In this article, Dolan argues that even though the new design for the IRS Large Business and International Division may give the agency more control over its resources, it may have left taxpayers with fewer options for remediating errors, securing certainty, and obtaining penalty relief.
The information contained herein is of a general nature and based on authorities that are subject to change. Its applicability to specific situations should be determined through consultation with your tax adviser. This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG LLP.
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Much has been written about the way budget reductions have affected IRS performance. Whether evidenced by the taxpayer or practitioner who gets "courtesy disconnected" trying to call the IRS or by the taxpayers frustrated because their audits are repeatedly reassigned to new agents, it is undeniable that our tax administration systems are under stress. While not all that stress flows directly from the shrunken budgets, much of it does. To look behind the cuts is to understand that they are the product of various forces. On one level, the IRS earned some of the cuts the old fashioned way -- the agency messed something(s) up and the appropriators have used the budget to demand change. On another level, some of the budget woes reflect nothing more than the time-honored reality that criticism of the IRS rarely loses votes.
Expecting budget pressures to persist, each IRS operating division was charged by the commissioner with reexamining its organization with the goal of reconciling its concepts of operation with the budget reality and of imagining what the IRS will look like in five years and beyond, its "future state." The Large Business and International Division was the first out of the gate: It announced its new design at the close of 2015, and the organizational structure through which it intends to operate became effective in early February 2016.
At a high level, LB&I intends to transition from its historical focus on comprehensive audits of the largest businesses to a new approach focused primarily on centrally identified tax compliance risk issues. The comprehensive, enterprise-wide audits will not go away entirely, but they will ultimately comprise a smaller percentage of LB&I's work. Under the new approach, once a risk issue is identified (centrally), campaigns and treatments will be designed to address the risks. We don't yet have any real examples of these new campaigns (and some may involve the development of regulations or other guidance rather than enforcement strategies), so it will take time to evaluate their impact. Taxpayers will be especially interested in understanding the practical implications of being selected for a campaign audit or other treatment.
To implement its new focus, LB&I has restructured itself into nine practice areas. The practice areas come in two types. Four are organized based on geography, and the other five are oriented to specific subject matters. As this new structure goes live, one of the overarching questions concerns how the geographic and subject matter organizations will intersect at the level of an individual taxpayer. According to LB&I's master plan, the subject matter organizations are to be deeply involved in identifying and addressing the "risk" issues. At the same time, the geography-based practice areas are to be responsible for the "examination process" and reportedly will include personnel who are most skilled in the examination processes and procedures. For the individual taxpayer, the natural questions are going to be: Who is really in charge of my audit? Will I have access to the technical specialists who are advising the local agents? Is it likely that a taxpayer will effectively be embroiled in multiple, even overlapping issue-focused audits for the same tax year? If so, won't it be more difficult to get a year closed?
The new design is built on a sound concept. Taxpayers and the IRS should spend their time on significant technical issues rather than haggling over temporary or otherwise immaterial issues. However, as straightforward as the shift from enterprise to issue focus might seem, it comes with significant cultural implications for LB&I. For decades, LB&I has focused on the largest enterprises. The highest pay grades and organizational prestige have attached to those that led and worked on the large case teams. It appears that the future state will value technical expertise most highly. Presumably the intent is for the higher grades and prestige to accrue to those who are technical experts and thought leaders and who are willing to coach, mentor, and lead other personnel. LB&I does not anticipate any significant near-term hiring. Therefore, the success of the new approach will depend on its ability to transform its workforce into one that is more technically oriented and issue-focused. Without the infusion of new talent and training dollars, this metamorphosis will require great skill and resolve. And perhaps more than a little time.
A reported driver of the new design is LB&I's desire to exercise more control over how it spends its resources. Rather than automatically committing staffing to recurring cycles of the same large case audits, the new approach is geared to make LB&I more agile and strategic in addressing emerging compliance risks no matter where they exist. If the design works as planned, agents and specialists will be assigned to campaigns and treatments that concentrate on an inventory of specific centrally identified risk issues. While agents will not be precluded from identifying additional issues during an issue-focused audit, the implication is that the additional issue will have to be material in order to expand the audit.
LB&I leadership predicts it will take up to four years for the new concepts of operations to fully evolve. Collateral issues will surely arise throughout implementation. One issue is the potential that the new design could make it more difficult for taxpayers to self-initiate voluntary mitigation of compliance risks.
Before the IRS's last major reorganization following the Internal Revenue Service Restructuring and Reform Act of 1998 (when the agency was structured along geographic lines with districts), it was relatively common for taxpayers and their advisers to approach the IRS in order to voluntarily correct an error or omission. If district personnel considered it in the best interests of tax administration, they would accept the taxpayer's "disclosure," collect any additional tax due, and work with the taxpayer to resolve potential penalty or amended return issues. In large part, this culture of local problem solving was a byproduct of strong institutional relationships built between district personnel and the local taxpayer and tax practitioner communities.
As the IRS shifted its structure from district-based operations to centralized national operating divisions, it became more difficult for frontline taxpayers to access informal voluntary resolution routes. In today's environment, it is very difficult for taxpayers to find IRS personnel who have the authority and willingness to field a voluntary compliance request unless that taxpayer already happens to be under audit.
