Procedure & Administration
In a March 2012 speech to the Tax Executive Institutes (TEI) midyear meeting, Steven Miller, then the IRS deputy commissioner for Services and Enforcement, described the large taxpayer examination process as too long and too costly, and he outlined ways in which he thought the process should change. As a backdrop for his suggestions, he sketched a picture in which currently a very significant investment of IRS resources is dedicated to an important but relatively small number of very large corporations and partnerships. Often these examinations are conducted by teams of IRS examiners and specialists, and it is not uncommon for the examinations to extend over many months and sometimes years. Because of the size and importance to the economy of these largest entities, Miller explained that the IRS would always maintain some examination presence among them, but he suggested there was an opportunity to create a far more efficient form of oversight.
Furthermore, in the Service’s view, it was critical that new efficiencies be found so the IRS can redirect resources to other pressing compliance challenges. Among the identified candidates for the redirected staffing are middle-market cases, cross-border transactions, emerging financial products, and the many issues that emerge from the burgeoning universe of passthrough entities.
The IDR Problem
As part of the TEI presentation, the deputy commissioner described steps he believed would facilitate more efficiency in large case examinations. First, in his view, was the need to improve the information document request (IDR) process. The IDR is the formal vehicle by which IRS examiners solicit specific documents and information they believe may be relevant to determining the validity of specific tax return positions.
As explained to the TEI membership, the IRS believes some taxpayers unnecessarily delay the examination process by providing late or inadequate IDR responses. Not surprisingly, many taxpayers do not share the IRS’s assessment, believing instead that the IDR process is burdened by imprecise and overly broad requests that cost taxpayers significant time and money to produce information that often is not germane to the issues identified within the examination.
Premature Referrals to Appeals
In the IRS’s view, another contributor to the delay and costs of the examination process is the tendency for cases to go to Appeals before they are completely developed. The IRS believes that these cases proceed prematurely to Appeals because taxpayers often hold back critical evidence or arguments during the examination stage to trump the government’s case in Appeals. Like the differences of opinions on the IDR problem, many taxpayers have a different view of how many underdeveloped cases make their way to Appeals. In the view of many taxpayers and practitioners, a case or an issue may be underdeveloped when it arrives at Appeals not because of some taxpayer tactic but because the IRS examiner or team did not have the requisite technical expertise to fully evaluate and develop some issues or might not have asked for the information from the taxpayer in a timely manner.
Often taxpayers unsuccessfully try to persuade an examiner of an issue’s technical merit only to find that it cannot be resolved until the Appeals personnel get involved in the issue in a way that did not occur during the examination. Thus, in the eyes of at least some taxpayers, the “underdevelopment” issue is often a result of their inability to engage the examiners early to address a technical issue and has little to do with any tactic to withhold information or arguments.
The IRS announced it was studying the problems and actively sought input from various constituent groups, hinting early on that at least part of the solution would include a reinvigorated IDR process with more precise and more strictly enforced deadlines for responses. Additionally, there was a worrisome suggestion that the government would more frequently issue summonses to compel responses to IDRs that were late or inadequate. In the year and a half since Miller’s TEI speech, it has not been uncommon during opening examination conferences for examiners to demand shorter time frames for IDR responses and to rattle the summons saber.
In considering solutions for so-called premature Appeals referrals of under-developed cases, the IRS said it would also study ways to make the process more efficient. For starters, it suggested Appeals would more routinely return to the exam team any cases that appeared to raise a new issue or arguments. On a more comprehensive front, on July 15, Appeals leadership discussed the Appeals Judicial Attitude and Culture Project. As a result of this project, Appeals employees will be expected to take a more “quasi-judicial” approach toward their cases, ensuring that the Large Business & International (LB&I) division, not Appeals, is doing the investigating. Thus, when Appeals receives new information in a case, it will be sent back to the LB&I examination function, except in the rare instance where Appeals requested the new information.
Additionally, it is expected that Appeals will clarify its policies related to new issues and premature referrals. The IRS plans to change the section of the Internal Revenue Manual that allows Appeals to raise new issues or facts in a case. Further, Appeals will send a case back to Exam only if the taxpayer provides new information to Appeals that the Exam team did not have.
New IDR Directive Is Well-Received
On June 18, 2013, the acting commissioner of the LB&I division issued a directive addressing IDRs (LB&I-04-0613-004). Instead of striking a summons-based tone that many practitioners feared it would, the directive drew on what were described as best practices for information gathering in LB&I cases. The directive reported that all LB&I examiners had attended mandatory training during which several IDR-related actions were prescribed.
The directive, which is effective for all IDRs issued after June 30, requires that first and foremost all IDRs issued during the course of an LB&I examination be “issue focused.” In further defining the requirement, the directive makes clear that examiners must identify and state the issue that led the examiner to request the information included in the IDR. Examiners are also required to discuss the IDR with the taxpayer in advance of its issuance, and both parties are to discuss and determine a reasonable time frame for a response.
The directive expresses the expectation that the steps outlined will result in a more efficient IDR process and a diminished need to enforce IDRs through issuing summonses. However, the directive does explicitly state that in the coming months LB&I will announce changes to the IDR enforcement process. Even though the IRS expects the new IDR process to limit the circumstances in which enforcement will be necessary, the Service plans to have in place an effective and swift process for when it is needed.
The LB&I directive is a welcome clarification of the IDR policy. For many it is a reaffirmation of practices that have been effectively employed for years. For others, it may facilitate striking a different balance in an examination. By focusing on the actual issues of interest and determining the response time required before an IDR is issued, everyone’s lot should improve. Taxpayers will avoid the expense and aggravation of producing voluminous materials in response to unfocused IDRs, and the IRS will have more time to receive the information it actually wants and needs.