ISSUE ONE: LB&I EXAMINATION PROCESS

The Internal Revenue Service introduced the Large Business & International Examination Process (LEP) in 2016. Designed to provide an organizational approach for conducting efficient examinations from the first contact with the taxpayer through the final stages of issue resolution, LEP is described in IRS Publication 5125 (2-2016). See also IRM 4.46 LB&I Examination Process. Many aspects of LEP are working well; in particular, LEP has resulted in closer collaboration on the formulation and issuance of Information Document Requests (IDRs). The LB&I subgroup understands that the IRM is in the process of being revised to reflect the new issue-based “campaign” initiative  and that additional changes will likely be made to LEP as LB&I gains experience with the campaign process.

Following discussion with LB&I, the subgroup determined to provide comments and recommendations on three aspects of LEP:

1. Metrics—What metrics can be used to measure the effectiveness of LEP?
2. AOF—Part of the LEP is the Acknowledgment of Facts (AOF) presented to the taxpayer by the examination team for unagreed issues. How can the AOF process be improved?
3. Coordination and Communication—How can communication and coordination in LEP be improved to ensure efficient and timely closure of examinations?

In developing its recommendations, the subgroup invited input from other professional colleagues including Tax Executives Institute members, other tax advisers and LB&I taxpayers, but the comments below represent the views of the IRSAC itself.

Metrics

Based on the work of the subgroup, the IRSAC believes that qualitative and quantitative metrics are needed to assess both how well LEP is working and to identify possible improvements. Qualitative metrics could be obtained through post-examination surveys seeking taxpayer and examination team feedback on what worked and did not work in the process. To ensure candid feedback, it may be best that the surveys are submitted to a third party or other group that has not been involved in the taxpayer examination. When aggregated with data from multiple taxpayers, the feedback could be helpful for identifying systemic issues and areas for improvement. It could also be useful to improve subsequent examinations of a particular taxpayer.

There are several areas where quantitative measures could be helpful, beginning with determining the effectiveness of the examination plan. One of the key aspects of LEP is the preparation of an examination plan that articulates the issues to be examined, lays out a timetable for the examination, and identifies the personnel involved. While the presence or absence of particular factors may not, by itself, signal the optimal (or suboptimal) application of the LEP, the IRSAC believes that in measuring the effectiveness of the planning process, the following metrics be considered:

• Was the examination completed on time (measured by the initial examination plan)? If not, were the reasons for the variance from plan discussed by the parties and documented in the case file?
• Were extensions of the statute of limitations required? If so, why, how many, and for how long?Were new issues raised that were not included in the initial plan? What resources were devoted to these issues? Was the reason for the addition of the new issues documented in the case file?
• Were IRS subject matter experts (e.g., economists, counsel, computer specialists) involved in the examination who were not identified in the initial plan?
• How many of the issues not included in the initial plan resulted in tax adjustments?

Monitoring these factors, and following-up when appropriate, will help determine how effective the planning process is, identify ways in which planning can be improved, and make the examination run more smoothly.

Quantitative measures associated with the conduct of the examination could also be helpful:

• Average time IDRs are outstanding.
• Average time elapsed after an IDR response is submitted for the IRS to inform the taxpayer whether the response is complete or additional information is necessary.
• Time elapsed after all IDRs are answered for the examination team to issue a Notice of Proposed Adjustment (NOPA) or inform the taxpayer that there will be no adjustment.
• Average time between referral to a subject matter expert and receipt of advice. Form of advice received.
• Average time to close a case.

It may also be desirable to capture information on the effort required relative to the tax compliance achieved. Some issues are complex and require extensive factual development before the correctness of the taxpayer’s position can be assessed. Sometimes, of course, the result of the exercise is a NOPA and a proposed assessment that is ultimately sustained (in Appeals or court). Other times, however, there may be considerable time spent when, at the end of the day, there is no adjustment. Voluntary compliance is the ultimate goal, but the amount of resources to achieve that goal must also be considered.

On the one hand, devoting significant time and resources to issues that do not produce adjustments could be a sign that LEP is not working well. On the other hand, agents should not be discouraged from dropping (“no-changing”) issues that are without merit. The IRSAC is concerned that if the IRS tracks IDRs or time spent relative to the dollar amount of NOPAs issued, agents may become so invested in a particular issue their assessment of the merits of that issue becomes skewed. Thus, we urge the IRS to consider this balance in fashioning any metrics.

