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Limited Issue Focused Examinations - Frequently Asked Questions

Frequently Asked Questions - Consolidated to include revisions to the LIFE process as of 8/1/03

The following are new questions that were developed based on an interim review of the process:

Q1. I understand that there have been some recent changes in how materiality thresholds are established and applied.  Can you clarify this for me?

A1. The materiality thresholds are intended to provide some discipline around the scope of an examination and to keep all parties focused on completing the examination timely.  The original vision for LIFE was to use the lowest dollar amount for each type of issue (timing, permanent, credits) selected for inclusion in the LIFE examination plan as the threshold in the MOU.   Any subsequent expansion of scope would have to meet these thresholds before they would be considered for inclusion in the examination.  Therefore, any new issues raised by the team or claims and affirmative issues raised by the taxpayer had to meet the thresholds established.   

Based upon feedback from both internal and external sources, an alternative approach is being provided.  This approach involves a two-step process.  First, the risk analysis is completed and the scope of the LIFE examination is established.  The scope is not determined or restricted by any dollar value threshold.  The next step is separate and distinct.  The team will determine thresholds to be used for any scope expansion by either party.  This includes new issues raised by the Service and claims/affirmative issues raised by the taxpayer.  The thresholds may be the lowest dollar value selected in the LIFE exam plan or another amount based on the examiner’s professional judgment. 

Q2. This is the first audit of my company.  During the initial appointment I asked if I might qualify for LIFE.   I was told that since the team did not have a history with my company we were not eligible for the LIFE process.  Is this correct?

A2. The team’s response was not consistent with the LIFE process.  Having a history with a taxpayer is only one of the qualifications that is considered by the team.  Other considerations include:

  • There are few significant or material identifiable issues
  • You exhibit a genuine spirit of cooperation

The fact that the team does not have a history with you is not sufficient justification for denying the LIFE process.  There may be other reasons why LIFE was not offered, and the team should be able to explain this to you.

Q3. I am very concerned about meeting the 30-day turnaround time for IDR responses.  This seems to be the standard for the LIFE process.  Is this correct?

A3. No. There is no standard response time for IDRs.  The team and the taxpayer should determine the response time(s) when the MOU is agreed upon.  You and the team can set a timeframe for all IDRs, individual timeframe for each IDR, or a combination of both. 

Q4. The team examining our company is in the process of deciding whether we should be offered LIFE.  Currently they are preparing two audit plans and this seems to be a waste of time since the chances of termination are quite remote.  Why is it necessary to prepare two audit plans?

A4. It’s not necessary to prepare two audit plans.  This seems to be the result of some confusion regarding the terms risk analysis and audit plan.  LIFE requires a full risk analysis in order to identify all of the material issues on the return.  This normally requires the issuance of some IDRs to gather preliminary information and the review of books/records, etc.  The team will develop a full list of potential audit issues, but this is not formalized into an audit plan.  Materiality concepts (dollar value, timing vs. permanent nature of issues) and other considerations are then utilized to prioritize those issues and to set the scope of the LIFE examination.  This reduced list of issues will be formalized into a LIFE audit plan. 

If LIFE is terminated, the team will expand the scope of the examination.  They will refer to the full list of issues identified in the risk analysis to modify the plan.

Q5. I am the Tax Director of a large publicly traded corporation.  I have been told by my examination team that LIFE does not apply to large CIC cases.  Is this correct?

A5. The LIFE process should be considered in all LMSB examinations. The examination team and Team Manager are responsible for evaluating whether to use the process. The fact that you are a CIC taxpayer will not disqualify you from the process. 

Q6. At what stage of the examination should LIFE be discussed and offered?

A6. LIFE would normally be discussed during the planning phase of the examination.  However, the team will not make a decision of whether the process applies until after the risk analysis process is completed.  The risk analysis process normally requires the review of preliminary data, books, and records.  Therefore, even if the team is considering the use of the process they may still have to gather this data before making a final decision.  A substantial history with a taxpayer may shorten the risk analysis process, but not eliminate it.

