial reporting requirements imposed by the Sarbanes-Oxley Act of 2002. Under CAP, a taxpayer works cooperatively with LMSB revenue agents in a pre-filing environment to resolve issues of tax controversy and to determine the proper tax treatment of completed transactions. The taxpayer provides information to the IRS about completed transactions and events that may affect the taxpayer's tax liability. In exchange for increased cooperation and transparency, the taxpayer enjoys the possibility of achieving tax certainty sooner--and with less administrative burden--than has previously been possible through conventional post-filing examinations. The IRS also benefits from CAP, in terms of reduced resource burdens and the ability to identify emerging taxpayer issues and compliance risks more readily.
Seventeen corporations volunteered to participate in the 2005 CAP pilot, and all have signalled their desire to continue through a second tax cycle in the 2006 CAP pilot. While it is too early to assess CAP's long-term viability, early program results are encouraging. In the coming year, LMSB hopes to add roughly 20 more large corporate taxpayers to the pilot.
Why CAP? Why Now?
It is no secret that traditional post-filing examinations for large corporations tend to be time-consuming and resource-intensive, for taxpayers and the IRS alike. Such examinations necessarily require a retrospective accounting of a taxpayer's prior business decisions, completed transactions, and tax behaviors. Typical post-filing examinations begin months or even years after the tax return filing; once underway, they can take years to complete. Depending on how far in the past an examination focuses, administrative and financial burdens on taxpayers can be significant.
Throughout the examination process, LMSB revenue agents issue data requests to taxpayers for more detailed information pertaining to various items on their tax returns. Taxpayers often have to sift through years of old financial and tax records in an effort to provide the requested information or to reconstruct the circumstances leading up to particular business decisions and transactions.
Perhaps equally significant, when issues under examination remain unresolved for extended periods, taxpayers may be obliged to maintain tax reserves on their books in anticipation of an exam outcome. In some cases, this can affect the corporations' financial statements, reporting, and even share price.
Since its formation in 2000, LMSB has taken various steps to streamline corporate examinations. Early on, LMSB adopted an "issue management" strategy focused on identifying, coordinating, and resolving complex and significant industry-wide issues on a more current basis through use of published guidance and administrative approaches. As part of the issue management approach, LMSB introduced various specialized audit tools and compliance processes designed to more quickly resolve issues of controversy. These include the Pre-Filing Agreement, in which taxpayers and the IRS come to a formal agreement on the treatment of specific tax issues before a return is filed; coordinated issue papers, in which IRS Counsel provides guidance on specific topics to promote uniform application of tax law; the Limited Issue Focused Examination, in which the IRS conducts a risk analysis and limits its tax examination to specific material issues determined in the analysis; and the Fast Track Appeals process, in which the IRS Appeals Division works in conjunction with the examination team and taxpayer to expedite settlement of remaining issues of controversy. All of these approaches have proven valuable to taxpayers and contributed incrementally to improved timeliness, shorter examination cycles, and reduced taxpayer burden.
In 2003 and 2004, LMSB undertook an "inventory sweep," with the intention of removing over-aged and unproductive returns from LMSB's inventory of unexamined returns. LMSB was able to retain for examination those returns that appeared to present the highest compliance risk, while de-selecting others that were of less compliance concern. This allowed LMSB to focus its examination resources on more current areas of risk. The inventory sweep constituted another effort to streamline corporate tax audits, reduce burden, and strengthen compliance.
During December 2003 and January 2004, LMSB's leadership conducted a comprehensive business process review to generate additional ideas for streamlining the examination process, improving exam coverage, and reducing taxpayer burden. They invited LMSB's traditional external stakeholder groups to present taxpayers' and practitioners' perspectives in the discussions. The assembled group evaluated various opportunities, including ways to leverage the increased corporate governance and SEC reporting requirements occasioned by the Sarbanes-Oxley Act. A small working team formed to move concepts forward to actual plans. They established guidelines that included:
* encouraging collaborative relationships to increase transparency and sharing of information;
* establishing an IRS single point of contact for issue and account payment resolution;
* minimizing taxpayer burden through ongoing monitoring and review of transactions and significant economic events;
* focusing limited resources on high-risk taxpayers and issues;
* ensuring an absolute commitment to preserving audit quality and maintaining integrity; and
* resolving issues through an accelerated and efficient process before filing the tax return.