Acknowledgment of Facts (AOF)

The LEP provides a process for the examination team to provide a statement of facts related to an unagreed issue and ask the taxpayer to acknowledge those facts are accurate. The goal of the AOF process is to ensure that all facts have been developed to facilitate resolution of the issue, either during the examination or, if the issue goes to Appeals, without the case needing to be referred back to the examination team for further factual development. In some cases, the AOF process has proven problematic, and we recommend the following to help achieve the intended result:

• Require a clear description of the legal issue. It may not be possible to know what facts are relevant without a clear exposition of the legal issues involved. In the proffered AOF, the examination team should explain what the legal issue is before setting forth the relevant facts.
• Ensure the AOF posits facts and not legal arguments. Some examination teams use the AOF as an advocacy piece to get the taxpayer to accept their legal theory. The AOF should be limited to facts.
• Include all relevant facts. The AOF should include not only the facts relied upon by the examination team, but also those considered relevant by the taxpayer. Discrepancies may arise because each has a different view of the issue. They may also arise because the examination team views a particular piece of evidence (e.g., an email) as proving a fact, while the taxpayer believes that other evidence must also be considered before a fact is established. We understand that the process allows the taxpayer to present additional facts for inclusion or to separately state disputed facts, but not all taxpayers understand they have those options.
• Provide training. This is a complex area and examination teams may need additional ongoing training to better understand the process and the intended goals. Taxpayers may also benefit from better information on the process, including, if appropriate, access to training materials.

Communication And Coordination

While the goals underlying the LEP are laudable, many taxpayers have expressed concern that the LEP can result in inefficiencies and failure to close examinations in a timely manner because of the number of IRS parties involved, the sufficiency of the coordination among those parties, and the lack of access and transparency between them and the taxpayer. Taxpayer examinations can be delayed for any number of reasons (some attributable to taxpayer actions, IRS actions, or outside factors), but communication and coordination are key to managing expectations and ultimately achieving good results.

An examination of a large taxpayer can raise complex procedural and substantive issues. To address this, the examination team may involve a number of experts—Chief Counsel, International Agents, Economists, Practice Networks – including those involved in campaigns. The large number of people involved complicates coordination and communication efforts, and may make it difficult to meet agreed timetables. The involvement of a large number of people and the importance of coordination are not new challenges. The IRSAC believes it is in the interest of both the IRS and the taxpayer to conclude examinations promptly. Information is more readily available the closer in time the examination is conducted to the tax year in issue. It also provides earlier financial certainty for the taxpayer.

Recommendations

The IRSAC has the following suggestions:

1. Identify all personnel working on a case.

The IRS examination team should identify any personnel working on a case as they are engaged and the case manager should facilitate direct contact between the taxpayer and those personnel when appropriate.

2. Identify the “decision maker” for each issue.

It is often not clear who has the ultimate say so on a substantive issue. The IRS should decide who that individual is and tell the taxpayer.

3. Make a single examination manager accountable.

Give the case manager or other identified person express authority over administrative aspects of the case, i.e., over everything other than substantive tax matters. This would include examination scope, materiality thresholds, years under examination, cycle time, IDR timing and volume, and all other organizational aspects of the examination. That individual should then be held accountable for smooth conduct and timely closure of the examination. Diffusing this authority, or failure to hold individuals accountable, is a recipe for delay. The case manager will need to take initiative to ensure regular calls or meetings with the IRS personnel involved as well as regular communication with the taxpayer. The case manager should also monitor the examination for instances of steadfast examiners or resistant taxpayers and take early action to rectify such situations.

ISSUE TWO: CAMPAIGNS

LB&I requested that the subgroup consider how LB&I can gain external feedback throughout the campaign process to ensure external comments are considered by LB&I so appropriate adjustments can be made to individual campaigns and the campaign process in real time.

Background

Due, in part, to decreased funding and staffing, LB&I has undertaken a major reorganization a principal aspect of which is to transition much of its examination work from its historical enterprise-based examination system to a more issue-based system. A key aspect of this revised approach is LB&I’s focusing less on traditional examinations of large taxpayers and more on issue-specific compliance “campaigns.” According to TIGTA’s report, “The Large Business and International Division’s Strategic Shift to Issue-Focused Examinations Would Benefit From Reliable Information on Compliance Results,” No. 2016-30-089 (Sept. 14, 2016), LB&I indicated that the majority of the future examination workload will be selected using “campaigns.”