Q7. My company is being examined under LIFE.  We have set the threshold for expense items at $1 million.  The agent is proposing adjustments under this threshold.  Can the agent propose this adjustment?

A7. The thresholds identified within the MOU govern scope expansion to new issues by the team and claims/affirmative issues by you.   Once an item is selected for examination, any adjustments, whether resulting in an increase or decrease to taxable income, are not subject to thresholds.  Therefore, the agent is correct in proposing the adjustment. 

Q8. I am confused about my ability to file claims if the LIFE process is utilized.  Can you help me understand it better?

A8. Claims and affirmative issues have the same impact on scope as new issues raised by the exam team.  They result in an expansion of the scope.  To maintain focus on the LIFE audit plan and to discourage any expansion, the LIFE process invokes certain guidelines regarding claims.  They are:

  • Claims may be filed before the MOU is signed because to that point there are no materiality thresholds.  
  • Once the MOU is signed, claims must be filed by an agreed upon date and are subject to the materiality thresholds.  
  • Affirmative issues for obvious computational/mathematical accounting errors/omissions can be filed at any time regardless of the materiality thresholds.  This type of issue may not be technical or legal in nature and must require little time for the audit team to resolve.  An example of this type of issue might be an inverted Schedule M-1 adjustment.
  • Claims filed after the agreed upon date or below the materiality thresholds outlined in the MOU could be cause for termination of the LIFE process.  This will result in an expansion of the scope of the examination.   
    If, during the examination you find information relating to any issue included in the LIFE examination plan that decreases tax liability, this information is not considered a claim or affirmative issue.  Therefore, it is not subject to the claim guidelines noted above.    

Q9. I have just signed a LIFE agreement to cover the examination of my 2000 and 2001 corporate income tax returns.  We have set very aggressive timelines in order to complete the examination without requiring statute extensions.  The examination team has provided a list of issues they will examine and have noted that one may require the involvement of Counsel.  What impact will this have on LIFE ….or…. what impact does LIFE have on Counsel?

A9. LIFE is an examination process and as such, does not directly impact Counsel, nor does Counsel specifically impact LIFE.  In your case, the examination team has identified a potential need for guidance.  This issue should clearly be prioritized and addressed as early in the examination as possible to prevent it from derailing your timeline.  Counsel has been working to provide more timely assistance to LMSB.  A new process known as Technical Expedited Advice Memorandum (TEAM) has been implemented to shorten the time needed to obtain guidance.

The following questions were already on the website, but may have been modified based on recent changes to the process:

Q10. The concept of limited scope examinations has been around for a long time, what is the difference between LIFE and what was done previously?

A10. LIFE requires a commitment by both the Service and the taxpayer that is reduced to writing in the Memorandum of Understanding (MOU).  This MOU governs key aspects of the LIFE process.  For the taxpayer, this includes: providing the computations for agreed rollover and recurring issues, filing claims by an agreed upon date and only when above the established materiality threshold(s) and with supporting documentation.  The taxpayer must also adhere to agreed upon response times for Information Document Requests (IDRs) and discuss issues as they arise.  

For the Service, the LIFE MOU requires the examiner to share a list of full scope and LIFE issues with the taxpayer.  Materiality thresholds will be established below which new issues will not be raised; greater involvement and interaction with the taxpayer in the planning process, timely response to information provided by the taxpayer and a commitment to use appropriate issue resolution processes throughout the examination.

Q11. If a taxpayer is not offered LIFE, is the team required to inform them why?

A11. The agent/team must consider the use of LIFE in all examinations.  If a decision is reached that LIFE will not be offered, there is no mandate to raise the discussion with the taxpayer.  However, if a taxpayer asks, the examiner should share the reasons for the decision.

Q12. I have not been offered a LIFE examination.  Is there an appeals process that I can invoke?