Given the IRS's desire to control its resources by concentrating its staffing on the highest-risk issues, it may become even more difficult for a taxpayer to self-initiate corrections. While taxpayers can always amend a prior return, that will not be the optimum answer for many. Setting aside the state implications of amending a federal return, the amended return process provides no opportunity for taxpayers and the IRS to deal proactively with mitigating penalties or other procedural burdens. When an amended return is filed, it is usually only after several months and a string of notices that a taxpayer gets access to a live IRS representative.
To be sure, the IRS has created some notable national voluntary disclosure programs like the offshore voluntary disclosure program and the voluntary classification settlement program. These programs, while effective, generally involve substantially more process and bureaucracy than was typically the case with district-level resolutions.
Another example of a national initiative that provides taxpayers and the IRS a somewhat lower-profiled and streamlined way to deal proactively with significant issues is the prefiling agreement (PFA) program.1 Under the PFA program taxpayers can request that the IRS examine an issue before it actually goes on the relevant tax return. Generally a PFA benefits both parties insofar as it facilitates contemporaneous access to the key people and records associated with a significant transaction. The outcome of a successful PFA is before-the-fact agreement on the appropriateness of a specific return position. A PFA eliminates the need for any later audit of the issue and obviates the taxpayer's setting up a financial reserve for any otherwise uncertain tax position. Taxpayers who have successfully concluded PFAs likely wonder what will happen to the process in the IRS's future state.
On the other end of the "helpfulness" spectrum is LB&I's almost automatic, nationalized approach to international information reporting penalties for forms like Form 54712 or Form 5472.3 The environment surrounding these penalties has changed markedly in recent years. Not that long ago taxpayers, with the awareness and at least implicit acquiescence of the IRS, could annotate corporate income tax returns to reflect that international transaction information was "available upon request," and penalties would generally not be assessed for inadvertent failures in which the taxpayers had substantially complied and also had strong internal procedures. Fast-forward to today where the penalty regime calls for assessment of $10,000 penalties for every missing or late form 5471 or 5472. Further, because the penalties are "assessable," they are automatically assessed without any of the taxpayer notice and response features that accompany "deficiency" assessments. Often a taxpayer's first interaction with an IRS representative doesn't come until the assessed penalty is already in the hands of IRS collection personnel. Further, the automatic $10,000 penalty is routinely assessed even if there is no tax due on the related income tax return. When you combine an automatic penalty regime with the lack of taxpayer opportunity to proactively disclose, explain, and mitigate the consequences of potential noncompliance, you run a risk of undermining the very behavior -- self-correction -- that is most essential in a system reliant on voluntary compliance.
Given what is known thus far, it is unclear whether the new LB&I design will further narrow the self-initiated resolution options for taxpayers that are not otherwise under coordinated industry case (CIC) audit or specifically identified for an issue-focused treatment. For example, taxpayers that were previously within the CIC program but are only subject to campaign-based audits are going to miss having the ability to use the provisions of Rev. Proc. 94-69, 1994-2 C.B. 804 . That revenue procedure allows taxpayers under continuous audit to disclose return corrections at the beginning of an audit and thereby achieve "qualified amended return" treatment for penalty purposes without the need for formally amending the federal return.
Even some taxpayers that remain within the CIC program may find their opportunities to correct return positions via informal claims truncated. Under a published draft revision of Publication 5125, Large Business & International Examination Process, informal claims will be limited to those submitted within the first 30 days of the audit. Claims identified after that will have to be submitted as formal amended returns.
As previously suggested, taxpayers could also soon find it more difficult to obtain PFAs in the new environment. While at its peak the PFA program has only entertained a modest number of applications per year, many taxpayers have embraced a PFA to achieve early tax return and financial statement certainty on significant issues. Historically the IRS has been most willing to enter into PFAs when agents were already assigned to the requesting taxpayer's audit. Conversely, it has been more difficult to secure a PFA when agents were not already assigned to a taxpayer. As LB&I conducts fewer CIC audits and is more concerned with controlling how it spends its resources, PFA applications may well be declined for "lack of resources."
Make no mistake: It is both prudent and important for the IRS to invest its resources in ways that produce the best return on its investment (ROI). Enhanced compliance is presumably the ultimate measure of that return. Unfortunately, the easiest piece of the compliance puzzle to measure -- proposed audit adjustment dollars -- is, at best, only a partial measure of that return. In reality, the ROI is greatest when IRS action prompts wholesale positive change in compliance behaviors. ROI is also improved when compliance risks are addressed early rather than after they have become more insidious.
The LB&I redesign wisely envisions use of a spectrum of treatments in addition to audits. Toward that end, compliance clearly benefits when taxpayers come forward voluntarily to disclose and resolve potentially uncertain issues. The challenge for the IRS will be to create avenues and metrics within its "future state" that not only drive its issue-focused agenda but, as important, accommodate the interests and needs of responsible taxpayers who want to do the right thing.
The national taxpayer advocate and others have argued passionately that individual taxpayers require and deserve better access than the IRS currently provides. As correct and compelling as those arguments are, similar issues exist for LB&I's constituents -- large businesses whose operations and attendant tax obligations implicate some of the most complicated provisions of the code. Any future IRS state that doesn't include practical opportunities for business taxpayers to voluntarily declare, clarify, disclose, and remedy compliance risks will miss a powerful opportunity to enhance the overall return on IRS investment in improved compliance.
1 Rev. Proc. 2009-14, 2009-3 IRB 324.
2 Form 5471, "Information Return of U.S. Persons With Respect to Certain Foreign Corporations."
3 Form 5472, "Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business."
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