The campaign approach shifts the task of identifying issues from revenue agents in the field to a more centralized risk-based assessment approach relying on the expertise of subject matter experts. LB&I published an agile development model, which features an “integrated feedback loop,” to demonstrate how LB&I will identify, develop, and adapt to new compliance issues. The integrated model illustrates how LB&I will use data analysis, as well as feedback from examiners (and other participants in the process), to identify areas of potential non-compliance for campaign consideration. An initial analysis is performed to describe and scope the issue, for example, determining the number and types of tax returns potentially involved, the resources required to address the issue, and whether the issue involves permanent or temporary change in tax.

If the scoping phase indicates that the non-compliance issue is potentially significant, the campaign development phase will begin. The potential campaign issue will be referred to the appropriate IRS Practice Area to analyze the legal authorities involved, determine what training will be necessary, study the resources necessary to address the issue, consider the best treatment streams to bring taxpayers into compliance, and determine the tax return population with the issue present. Potential campaign issues are then presented to the Compliance Integration Council, which includes LB&I leadership, for consideration and approval. As part of the approval process, the council considers whether additional information is necessary or changes to the potential campaign are required, and whether resources exist within LB&I to address the issue.

After a campaign is announced LB&I moves to an execution phase by contacting the taxpayers whose returns include the campaign issue, applying the treatment streams, and resolving cases. The LB&I leadership assigned to each campaign hosts “network” calls with agents examining taxpayers with the campaign issue. The progress of each campaign will be monitored by LB&I (using various metrics) to determine whether taxpayer behavior is changing as a result of the campaign or if different treatment streams (including revised forms, published guidance, etc.) will be required to accomplish the goals. The monitoring phase is also important to determine whether resources are being used efficiently or changes are necessary.

The first set of campaigns was announced on January 31, 2017. LB&I identified 13 campaigns involving various types of non-compliance concerns. LB&I has publicly stated that it will continue studying additional potential non-compliance issues and add new campaigns in the future. LB&I has emphasized that the “integrated feedback loop” has an external as well as an internal facet. Hence, LB&I has stressed the importance of working with taxpayers and the practitioner community to ensure its views regarding various issues that may or do present risks are properly articulated.

LB&I has also pledged to maintain a dialogue with taxpayers, practitioners, and other stakeholders on campaign development and other important tax administration issues. As part of its efforts to promote transparency and an understanding of the campaign process and the initial tranche of campaigns, LB&I sponsored a number of webinars to explain the new campaigns and allow external stakeholders to ask questions.

Recommendations

In developing its recommendations, the subgroup met with LB&I executives, studied articles, press, and other publications discussing the campaign approach, and collected feedback directly from taxpayers, tax practitioners, and other external stakeholders. Based on the subgroup’s work, the IRSAC recommends the following:

1. More Transparency will Result in External Feedback

LB&I should strive to become more transparent by publishing (and periodically updating) information regarding the overall campaign structure and the specific campaigns. The information should include training manuals for revenue agents working campaign cases, any changes to specific campaigns, and to the extent disclosure would not undermine tax administration the metrics for each campaign. The IRSAC believes that transparency by LB&I will naturally produce the external feedback that LB&I is seeking. In addition, it may have the correlative effect of encouraging self-correction and voluntary compliance by taxpayers that may not be initially identified as the subject of particular campaigns.

Some examples of activities LB&I may consider undertaking are:

• hosting more public meetings with different external groups (e.g., professional associations);
• publishing FAQs and feedback received on the campaign process, particular campaigns, and soft letters used as campaign treatment streams;
• hosting presentations through the IRS Office of National Public Liaison; and
• reviewing articles published in the tax press regarding campaigns on irs.gov.

2. Feedback Through IRS Revenue Agents

LB&I should assess ways to use revenue agents to gather and communicate external feedback to LB&I leadership. The subgroup understands from discussions with LB&I leadership that a list of “Standard Questions” has been developed for revenue agents who are examining campaign cases to provide certain information regarding the cases they are working on. The questions cover various topics including whether: adequate training is provided; the specific campaign issue warrants examination; an adjustment was proposed; the applicable treatment stream is an effective way to achieve the compliance goal; and the revenue agent has any overall feedback regarding the campaign being worked. The IRSAC recommends that these standard questions be expanded to include questions that would solicit external feedback provided to the revenue agents working the campaign cases.

Solicitation of external feedback should be encouraged by LB&I during campaign training sessions. The feedback provided by revenue agents should include any comments or written communications received addressing specific campaign issues. The “network” calls could also be a platform for revenue agents to provide the external feedback received during the examination.

During the scoping phase of campaign development, LB&I should review responses to Information Document Requests (IDRs) and other communications received from taxpayers and other external stakeholders during examinations of the same issues that are being assessed for campaign consideration. Revenue agents who suggest a campaign could be required to include helpful external responses to IDRs covering the suggested campaign issue.