A12. No.  The decision not to offer LIFE may not be elevated to the Office of Appeals.  You may utilize the rules of engagement by asking to speak to the team manager, territory manager, etc. 

Q13. The LMSB team has proposed a LIFE examination for our most recent cycle.  As the tax director, I’m seriously considering this but I do not like all of the aspects of the process.  For example, I do not want to have to discuss issues (NOPA/5701s) as they arise.  I also do not want to be bound to provide responses to Information Document Requests within an agreed upon timeframe.  I would like to renegotiate these provisions with the team.  More specifically, I would like to change this language to indicate that we will make “reasonable efforts” or “our best efforts to respond” by the date agreed to.  What are our options?

A13. There are two basic principles of the LIFE process that impact on this request.  The first is consistency of application amongst all LIFE examinations.   To accomplish this, a standardized template for the Memorandum of Understanding must be used.  LMSB will not negotiate or change provisions of the process for any taxpayer. 

Second, is the idea of keeping the examination moving forward at a rate which will complete the examination by a date that is agreed to by the taxpayer and the team.  One of the “best practices” incorporated in the process is the discussion of issues as they arise.  If these provisions are untenable to you, then you should inform the team and a normal examination will be pursued.

Q14. During our initial informal meeting with the taxpayer, their representative brought up the LIFE process.  In short, they have indicated they want a LIFE examination and have proposed materiality language for the MOU.  For example, they have proposed a standard that calls for not reviewing any G/L account with a year-end balance of less than $150,000 and not inspecting any invoice less than $25,000.  Should this be accepted?

A14. Any discussion of the materiality thresholds is premature at this point.  You cannot determine whether the LIFE process is appropriate until after you have reviewed the taxpayer’s past behavior and past examination results, and completed your risk analysis to determine the Large, Unusual and Questionable items. 

Most importantly, these thresholds relate solely to the expansion of the examination to new issues and the filing of claims or affirmative issues by the taxpayer.  The thresholds have nothing to do with the review of G/L accounts or invoices.  Similarly, these thresholds have nothing to do with the size of invoices or expenditures that may be reviewed for the issues that are included in the LIFE examination plan or the depth to which these issues will be examined.

Q15. The team has just supplied me the issues that will be examined in the LIFE plan as well as the materiality thresholds that will be used for scope expansion.  I have serious concerns about them.  Do I have any recourse?

A15. The scope of the examination has always been within the purview of the examination team.  However, the examination team should discuss the proposed LIFE examination plan and materiality thresholds and you should feel free to provide feedback.  You may also discuss your concerns with the team manager. 

The sharing of information and the practice of discussing the thresholds with the taxpayer is important, but the LIFE process is not intended to cause this to be a protracted point of negotiation.  The examination team will identify the LIFE issues and thresholds, listen to concerns or recommendations from the taxpayer and then decide whether to accept them.  If an agreement cannot be reached in a relatively short period of time, perhaps the LIFE process is not appropriate in this case and you may decline to participate in the LIFE process.

Q16. I file a consolidated return.  Will the examination team be allowed to select      which subsidiaries should be offered the LIFE process?

A16. No, the team cannot pick and choose which entities within a consolidated return will be worked using LIFE.  The MOU states that LIFE is being used for the entire entity.  However, the team is permitted to have different materiality thresholds for each of the entities. 

Q17. If I enter into a LIFE examination on a corporation, does the MOU also extend to related shareholder or partnership returns?

A17. No.  The LIFE process is applied on an entity basis.  Since a partnership or shareholder is a separate entity for tax purposes, the team would be required to evaluate whether LIFE is appropriate and secure a separate MOU.

This is also true for prior and subsequent year returns that are picked up as the result of a LIFE examination.  In this instance, the LIFE process does not automatically extend to these returns.  The agent/team will need to determine if the LIFE process is appropriate, and if it is, secure a separate MOU or update the existing MOU to reflect the additional periods.

