Tier I Audit Issues: Current IRS Priorities, Policies and Procedures - - PowerPoint PPT Presentation

Presenting a live 110‐minute webinar with interactive Q&A

Tier I Audit Issues: Current IRS Priorities, Policies and Procedures

Preparing for the Latest IRS Approach to Examination and Enforcement

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific THURSDAY, JANUARY 13, 2011

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

George Hani Member Miller & Chevalier Washington D C George Hani, Member, Miller & Chevalier, Washington, D.C. Jean Pawlow, Partner, McDermott Will & Emery, Washington, D.C. Matthew Lerner, Partner, Steptoe & Johnson, Washington, D.C.

For this program, attendees must listen to the audio over the telephone.

Please refer to the instructions emailed to the registrant for the dial-in information. Attendees can still view the presentation slides online. If you have any questions, please contact Customer Service at1-800-926-7926 ext. 10.

Continuing Education Credits

FOR LIVE EVENT ONLY

Attendees must listen to the audio over the telephone. Attendees can still view

the presentation slides online but there is no online audio for this program. Please refer to the instructions emailed to the registrant for additional

• information. If you have any questions, please contact Customer Service

at 1-800-926-7926 ext. 10. at 1 800 926 7926 ext. 10.

Tips for Optimal Quality

S

• und Qualit y

If you have any difficulties with the sound during the call, press *0 for assistance.

Viewing Qualit y

To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again press the F11 key again.

IRS Tier I Audit Issues: Current IRS P i iti P li i d P d Priorities, Policies and Procedures Webinar

• Jan. 13, 2011

Matthew Lerner, Steptoe & Johnson mlerner@steptoe.com George Hani, Miller & Chevalier Chartered ghani@milchev.com Jean Pawlow, McDermott Will & Emery jpawlow@mwe.com

Today’s Program

Tier I Audit Program Background

[George Hani]

Slide 6 – Slide 9 Preparing For An Audit With Tier I Issues

[Mat t hew Lerner]

Managing An Audit With Tier I Issues Slide 31 – Slide 38 Slide 10 – Slide 30

[George Hani]

Tools For Possible Issue Resolution

[Jean Pawlow]

Slide 39 – Slide 61 Latest Revisions To Tier I Issue List

[Mat t hew Lerner]

Slide 62 – Slide 66

TIER I AUDIT PROGRAM

George Hani, Miller & Chevalier Chartered

TIER I AUDIT PROGRAM BACKGROUND

O i Of Ti d I P Overview Of Tiered Issue Program

• Modeled after successful tax shelter enforcement

― Identifies issues with “strategic” importance or that pose “compliance risk” co pl a ce s ― Issue management team ― Led by “issue owner executive” ― Cross-functional members of team ― Develops IRS approach to issue ― Actively coordinates audits Actively coordinates audits

• For all Tier I issues, proposed resolution must be “approved”

by issue owner executive

7

O i Of Ti d I (C ) Overview Of Tiered Issues (Cont.)

• Originally announced in Spring 2007

― Few changes to the identified Tier I and Tier II issues ― Tier III issues announced in Fall 2008 Tier III issues announced in Fall 2008

• Stated IRS goals

― Consistency ― Reduce audit time ― Resource management

• Every issue has its own evolution of IRS thinking
• Every issue has its own evolution of IRS thinking

― Foreign earnings repatriation and Sect. 199 ― R&E credit claims

8

A i V M i i S Active Vs. Monitoring Status

• Active: Issues being researched and developed
• Monitoring

Returns identified ― Returns identified ― Legal analysis completed ― Guidance and tools disseminated to the field

• Issues are “never” de-tiered or demoted
• Issues move to monitoring status when IRS position has been

established and management confident is that field staff will established, and management confident is that field staff will execute.