Over a period of months, the working group developed an entirely new concept for corporate compliance reviews, an approach that differed significantly from the traditional examination. The new process was dubbed the Compliance Assurance Process or CAP.
How CAP Works
The Compliance Assurance Program requires extensive communication and cooperation between the IRS and participating taxpayers. Throughout the tax year, taxpayers are expected to engage in full disclosure of information concerning their completed business transactions and material issues. By participating in this program, taxpayers may achieve tax certainty sooner than is possible through the conventional post-filing audit process.
CAP combines proven approaches used in the Pre-Filing Agreement and Limited Issue Focused Examination processes. It also provides the IRS with more timely information concerning taxpayer compliance issues and risks.
Early in the CAP cycle, a taxpayer enters into a Memorandum of Understanding (MOU) with the IRS. The MOU outlines roles and responsibilities for both parties, describes the process that will be followed, including communication and disclosure responsibilities, and enables the taxpayer and the IRS to discuss collaboratively the scope of the CAP review. (The ultimate decision of identifying issues for the compliance review, however, remains within the discretion of the IRS.)
After the MOU is signed, the IRS works with the taxpayers during the year to identify and attempt to resolve potential issues relating to the tax return for that year. An LMSB Account Coordinator is assigned to the CAP taxpayer. Responsible for managing the CAP cycle, the Account Coordinator conducts a taxpayer risk analysis using taxpayer-provided data and information collected from a variety of third-party sources, including SEC filings, taxpayer annual reports, and news stories. The risk analysis informs the Account Coordinator about the taxpayer's recent business activities and transactions and provides a better understanding of the taxpayer's overall business environment.
As the CAP year progresses, the Account Coordinator reviews the taxpayer's significant business transactions in accordance with the materiality thresholds established in the MOU. As issues are resolved, the Account Coordinator documents the issue resolution and tax treatment in an Issue Resolution Agreement (IRA). If the Account Coordinator and the taxpayer have difficulty resolving an issue, the parties may use existing IRS resolution processes, such as Fast Track Appeals. After the close of the tax year, the Account Coordinator will incorporate the resolved issues into Form 906 closing agreements, based on the completed IRAs.
Transparency and communication are essential elements of the CAP approach and are emphasized in the MOU. The taxpayer enters CAP with the expectation of openly and willingly disclosing pertinent information to the Account Coordinator on the issues and completed transactions under examination. The Account Coordinator enters with an expectation of having to actively partner and communicate with the taxpayer, efficiently manage and coordinate information data requests, and keep the exam process moving forward to its conclusion. A taxpayer may be removed from the CAP program for failing to comply with the terms of the MOU, and a taxpayer who is dissatisfied with the performance of the account coordinator may escalate its concerns to LMSB senior management through established rules of engagement.
At the conclusion of the CAP cycle, the Account Coordinator reviews the agreements reached with the taxpayer on various issues examined during the CAP cycle. If the taxpayer has fully complied with the terms of the MOU, all identified issues have been resolved through closing agreements, and the Account Coordinator has verified the substantial accuracy of the proposed return, then the IRS will provide the taxpayer with written confirmation that it will accept the taxpayer's return, as long as it is filed in a manner consistent with any closing agreements and no post-filing examination is required for that tax year. This type of written confirmation is known as a "Full Acceptance Letter."