Q18. I am the controller of a corporation that has been approached about participation in the LIFE process.  We are small and do not have the staff to react quickly to document requests.  Because of this I am considering rejecting the LIFE offer.  Will this create some kind of stigma for me for current and future examinations?

A18. No, this should not have any negative connotations for the current or future examinations.  We realize that this process may not be for everyone.  Resource decisions may cause a taxpayer to decline a LIFE examination; this does not mean that a taxpayer is not cooperative

Q19. The team will be setting materiality thresholds below which the taxpayer agrees not to file claims.  As part of the risk analysis process in CIC examinations, the team issues the section 6662 "disclosure letter" (a/k/a Rev. Proc./qualified amended return) to the taxpayer.  In response, the taxpayer provides a letter that reflects all known adjustments to the return.  Some increase taxable income and some decrease it.  How do we deal with the items below the thresholds?

A19. The LIFE examination plan, materiality thresholds, and LIFE MOU should not be finalized until after the taxpayer's response to the "disclosure letter."  Therefore, these issues fall outside of the LIFE MOU materiality thresholds and should be addressed and adjusted, if necessary.  The team may examine these issues even if they fall below the threshold, but they are not obligated to do so. 

Q20. Does LIFE apply to specialist issues?

A20. Yes, the LIFE process applies equally to all issues.  This includes all specialists. 

Q21. Will the use of LIFE reduce the number of specialists utilized on my examination?
A21. This answer depends on the results of the risk analysis process.  Mandatory referrals are still required to be made by the examination agent/team to all applicable specialists.  These specialists will be involved in the planning process.  Specialists’ issues should not be excluded from the overall examination strategy simply because the audit team is trying to limit the exam to a "few" significant issues. There may be instances where issues are selected because of compliance consideration rather than materiality principles.  

Q22. Can a LIFE examination have only five issues and still take two years to complete?  If so, this does not seem to fit the accelerated timeframe inherent in the LIFE process.

A22. Typically, the answer would be no.  However, there may be LIFE examinations in which the complexity of the issues and/or the need to obtain Chief Counsel guidance will necessitate two years to complete.  We think this would be the exception, not the rule--especially considering all of the issue resolution tools and the new issue guidance processes now available.

Q23. Is a LIFE examination more concerned with the number of issues examined  or the time to complete the case?

A23. The process is concerned with both.  By using risk analysis and materiality considerations, LIFE should help to focus on fewer issues than would be examined in a traditional, full scope examination.  The focus on fewer issues and the increased cooperation between the Service and the taxpayer should work to reduce both the resources expended and the time span of the examination(s).

Q24. Can some of the LIFE techniques be used on an examination even if a LIFE MOU is not signed?

A24. If the MOU is not signed, some of the features may be utilized but the scope limitation is not required by the Service.  While most of the features in the LIFE process are good business practices, in order to be a limited scope exam under LIFE, all features must be followed and the MOU must be signed. Most of the features in the LIFE process come from “best practices” already being utilized by LMSB agents and taxpayers.

Q25. Will there be a standard MOU for the LIFE examination?

A25. Yes.  This MOU template is available on the website.  This template will be used on all LIFE examinations. The MOU addresses the key aspects of the examination and is one of the cornerstones of the LIFE process. 

Q26. What happens if I am unable to adhere to the terms and agreements in the MOU? 

A26. There will be occasions where items within the MOU cannot be adhered to. However, every attempt should be made to comply.  If this situation arises, you should speak to the agent/team, if possible, before this occasion arises.  If the MOU is repeatedly breached or a single egregious act occurs, this would be grounds for termination of the LIFE process and a return to the traditional, full scope examination.  This decision will be up to the team. 

Q27. What happens if the Service fails to meet the commitments made in the MOU? 

A27. Again, there will be occasions where items within the MOU cannot be adhered to; however, every attempt should be made to comply.  The team should try to advise the taxpayer if a failure may occur.  If the taxpayer feels that the team is not meeting its commitments, the team manager should become involved.  If the team manager is unable to resolve the problem, you may terminate the LIFE examination.
Q28. If, during a LIFE examination, a taxpayer identifies errors/omissions that are below the materiality threshold, will these be ignored?  Or, if an agent/team finds a computational/mathematical issue that falls below the materiality threshold, will it be raised?