9

PREPARING FOR AN AUDIT

Matthew Lerner, Steptoe & Johnson

PREPARING FOR AN AUDIT WITH TIER I ISSUES

• Internal Revenue Service Circular 230

Disclosure: As provided for in Treasury regulations advice (if any) relating to federal regulations, advice (if any) relating to federal taxes that is contained in this communication is not intended or written to be used, and b d f h f ( ) cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting marketing or Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

11

Preparation Begins At Time Of The Transaction

• Review IRS materials on your tiered issue



Understand what facts the IRS views as important in connection with the transaction



Understand the IRS’ view of the law related to the relevant tiered issue



Consider planning transactions and corporate practices in p g p p light of the IRS’ position



Develop and maintain adequate contemporaneous documentation

12

Understand How I RS Approaches Your I ssue

• Read published guidance available on the IRS Web site:

ead pub s ed gu da ce a a ab e o t e S eb s te Directives, settlement guidelines, audit guidelines, notices, rulings, coordinated issue papers, regulations, etc.

• These materials give you a roadmap of what the IRS views as

important.

13

Understand How I RS Approaches Your I ssue (Cont.)

• Re-examine published IRS materials
• Focus on the sample IDRs and other materials that you know

the IRS will seek

• Gather the relevant material from your files



Assists with currency All t d t i h t i i i h d f ti d



Allows you to determine what is missing ahead of time and to gather or prepare additional responsive material

14

Understand How I RS Approaches Your I ssue (Cont.)

• Do a critical evaluation of your case and its facts
• Assess whether your case is a strong one that should be

d i kl promoted quickly

• Determine whether your issue is one that the IRS views as well-

d l d h th th t iti t i fl th developed or whether there are opportunities to influence the process by:



Showing that it is not an abuse



Demonstrating favorable law



Demonstrating favorable law

15

Understand How I RS Approaches Your I ssue (Cont.)

• Determine whether your issue is one the IRS views as an abuse

ete e et e you ssue s o e t e S e s as a abuse

• r whether it is a common issue the IRS is trying to figure out.



“Abuse” issues will receive little flexibility from the IRS.



The IRS is likely looking for vehicles to litigate with respect



The IRS is likely looking for vehicles to litigate with respect to abuse issues.



The IRS may be trying to develop a deeper understanding

• f a common issue
• f a common issue.

16

Technical Resources And Guidance Technical Resources And Guidance

17

Work With Taxpayers With Similar I ssues

• Identify other taxpayers with a similar issue



Learn about their facts



Learn how the IRS is approaching the issue



Try to accelerate the strongest taxpayer’s case

• If the issue is new and the IMT is still formulating its approach,

getting cases with favorable facts in front of it may:



Influence pattern IDRs



Influence legal position



Increase impetus to give exam teams flexibility

18

Understand I RS’ General Litigation i d Strategy On Tiered I ssues

• Consider how your case fits in



Do you have better/worse facts?



What has been the IRS approach to this issue?



What is the IRS record on this issue? How long has this issue been a Tier I issue?



How long has this issue been a Tier I issue?

19

Understand I RS’ General Litigation i d ( ) Strategy On Tiered I ssues (Cont.)

• Consider the IRS docket on your issue:



Is the Service litigating?



What is the range of cases that exist? Where does your f ll i h b h IRS f bl case fall in the spectrum between the most IRS-favorable and the most taxpayer-favorable cases?



What are the facts in these cases? Can you distinguish your facts? your facts?



What is the strength of the cases further along than yours?

• Do not fall into the common trap of convincing yourself your
• Do not fall into the common trap of convincing yourself your

case is the best, without developing more information.

20

Understand I RS’ General Litigation i d ( ) Strategy On Tiered I ssues (Cont.)

• For example, if you have a strong case and your issue has not

been tested:



Put pressure to move the audit quickly to make your case

• ne of the first



Show the IRS it does not want your case to be the first; y ; the issue owner-executives do not want to make law with cases that have good facts.



In this case, the IRS will be more willing to engage in , g g g meaningful settlement discussions.

21

Distinguish Your Facts Distinguish Your Facts

• Distinguishing your facts is critical



Be prepared early in your audit to distinguish and defend your facts C id h f i i IRS id

• Consider the facts given in any IRS guidance



May be difficult if guidance is vague and facts given are generic

• C

id th di i IRS id

• Consider the wording in any IRS guidance



“FTC Generators are highly structured transactions that

exploit the FTC regime,” vs.



