4.51.3  Limited Issue Focused Examinations (LIFE)

4.51.3.1  (01-01-2007)
Overview of the LIFE Process

  1. This section identifies the Limited Issue Focused Examination (LIFE) process and its main features, and shows how LIFE is different from other examinations.

4.51.3.1.1  (01-01-2007)
Introduction to the LIFE Process

  1. ) The Limited Issue Focused Examination (LIFE) process is an alternative to the traditional, full scope and traditional, limited scope examination processes. It is a streamlined, issue-focused process promoting the examination of those issues representing the greatest compliance risk. This provides for a quality examination with the least burden to both the taxpayer and the government. The LIFE process should improve all three of our balanced measures: Customer Satisfaction, Employee Satisfaction and Business Results

  2. LIFE requires an LMSB examiner or examination team to enter into a Memorandum of Understanding (MOU) with a taxpayer to govern key aspects of the examination. See IRM Exhibit 4.51.3-1. The MOU identifies the issues to be examined and the materiality thresholds to govern any expansion in the scope of the examination. The MOU requires cooperation between the examiner or examination team and the taxpayer to complete the examination. If the taxpayer does not meet their commitments in the MOU, the process may be terminated. The scope of the examination may then be expanded to include the issue that prompted the termination and some or all of the Large, Unusual and/or Questionable (LUQ) items identified in the risk analysis.

    Note:

    Hereinafter, the term "examiner" will be used to denote an individual examiner or examination team, including managers, as appropriate.

  3. The LIFE process should be considered during the risk analysis phase of every LMSB examination. The decision to utilize the LIFE process should be made by involving all members of the examination team, including specialists and specialist team managers. See IRM 4.10.2.4.1, Risk Analysis.

    Note:

    Form 13744, Examiner's Risk Analysis Worksheet, should be used in all LMSB risk analyses.

    Note:

    As used hereinafter, the term "team manager" means the team manager whose group is assigned the primary control as defined in IRM 4.45.3 . The term "specialist team manager" refers to any other team manager who participates in a case.

4.51.3.1.2  (01-01-2007)
How LIFE is Different from Other Examinations

  1. LIFE is a distinct LMSB process intended to streamline the audit process by focusing the examiner’s efforts on only the most material issues on a tax return. The decision to utilize the process can only be made after performing a full risk analysis. Once the risk analysis is completed, the examiner will determine whether the LIFE process makes good business sense. The final decision to utilize the LIFE process can only be made with the concurrence of the team manager. The taxpayer is also a participant in this decision because he/she must agree to support the process.

  2. LIFE is not the same as a traditional, full scope examination because:

    1. The examination plan is more issue-driven than resource-driven.

    2. The scope of the examination is limited based on materiality concepts.

    3. Some mandatory compliance checks and mandatory steps may be waived

    4. Once the scope is set, it is not necessary to comment on other LUQ items.

    5. Once the scope is set, managerial approval is required to expand it, and

    6. LIFE requires the taxpayer to commit to actions specified in the LIFE MOU

  3. LIFE is different from a traditional, limited scope examination because, in a traditional, limited scope examination

    1. The examiner may only waive gross income and inventory checks,

    2. The limited scope examination can involve only one or two issues, and

    3. There are only a few instances or circumstances where the traditional, limited scope examination is appropriate, such as whipsaw issues and other related returns

4.51.3.2  (01-01-2007)
When to Use LIFE

  1. This paragraph identifies when to use LIFE: the criteria for selection cases for the LIFE process and how to designate them as LIFE.

4.51.3.2.1  (01-01-2007)
Criteria for Using the LIFE Process

  1. LIFE should be considered in every LMSB examination. It is most appropriate when one or more of these characteristics are present:

    1. The risk analysis identifies a limited number of material items (no specific number since this will vary based on the facts and circumstances)

    2. Prior experience indicates the taxpayer is both capable and willing to meet the commitments required in the MOU

    3. Workload demands exceed resources available and require scope limitation

    4. Special project cases where the primary issue is identified

    5. Out-of-cycle returns when there is an issue requiring examination for tax administration purposes

    6. There is no prior examination history of the taxpayer, but the interaction to date indicates the taxpayer is both capable and willing to meet the commitments required in the MOU, or