A28. The LIFE MOU specifies that obvious computational/mathematical or accounting errors/omissions identified may be corrected even if they fall below the thresholds.  These will not include technical issues that are resource intensive and they should require little or no time to develop.

Q29.  Can materiality thresholds from the last cycle be used for the current cycle?  In the alternative, could the thresholds for a similar (size and industry) taxpayer be used for my examination? 

A29. Each taxpayer is unique.  Each examination cycle and/or year stands on its own, and comparisons between taxpayers or between years for the same taxpayer should not be made.  Thresholds should be established based on the unique characteristics of the taxpayer and the return under examination.  Although, in most cases, thresholds will cover all years under examination at that time, there may be unique instances that would make it appropriate for thresholds to be set for each year, independently of each other.  This might be the case if a taxpayer’s size were to increase materially due to a large acquisition in one year.

Q30. Is LMSB attempting to establish a materiality standard for all taxpayers?

A30. Absolutely not!  No two taxpayers are identical.  The differences in location, size, business practices, industries, etc., make it impossible and impractical to set one standard.

Q31. If the Service intends to use the LIFE process for my examination, shouldn’t this reduce the initial risk analysis and planning process?

A31. A full risk analysis is needed to properly identify the material items, prioritize the potential issues, and arrive at a final issue selection.   If the examination team has a prior history with the taxpayer, this may reduce the risk analysis and planning process.  This would be true whether this is a LIFE examination or traditional examination. 

Q32. What is an issue?

A32. The agent or team determines what an issue will be.  It can be as simple as a single transaction or as broad as an account or an event.  This definition is up to the team.   The team should ensure that the definition is understood within the team and with the taxpayer.

Q33. My examination is being handled under LIFE and the date to file claims passed some time ago.  A court decision has been published that will greatly reduce our tax liability.  I have the documentation to fully support the claim amount.  If I file this claim, will it terminate the LIFE examination?

A33. If the claim amount is below the materiality threshold established for claims, filing the claim will result in termination.

If the claim amount is above the materiality threshold - you should immediately discuss this situation with the team/team manager.  The decision to terminate the LIFE process will depend upon a number of factors including how quickly you can submit the claim (with supporting documentation) and the amount of additional work required by the examination team. 

If this is a recent court decision and you have determined an amount with certainty and documentation, the team/team manager may consider this claim without terminating the LIFE process.

Q34. A LIFE examination has been in process for some time and the date to file claims above the materiality threshold is long past.  The taxpayer presents a claim that they have been preparing since before the opening conference.  The claim amount is above the materiality threshold established.  There was no prior discussion with the examination team that this claim was under development.   Should the LIFE examination be terminated?

A34. Yes. Not only was the MOU violated by the submission of a claim past the due date, but the taxpayer has failed to communicate with the examination team.  
35. The MOU states that the taxpayer is responsible for providing the computation and support for all agreed rollover and recurring issues.  Please define “rollover” and “recurring”.

 We will try to demonstrate this by example:
FACTS:  A consolidated return was examined and there was one large subsidiary in which the taxpayer expensed the purchase of all office furniture.  The examination team adjusted this item and the taxpayer agreed.   The scope of the examination was not expanded to include this issue for the other subsidiaries.

Rollover Issue:
Since the office furniture purchases were capitalized during the prior examination, the taxpayer is entitled to additional depreciation in subsequent years (new cycle under examination).  This would be the rollover adjustment.

Recurring Issue:
Assuming that the taxpayer has not corrected their capitalization policy, the recurring issue would be the proper capitalization of office furniture purchases in all subsequent tax years for all subsidiaries.  The taxpayer should identify the assets that should be capitalized and provide the computation for the depreciation for all years that have been filed.