“The Issue Management Team has concerns that some



The Issue Management Team has concerns that some studies used to support RC Claims lack adequate documentation …”

22

Tiered I ssues: A Case Study

23

I RS Materials On Research Credit Claims: Guidance

IRS Materials on Research Credit Claims: Quick Reference Guide

24

I RS Materials On Research Credit Claims: Q i k R f G id Quick Reference Guide

• Issue description: Gives you insight into how LMSB views the

issue



Suspicion of pre-packaged products F b i i



Focus on substantiation

• Links to various relevant IRS materials, including:



Industry director directives



Mandatory IDRs



Appeals settlement guidelines



Administrative and technical guidance

• Caution: The quick reference guides on the IRS Web site are
• ften outdated. More recent materials may be elsewhere on the

IRS Web site but not yet added to the quick reference guide.

25

I RS Materials On Research Credit Claims: Research Credit Claims Audit Techniques Research Credit Claims Audit Techniques Guide (RCCATG)

• Released May 2008

y

• The RCCATG may give you insight into what examiners are likely to focus on.

For example:



Examiners are likely to be wary of estimates: A frequent theme throughout the RCCATG is that examiners should not accept unsupported g p pp allocations.

• Begin organizing all relevant documentation to ensure that you can

respond to all requests for substantiation



Examiners are likely to focus on the nexus between expenditures and y p activities.

• Research expenses must be tied to activities that meet the

requirements of Sect. 41.

• The accounting method or approach used by the taxpayer must

g pp y p y provide information to demonstrate this nexus.



RCCATG Exhibit A (claim checklist): Helpful in understanding the approach the examiner will take



Knowing this approach allows you to plan ahead.

26

g pp y p

I RS Materials On Research Credit Claims: M d t I DR Mandatory I DRs

• RCCATG Exhibit C (mandatory IDRs): Because this list of IDRs is

RCCATG Exhibit C (mandatory IDRs): Because this list of IDRs is mandatory, you can begin formulating responses as soon as you believe this issue will be examined or even as you file your return.



Make certain that you develop and maintain information that the IRS will demand.



Make certain that key details are not lost.

• Your responses to the mandatory IDRs may set the focus of the

examination. examination.



The RCCATG instructs examiners that “the responses to the mandatory IDR will identify the issues that you will need to focus

• n and will assist you in developing an audit plan” (p. 5).



If the examiner and research credit technical advisor determine



If the examiner and research credit technical advisor determine that the amount claimed is not adequately supported, a notice of claim disallowance will be issued (p. 5).

27

I RS Materials On Research Credit Claims: M d t I DR (C t ) Mandatory I DRs (Cont.)

• Examiners will consider certain areas when evaluating the IDR

Examiners will consider certain areas when evaluating the IDR

• response. By knowing these points, you can make sure your

response covers these areas (p. 7, “Additional Areas to Consider;” p. 8, “Evaluating Information”). For example:



Consistency and base period issues



Consistency and base period issues



Substantiation



Statistical sampling



Contingency fees



Contingency fees



280C elections

• Examiners will focus on your ability to substantiate the research

credit claim.



You should be proactive about directing the examiners to your substantiation and explain its relevance. You should not just provide the examiners with documents and have them try to discern the relevance of the material.

28

y

I RS Materials On Research Credit Claims: M d t I DR S l Q ti Mandatory I DRs: Sample Question

• Do you have contemporaneous documentation that:



Identifies qualified research by each new or improved business component? If not:

• How did you identify that qualified research relates to development of a new or

improved business component? p p

• How did you determine that you satisfied the 80% process of experimentation

requirement of I.R.C. §41(d)(1)(C)?



Tracks, by each new or improved business component, the time spent by each employee performing qualified services? If not, how have you each employee performing qualified services? If not, how have you determined the amount of employee qualified services that should be allocated to new or improved business component(s)?



Identifies the general ledger accounts which were used to quantify the QRE supplies? QRE supplies?