On the other hand, if the taxpayer has fully complied with the terms of the MOU, but the IRS and the taxpayer cannot resolve all identified issues prior to filing the tax return, the IRS will provide the taxpayer with written confirmation that it will accept the taxpayer's return with respect to the resolved issues, as long as the return is filed in a manner consistent with any closing agreements and no post-filing examination of those resolved issues is required for that tax year. This type of written confirmation is known as a "Partial Acceptance Letter."
After the taxpayer files the return, the Account Coordinator will conduct a post-filing review of the return to verify that all of the items resolved via Form 906 closing agreements were reported as agreed, and ensure that all of the issues having a material effect on the taxpayer's federal income tax liability for the CAP year were identified. If the post-filing review reveals that all the material issues were identified and resolved, the IRS will issue a "No Change Letter," concluding the examination of the taxpayer's books for the purposes of Code Sec. 7605(b).
In contrast, if the post-filing review reveals that the return is not consistent with the terms of any previously executed Form 906 closing agreements, or if the taxpayer has reported items on its return that were not adequately disclosed in during the CAP cycle, the IRS will conduct an issue-focused examination on the newly identified and unresolved issues. The IRS will continue to examine all outstanding unresolved issues, and the taxpayer will retain access to all available Appeals proceedings to resolve any remaining issues.
Throughout the CAP cycle, the Account Coordinator and IRS Counsel work together to resolve CAP issues and taxpayer concerns. IRS Counsel provides legal guidance to Account Coordinators in a variety of areas, including Sarbanes-Oxley provisions (including section 404); Announcement 2005-87 clarifying CAP tax return information as it relates to section 6103; preparation of Issue Resolution Agreements and Form 906 Closing Agreements; and more.
On December 12, 2005, the Chief Counsel issued Announcement 2005-87, formally announcing the CAP pilot and describing its function. LMSB continues to work closely with Counsel to improve the efficiency of legal guidance for complex issues encountered during the CAP process.
Taking Stock: Status of the CAP Pilot
Even though the CAP pilot has been in progress for less than a year (i.e., not a full tax cycle), the program has achieved notable successes. To date, CAP teams have issued a total of 13 IRAs, with 11 more in process, and one Full Acceptance Letter. The Full Acceptance Letter was followed by a post-filing review, at the conclusion of which the Account Coordinator issued the taxpayer a No Change Letter, signifying that no further examination would be required for that year's tax return.
CAP exam teams are reporting an average of eight material issues per taxpayer. In some cases, taxpayers themselves have identified issues, for example, their intent to utilize the foreign earnings repatriation provision of section 965 and the manufacturing deduction under section 199 (both enacted as part of the American Jobs Creation Act), as well as acquisitions and recapitalization issues. In other cases, CAP teams have identified issues, such as transaction costs, transfer pricing, research credits, golden parachutes, and self-constructed assets such as depreciation of interests.
During the summer of 2005, LMSB hired an independent research firm to survey CAP taxpayers to better understand their reasons for participating in the pilot and factors influencing their overall satisfaction. Fourteen of the seventeen CAP taxpayers participated in the survey.
Overall, the survey confirmed that taxpayers are satisfied with their CAP experiences, in particular, their working relationships with CAP Account Coordinators. Most taxpayers described the IRS's commitment to CAP as strong and commented positively on their interactions with the CAP teams regarding information requests. The majority envision CAP as a way of doing business with the IRS in the future, and all expressed their desire to continue in the program in 2006.
Participants reported the opportunity to achieve tax certainty sooner and the ability to focus on current issues as primary factors driving their interest in the program. They cited mutual cooperation, open communications, trust, and focus on significant issues as some of the keys to CAP success.
IRS CAP team members also reported positive impressions. Account Coordinators and revenue agents stated that CAP participants had been generally transparent in their dealings with the IRS, and had demonstrated openness with respect to their completed, current, and upcoming transactions and issues. Many taxpayers revised their internal procedures for obtaining data to ensure it could be provided to the CAP teams in a timely manner. One Account Coordinator summarized his satisfaction, as follows: "CAP is an approach that works, especially because taxpayers and agents work in a positive and cooperative atmosphere."