Since these are agreed issues (rollover and recurring) in the prior cycle, the taxpayer must supply the computations, regardless of the materiality thresholds that have been established.  This treatment is consistent with what is likely to have happened in a subsequent examination if the LIFE process had not been utilized.

Q36. I have a question about materiality and the deferral period.  Let's assume a taxpayer purchased a "hard" asset (vs. an intangible) in 1997 and it has a 3-year recovery period.  The agent/team is examining the 1997 tax year and find that 1) the taxpayer did not place the asset into service until 1999, and 2) they expensed the cost of this asset in 1997.  What is the deferral period?  Is it three years (since it has a 3-year recovery period) or five years (since they placed it in service in 1999 which triggers the start of the 3-year recovery period)?

A36. The deferral period would be five years.  This is the difference between what the taxpayer did (expensed in 1997) and what they should have done (start depreciating the asset in 1999 over a 3-year recovery period).  This 5-year deferral period would be more material than if the team/agent were examining a 3-year recovery asset that was placed in service immediately upon purchase (assuming the cost of the asset was the same).

Q37. Are the materiality thresholds used for the selection of issues or are they used to determine whether or not an adjustment should be made?

A37. In the LIFE process, materiality thresholds govern scope expansion.  Scope expansion includes new issues raised by the examination team and claims/affirmative issues raised by the taxpayer.  Thresholds do not apply to whether an adjustment can or will be made during an examination.  They do not apply to the accounts or transactions that might be reviewed within the taxpayer’s accounting system(s) for the issues selected for the LIFE plan or the depth to which an issue will be examined.

Q38. In the LIFE process, taxpayers must discuss issues as they are raised.  What does this mean?  Does this mean that the taxpayer has to agree to the proposed adjustment?  Agree to the accuracy of the facts?  Agree to disagree?

A38. First, in the LIFE process, the taxpayer must cooperate in the development of issues by supplying information timely.  Therefore, all of the facts of a particular issue should be on the table.  This does not necessarily mean that both parties have to agree to the facts, but they must continually work towards agreement on the facts.

After a Form 5701/NOPA is issued, the taxpayer should advise the agent/team whether or not they agree with the issue.  If they don't agree, they should provide their position describing sufficiently the reason(s) for their legal disagreement.  We expect that this would be in writing, but this does not mean that they have to provide a formal protest.  They should outline any differences in facts and the legal basis for their position.  The extent of the legal arguments will be driven by the complexity of the issue.  Agreeing to disagree is fine, but both parties should understand the basis for the disagreement.  In addition, issue resolution tools should be considered.

Q39. If the LIFE process is being utilized, and there are unagreed rollover issues below the materiality threshold for scope expansion in the current cycle, should the issue be examined?

A39. The materiality thresholds established in the MOU have nothing to with whether these issues will be included in the examination plan.  The examination team will make a decision to include these issues in the LIFE plan based on risk analysis regardless of the materiality thresholds that will/have been established.

Q40. Is the taxpayer relieved of the responsibility for supplying the section 905(c) amounts during an examination if they fall below the materiality thresholds?

A40. The taxpayer is statutorily required to advise the IRS of any section 905(c) adjustments, no matter what size the adjustment is.  If the taxpayer is under examination, they usually advise the international specialist of these adjustments.  If the taxpayer is not under examination, they are required to file an amended return.  The LIFE process does not alter the taxpayer's responsibilities conferred by section 905(c).

Q41. A current audit of a CIC taxpayer has three rollover issues from the last cycle.  Two are agreed and one is unagreed.  The unagreed one is above the materiality threshold and the other two are not.  Which of these issues should be included in the LIFE examination plan?

A41. Any rollover or recurring issue may be included in the scope of the LIFE examination plan, regardless of the materiality threshold(s) established for the return.  The decision to include such issues should be based on the risk analysis performed by the examination team. The risk analysis will be completed before any thresholds are established.  

Page Last Reviewed or Updated: 06-Nov-2014