Identifies the amount of QRE supplies consumed in the conduct of qualified research for each new or improved business component? If not, explain how you determined the amount of QRE supplies used in the

29

conduct of qualified research.

I RS Materials on Research Credit Claims: A dit T h i G id (ATG) Audit Techniques Guide (ATG)

Th ATG f M 2005 i l il bl h IRS W b i

• The ATG from May 2005 is also available on the IRS Web site



Although the RCCATG is more recent and covers many of the same issues, this ATG is also helpful because it indicates how examiners have been instructed to approach the issue in the recent past.

• F

b t ti ti

• Focuses on substantiation



Examiners are instructed to verify information independently and request certain documents (p. 5).

• Suggests that the examiners should hold a meeting with the taxpayer

i i f di i d d b d d ( 8)



Lists issues for discussion and documents to be produced (pp. 7-8). For example:

• Who prepared the research credit computation workpapers?
• Was this documentation prepared contemporaneously with the

research activities? research activities?

• Describes the IRS view of the law (pp. 9-28)



You can apply this statement of the law to your facts, and understand how the IRS is likely to respond to your facts and begin formulating arguments

30

formulating arguments.

MANAGING AN AUDIT WITH

George Hani, Miller & Chevalier Chartered

TIER I ISSUES

Common Problems Encountered In Audits

• Overcoming the stigma of being a “Tier I” issue

― Tendency to view issue as a tax shelter ― Pejorative names: “Sect 118 abuse” Pejorative names: Sect. 118 abuse ― Sets tone early that taxpayer is a “bad” taxpayer ― Taxpayers tend to be more defensive. ― Exam teams tend to be more skeptical (on the tiered issue and other issues). ― Common to have discussion of penalties prior to the Common to have discussion of penalties prior to the issuance of a Form 5701 notice of proposed adjustment

• Result: Level of contentiousness increases

32

Common Problems Encountered In Audits (Cont.)

• Exam team loses control
• Common phrase used by IRS management:

― “The IMT controls the strategy; the exam team controls The IMT controls the strategy; the exam team controls the case.”

• Unclear whether exam teams grasp that distinction

― More common reaction is “that is above my pay grade” ― Easier for exam teams to “follow the party line”

• Result: Exam team loses interest

Result: Exam team loses interest

33

Common Problems Encountered In Audits (Cont.)

• Communication breakdowns

― Exam team must coordinate with IMT ― Become game of “telephone” Become game of telephone

• Taxpayers try to contact IMT directly

― Angers exam team ― IMT personnel unfamiliar with your facts ― Adds to time delay

• Result: Taxpayer frustration
• Result: Taxpayer frustration

34

Common Problems Encountered In Audits (Cont.)

• Inability to differentiate yourself from the pack
• Tax shelters were primarily mass-marketed ideas for which

standardized IRS response was effective sta da d ed S espo se was e ect ve

• Individual tiered issues do not have that same degree of

uniformity “O i fit ll” ― “One size fits all” ― Easier for exam teams to treat you just like all other taxpayers than to justify to the IMT why you are different

• Result: No resolution

35

Ti I I A di M Tier I Issue Audit Management

• Opening conference

― Try to have as many decision makers as possible attend ― Scheduling: Set standards you know you can meet Scheduling: Set standards you know you can meet ― IDR response times ― Timing of NOPAs (5701s) ― Completion of exam ― Identify your scheduling constraints Consider voluntary presentation of issues ― Consider voluntary presentation of issues ― Make your view be the first view they hear

36

Tier I Issue Audit Management (Cont.)

• IDR management

― Establish tracking system ― Share your tracking system with IRS Share your tracking system with IRS ― Standardized IDRs ― Request discussion with IRS prior to issuance of IDRs ― Don’t accept standardized IDR if it does not fit

• Create a record of all IRS interactions

37

Tier I Issue Audit Management (Cont.)