3. Feedback Through Practice Networks

LB&I should consider publishing detailed information on announced campaigns in the same manner currently used in respect of Practice Units. The purpose of the Practice Units is to provide IRS staff with explanations of general tax concepts as well as information about a specific type of transaction. The publication of the Practice Units is intended to advance transparency generally, which could prompt feedback from external stakeholders that facilitates the updating, correction, or other refinement of the Practice Units. LB&I leadership has stated that the use of Practice Units will continue to evolve as the compliance environment changes and new insights and experiences are contributed. The Practice Unit website already provides a link to an email address (lbi.practice.unit.public.feedback@irs.gov), which allows external stakeholders to provide feedback on particular Practice Units.

4. Revisions To The IRS Future State Guiding Principles To Encourage External Feedback

The IRSAC recommends that the guiding principles of the Future State be expanded to describe LB&I’s interest in external feedback to shape the future state of LB&I. Currently, the guiding principles do not mention how external feedback will be used by LB&I in the new campaign approach to non-compliance. The integrated feedback loop should be edited to show how external feedback will factor into the development of campaigns.

ISSUE THREE: SCHEDULE UTP

LB&I asked the subgroup to consider how LB&I may use Schedule UTP in light of both the decreased filing thresholds and LB&I’s overall shift to more issue-based enforcement. More specifically, LB&I asked the subgroup to consider how Schedule UTP may be revised to increase taxpayer compliance, yield more helpful information, enable better use of LB&I resources, and better serve taxpayers (i.e., reducing their burden in eliminating the need for further probing in many cases).

Background

In previous years, the IRSAC has focused on one or more aspects of risk assessment. In continuing that work, LB&I asked the subgroup to look at Schedule UTP. Schedule UTP was first issued in 2010 and seeks to leverage information and insights derived from audited financial statements. The schedule asks for a concise description of tax positions in respect to which the taxpayer of a specified size establishes a reserve in its audited financial statements. When issued in 2010, Schedule UTP was required to be filed by taxpayers with more than $100 million in assets. The threshold was reduced in 2012 to $50 million and then to $10 million in 2014. The lower filing threshold has significantly expanded the number, size, and compliance profile of taxpayers required to file the form.

The IRS formally announced that it was considering adopting what became Schedule UTP in Announcement 2010-9, in which the IRS explained that it was developing a schedule requiring certain taxpayers to report uncertain tax positions in order to improve tax compliance and administration, as follows:

The information developed in the course of complying with FIN 48 or other accounting standards is highly relevant to understanding the taxpayer’s tax positions and assessing how those positions affect the taxpayer’s tax liability. United States v. Arthur Young, 465 U.S. at 815. That information also would aid the Service in focusing its examination resources on returns that contain specific uncertain tax positions that are of particular interest or of sufficient magnitude to warrant Service inquiry, as well as allowing examination teams to identify all of the issues underlying the tax returns more quickly and efficiently.

Noting that the additional reporting would take the form of a schedule that would “require the annual disclosure of uncertain tax positions in the form of a concise description of those positions and information about their magnitude,” the IRS explained that the schedule would—not require the taxpayer to disclose the taxpayer’s risk assessment or tax reserve amounts, even though the Service can compel the production of this information through a summons. United States v. Arthur Young, 465 U.S. 805, 815 (1984). While the Service intends to require the reporting of uncertain tax positions, the Service is proposing to otherwise retain its existing policy of restraint as described in Announcement 2002-63, 2002-2 C.B. 72, and IRM 4.10.20.

In response to feedback from taxpayers and practitioner groups, Announcement 2010-17 sought to address concerns about the new schedule’s effective date and scope, and a draft Schedule UTP, along with draft instructions, was released in Announcement 2010-30.

The IRS received numerous comments on Schedule UTP before it was finalized. Specifically, numerous commentators stressed that the IRS’s reliance on FIN 48 information could prompt certain taxpayers to be more aggressive in their financial reporting (i.e., they might become less likely to establish reserves in respect of tax items), and many others expressed concern that the disclosures required by the new form could intrude on the work product privilege. The subgroup believes that Schedule UTP, as promulgated in 2010, reflects the IRS’s balancing of those and correlative concerns.

Currently Schedule UTP requires a taxpayer to provide concise descriptions of each disclosed Uncertain Tax Position identified. There is no specific penalty applicable in respect of the failure to file a required Schedule UTP or the filing of an incomplete or inaccurate schedule.