While CAP's performance to date has been strong, some concerns remain, many of which reflect the "newness" of the CAP approach and the inevitable learning curve that accompanies any new process. CAP taxpayers are expected to be forthcoming and transparent in their dealings with the IRS and demonstrate a genuine interest in resolving their issues. Some have had to adjust their expectations about working cooperatively with the IRS, though this appears to be going fairly well. Some concerns focus on developing a better understanding of materiality thresholds, handling confidential information, and being more aware of the effect of' the CAP approach on taxpayer resources. Others center on the timeliness of technical and issue guidance, the need to build stronger relationships with field specialists, and the importance of ensuring that resources are adequately allocated to support completion of audits in a timely manner. LMSB has been working to address these concerns, and will continue refining and adjusting the pilot as necessary.
LMSB plans to expand participation in CAP during the coming year. The next phase of the pilot will focus on:
Maintaining open lines of communication between CAP examination teams, taxpayers, and IRS National Office functions to better address unanticipated issues as they arise;
* Extending CAP training to other LMSB examination groups to prepare them to work CAP cases;
* Investigating ways to expedite issue resolution on issues that are occurring in real time;
* Ensuring that IRS technical, specialist, and support resources are available when needed;
* Continuing to work with field specialist management to better integrate field specialists into the overall CAP process; and
* Exploring ways to minimize the effect of rotational requirements for auditors.
LMSB will closely monitor the CAP pilot, seeking ongoing feedback from participating taxpayers and agents. While it may be too soon to fully evaluate CAP's potential for reducing taxpayer burden or enabling LMSB to shift compliance resources to higher-risk taxpayers and issues, early results appear promising.
For the first time ever, corporate taxpayers are working cooperatively and transparently with LMSB agents to resolve their tax compliance issues and complete their tax examinations in a pre-filing environment.
Of course, much more work needs to be done. Even at this juncture, it is clear that CAP represents a bold, exciting development in the evolution of corporate tax administration, one that advances the IRS's goals of improving service to taxpayers, enhancing enforcement of tax laws, and modernizing business processes and systems.
IRS Benefits * Eliminates need for post-filing examination --Saves time and resources --Resolves issues prior to filing --Creates real time environment * Provides quicker guidance to tax issues --Addresses emerging issues consistently and contemporaneously --Avoids potential controversy * Serves to potentially reduce prolonged litigation * Complements current corporate governance and accountability responsibilities --Enhances corporate reputation --Enhances tax reserve integrity affecting financial statements reporting --Increases investor confidence * Improves tax administration --Rewards compliant behavior --Focuses on material issues --Improves the audit process Taxpayer Benefits Time and Resources * Reduces potential for post-filing examination --Resolves issues prior to filing --Creates real time environment * Provides quicker guidance to tax issues --Addresses emerging issues consistently and contemporaneously --Avoids potential controversy * Serves to potentially reduce prolonged litigation * Improves tax administration --Rewards compliant behavior --Focuses on material issues --Improves the audit process Taxpayer Benefits Tax Return Certainty * Increases certainty of tax liability by tax return filing date --Consistent with the financial statemen model --Contemporaneous sharing of information --Collaboration in real-time resolution of issue(s) * Achieves currency for that year and enable the taxpayer to close books * Complements current corporate governance and accountability responsibilities --Enhances tax reserve integrity impacting financial statements reporting --Facilitates compliance with Sarbanes-Oxley --Provides certainty that the return is compliant with tax laws --Enhances public/investor confidence and corporate reputation
Ms. Nolan is the Commissioner of the Internal Revenue Service's Large and Mid-Size Business Division.
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|Title Annotation:||Large and Mid-Size Business Division|
|Author:||Nolan, Deborah M.|
|Date:||Jan 1, 2006|
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