• Understand and use the IRS rules of engagement

― Internal Revenue Manual, Sect. 4.51.1

• Among the stated goals:
• Among the stated goals:

― Clarify individual roles, responsibilities and lines of authority ― Help ensure end-to-end accountability ― Promote consistent tax treatment among similarly situated taxpayers p y ― Reinforce the importance of integrity and ethical behavior in all case-related decision-making K h d l t ll f bli ti

• Keep you own hands clean; meet all of your obligations

38

TOOLS FOR POSSIBLE ISSUE

Jean Pawlow, McDermott Will & Emery

TOOLS FOR POSSIBLE ISSUE RESOLUTION

Traditional Dispute Resolution Forums

EXAMINATION APPEALS

(1) Normal progression (2) Bypassing

APPEALS

appeals (3) “Docketed appeals case”

LITIGATION

appeals case

40

Choice Of Forum Strategies

• Tax controversy is not necessarily linear in movement.

a co t ove sy s ot ecessa ly l ea

• ve

e t. ― Case can move forward, backward or sideways. ― Large cast of potential decision-makers

• Major strategic decisions: Choosing or moving between possible

forums in order to best position a case for favorable resolution. p

41

E ’ A th it T R l I Exam’s Authority To Resolve Issues

• Revenue agents can make intermediate resolutions on the facts.
• They cannot “settle” cases based on the hazards of litigation or on

legal issues. g

• However, there are procedures that delegate appeals authority to

th i l l their level.

42

Delegation Orders 4 24 Delegation Orders 4‐24

• Give revenue agents authority to settle issues
• Apply to all LB&I taxpayers
• Issue previously decided by appeals
• Issue previously decided by appeals
• Same facts and same taxpayers or “directly involved”

taxpayers

• Legal authority remains unchanged.
• Appeals did not “trade” issues.

43

Delegation Order 4‐25

• Gives examination team managers (LB&I) and territory managers

Gives examination team managers (LB&I) and territory managers (SBSE) authority to accept settlement offers on program Issues, ISP issues and appeals coordinated issues with appeals settlement guidelines

44

W S War Story #1

• Bottom line: The best audit is no audit!
• Bottom line: The best audit is no audit!

45

Al i Di R l i F Alternative Dispute Resolution Forums

46

Early Referral Procedure (ERP)

• Allows taxpayer to accelerate appeals consideration of un-

agreed adjustment during audit ― Requires exam’s issuance of NOPA Requires exam s issuance of NOPA ― Requires exam’s and appeals’ concurrence

• Normal appeals rules apply

― No ex part e communications ― Written brief required

• If audit concludes while ERP issue is still under appeals
• If audit concludes while ERP issue is still under appeals

discussion, case converts to a normal appeals case.

47

Early Referral Procedure (Cont.)

• ERP may allow appeals to settle issue before 30-day letter issues

and hot interest rules kick in/

• Allows settlement negotiations without exam sitting at the table

ERP great tool for accelerating resolution of continuing issues

• ERP great tool for accelerating resolution of continuing issues
• Strategy requires advance preparation by taxpayer to accelerate

NOPA on ERP Issue NOPA on ERP Issue ― Prioritize ERP issue at opening conference

48

F T k S l Fast‐Track Settlement

• Rev. Proc. 2003-40
• Allows the taxpayer and exam to resolve un-agreed issues
• Allows the taxpayer and exam to resolve un agreed issues

based on hazards of litigations, with an appeals officer acting as a neutral party

• Procedures
• Fast-track is available for some, but not all, Tier I issues.

49

F T k S l (C ) Fast‐Track Settlement (Cont.)

• Take issue “up the chain”
• Hear an articulation of the IRS position
• Hear an articulation of the IRS position
• Test your case
• Loose rules of evidence
• More than one bite at the apple
• Most cases settled

50

W S War Story #2

• Bottom line: Buyer’s remorse!

51

A l S ill A G d O i Appeals: Still A Good Option

• Stress the hazards of litigation
• Is there anything else you would need to see … ?
• Have you discussed the strengths and weaknesses in English
• Have you discussed the strengths and weaknesses in English,

as opposed to percentages?

• Identify appeals officer’s settlement range

Identify appeals officer s settlement range

• Are there other factors such as future years, state taxes or

Joint Committee review? Joint Committee review?