Based on its review of the data from the schedules filed, LB&I has expressed concerns that the item descriptions provided on the schedules are in many cases not sufficient to identify, without further investigation, the actual issue in respect of which an uncertain tax position exists. Indeed, LB&I has determined that a significant number of Schedules UTPs submitted for 2010 to 2015 were either minimally compliant or not compliant at all because, for example, a description does not provide sufficient information for LB&I to understand the issue. Consequently, additional efforts on the part of LB&I were required to evaluate those tax returns and schedules. When LB&I determines that one or more of a taxpayer’s descriptions are inadequate, it issues a “soft letter” to the taxpayer. In addition, if the taxpayer is under examination, the LB&I examiner may issue an IDR to the taxpayer.

Recommendations

Circumstances have changed significantly since Schedule UTP was promulgated. Faced with diminished resources, the IRS has migrated to a more issue-based examination focus, which is one of the treatment streams embodied in LB&I’s “campaign” approach. While the original goal underlying Schedule UTP—assisting LB&I in identifying potential compliance issues by making greater use of audited financial statements—may be laudable, the subgroup has serious reservations about its utility in practice. While taxpayers frequently bristle at the burden imposed by new reporting requirements, usually that burden is theoretically counterbalanced by the benefit derived by the IRS. With respect to Schedule UTP, however, the information provided to the subgroup by LB&I suggests the benefit—if any—is minimal.

To be sure, the compliance burden on any individual taxpayer may not be great, but the aggregate cost of compliance to taxpayers (as well as to LB&I) is likely significant and has only grown as more taxpayers have been required to complete Schedule UTP. Stated simply, the cost may not be worth it.

Moreover, given the history of the schedule’s development (including the initial scaling back of required disclosures in response to the expressed concerns of taxpayers, practitioners, and other stakeholders) and LB&I’s experiences to date, the IRSAC believes there are serious questions whether the intended benefit of Schedule UTP can ever be achieved. To answer that fundamental question, we believe additional work is needed.

Hence, the IRSAC recommends that LB&I revisit the goal of Schedule UTP in light of its experience to date, the current environment, and new campaign approach to ensuring taxpayer compliance. Once that analysis is completed, LB&I can consider whether, even if there were more informative descriptions, the data on Schedule UTP would contribute materially to achieving the desired goal. If the answer is no, the form should be discontinued. If the answer is yes, the next step would be to consider possible modifications to the form.

Specifically, LB&I should initiate an assessment of Schedule UTP, with a set deadline for determining whether Schedule UTP will be modified or abandoned. An initiative would enable LB&I to better assess what its goals are for Schedule UTP and whether and how those goals are achievable. As part of that assessment, and apropos the large number of minimally compliant or noncompliant “concise descriptions,” the IRSAC recommends that LB&I endeavor to determine the cause of the noncompliance—is it due to ignorance of the filing requirements, the amorphous (subjective) nature of “uncertain tax positions,” or volitional noncompliance? (The reasons for minimal compliance are possibly quite different from those for noncompliance.) It seems to us that one path to answering the question would be to follow-up on the current issuance of soft letters in respect of inadequate concise descriptions.

In assessing whether Schedule UTP should be modified, the IRSAC recommends that LB&I consider, among other things, the additional compliance cost on taxpayers; the potential effect of any changes on privilege or work product; and the possible adverse effect on the preparation of financial statements. We recommend that LB&I weigh those costs against the benefit (e.g., better and more useful information) accruing from any modification.

We further recommend that LB&I, as part of the initiative that the subgroup is proposing:

• Assess whether the utility of the schedule is different based on the size of the taxpayer and whether and how frequently it is audited. This effort would test the proposition that Schedule UTP yields new or more useful information in respect of smaller taxpayers (i.e., those not under continual examination) than in respect of those that are part of the Coordinated Industry Case program.
• Consider whether Schedule UTP or the accompanying instructions could be modified to require more objective disclosures. As noted above, LB&I has found that a significant percentage of responses to current Schedule UTP are non- or minimally compliant. The subgroup wonders if removing the flexibility that the current schedule allows for in responding to the questions posed might lead to more useful information. We note that in prior years the subgroup likewise suggested that LB&I consider using more objective questions to risk assess issues and taxpayers, but as in those prior recommendations we recognize that there are drawbacks with that approach as well, including the need to constantly revise the objective questions.
• LB&I seek comments from the IRSAC and other stakeholders before releasing any revision.
• After any proposed changes to the form are devised, LB&I should consider again whether the revised form will materially advance the articulated goal for the form. If not, the form should be eliminated.

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