52

Appeals Case Data

2006 2007 2008 2009

Total Appeals Cases Received

97,138 102,269 115,819 125,126

Total Appeals Cases Closed

102,559 104,429 106,722 112,886

Year-End Appeals Case I nventory

55,172 51,502 59,899 72,002

53

C i A h T S l Creative Approaches To Settlement

• Split an issue based on percentages (hazards of litigation)

C d i f b t t th

• Concede an issue for some years but not others
• Bottom-line dollar agreement

g

• Trade issues: Use issues of “principle” as bargaining chips for

i f d ll l issues of dollar value

• Be sure to resolve penalties

p

54

P t A l M di ti (PAM) Post‐Appeals Mediation (PAM)

R P 2002 44

• Rev. Proc. 2002-44
• Non-binding process used after settlement negotiations are

No b d g p ocess used a te settle e t egot at o s a e unsuccessful A A l ffi t i d di t ( d if th t

• An Appeals officer trained as a mediator (and if the taxpayer

elects, a non-IRS mediator) facilitates communications between the IRS and the taxpayer, in order for the parties to reach their

• wn negotiated settlement.

55

Post Appeals Mediation (Cont.)

PAM h hi d bi l l

• PAM represents the third bite at an appeals settlement.
• PAM is available at the taxpayer’s request, if settlement

M s ava lable at t e ta paye s equest, settle e t negotiations fail to resolve issue. ― Current appeals practice is to acquiesce to the taxpayer’s PAM request PAM request.

• PAM envisions two professionally trained mediators overseeing a

non-binding settlement mediation between the taxpayer and an appeals officer.

• Mediation = Compromise

56

Post Appeals Mediation (Cont.)

• Why undertake PAM?

― Mediators may bridge the gap between parties’ last offers. Med ato s ay b dge t e gap betwee pa t es last o e s. ― Means of “correcting” hazards assessment by inexperienced appeals officer Q i k d L t h t ttl b f liti ti ― Quick procedure: Last chance to settle before litigation

• As the next stop is the courthouse, why not?

p , y

57

A bi i O i Arbitration Overview

• Announcement 2002-60
• Optional
• Taxpayer and appeals must first attempt to negotiate a

settlement

• Parties must execute a formal agreement to arbitrate
• Parties must execute a formal agreement to arbitrate
• Findings of the arbitration are binding
• Procedure and findings are confidential

58

ADR Closure Data

2006 2007 2008 2009

Post Appeals Mediation

• Rev. Proc. 2002-44

34 22 16 23

Post Appeals Arbitration

• Rev. Proc. 2006-44

2 1 nil nil

Fast-Track Programs

129 162 149 144

Total ADR Cases Closed

165 185 165 167

59

Li i i Litigation

• There is an exception to every rule!
• There is an exception to every rule!

― Con Ed ― Capit al One

60

C l i Conclusions

• Be prepared and plan ahead
• Find a decision-maker
• Find a decision maker
• Be creative
• Stay flexible

61

LATEST REVISIONS TO TIER I

Matthew Lerner, Steptoe & Johnson

LATEST REVISIONS TO TIER I ISSUE LIST

• Internal Revenue Service Circular 230

Disclosure: As provided for in Treasury regulations advice (if any) relating to federal regulations, advice (if any) relating to federal taxes that is contained in this communication is not intended or written to be used, and b d f h f ( ) cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting marketing or Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

63

I ssues Elevated To A Tier I Status I ssues Elevated To A Tier I Status

• Changes to the method of accounting for repair and

maintenances expense deductions (Jan. 22, 2010)

64

Changes Of Status Changes Of Status

• Domestic production deduction moved from “active” to

“monitoring” status (April 20, 2010)

• Leaking underground storage tank (UST) state remediation

reimbursement programs (issue regarding IRC §118 Abuse) p g ( g g § ) moved from “active” to “monitoring” status (July 9, 2010)



The state and local tax incentive sub-issue under the IRC §118 abuse issue remains in active Tier 1 status §

65

Additional New Guidance Additional New Guidance

• Industry directive on total return swaps used to avoid dividend

withholding tax, providing guidance and IDRs

66