    7. Improved currency is a primary concern and the taxpayer is reasonably compliant, even if there have been issues in the past

    8. The taxpayer has a complex tax return and the MOU will provide the needed structure for a limited scope examination.

  2. The following characteristics may provide sufficient grounds to decline to offer LIFE. While a single factor could be sufficient to disqualify a taxpayer for a LIFE examination, the presence of multiple characteristics should preclude LIFE. These characteristics include:

    1. A history of substantial noncompliance, such as aggressive positions or the use of marketed tax products

    2. A history of failing to consistently meet agreed upon Information Document Request (IDR) response times (including completeness)

    3. Average IDR response times that will most likely impede an efficient examination

    4. A tax shelter transaction that was not properly disclosed as required by any Notice, Revenue Procedure, Revenue Ruling or Treasury Regulation

    5. A large number of material issues which render scope limitation unreasonable

    6. An indication of fraud on the part of the taxpayer, or

    7. The taxpayer is unable or unwilling to meet the commitments required in the MOU.

4.51.3.2.2  (01-01-2007)
Cases Designated for the LIFE Process

  1. An examination may not be designated as LIFE before the risk analysis is completed, documented appropriately, and the MOU is signed by both the IRS and the taxpayer.

    1. The team manager will sign the MOU on behalf of the Service.

    2. A responsible corporate officer, tax matters partner (TMP) or a properly designated representative should sign on behalf of the taxpayer.

  2. The examiner, team manager, and specialists should consider using LIFE for the case beginning with the first time a return is inspected.

  3. The decision to offer LIFE ultimately rests with the team manager; however, this decision should be made with input from all team members including specialists and their managers.

  4. The team manager will ensure that the ERCS Aging Reason Code 20 is applied immediately after the LIFE MOU is signed.

4.51.3.3  (01-01-2007)
The LIFE Process

  1. This paragraph identifies the elements of the LIFE process and shows how it impacts other processes.

4.51.3.3.1  (01-01-2007)
Elements of the LIFE Process

  1. The key elements of LIFE include:

    1. Engaging the taxpayer, IRM 4.51.3.3.2;

    2. Risk analysis, IRM 4.51.3.3.3;

    3. Materiality (definition, key principles, and other considerations), IRM 4.51.3.3.4-5;

    4. Scope reduction including waiver (if applicable) of certain mandatory compliance checks and mandatory steps, IRM 4.51.3.3.6 ;

    5. A Memorandum of Understanding (MOU), IRM 4.51.3.4 ; and

    6. Termination of the LIFE Process, IRM 4.51.3.4.4.

  2. The LIFE process impacts other aspects of an examination. These include:

    1. The examination plan, IRM 4.51.3.3.7;

    2. The examination of other returns, IRM 4.51.3.3.8 ;

    3. LMSB Quality Measurement System (LQMS) standards, IRM 4.51.3.3.9;

    4. Joint Committee review, IRM 4.51.3.3.10; and

    5. Territory Managers’ operational reviews, IRM 4.51.3.3.11.

4.51.3.3.2  (01-01-2007)
Engaging the Taxpayer

  1. The examiner should discuss the possibility of using the LIFE process during the early stages of the examination.

  2. The examiner must explain:

    1. That the LIFE process is not appropriate for every examination

    2. That the decision to offer the process rests with the IRS

    3. The final decision will not be made until after the examiner completes the full risk analysis

    4. The specific language of the LIFE MOU may not be negotiated

    5. The examiner’s decision not to offer LIFE may not be elevated to the Office of Appeals, and

    6. Either party may terminate the LIFE process if the other fails to meet their commitments under the MOU.

  3. If the examiner and team manager determined that the LIFE process is not appropriate, this should be documented in the workpapers.

4.51.3.3.3  (01-01-2007)
The Risk Analysis in LIFE Examinations

  1. The examiner will perform a risk analysis in the same manner as in a traditional, full scope examination. Risk analysis is explained in IRM 4.10.2.4.1 and IRM 4.46.3.3.2.2, Risk Analysis and Risk Management.

  2. All mandatory referrals to specialists will be made as early in the planning process as possible. Mandatory referral guidelines are established for each specialty area; the LIFE process does not in any way supersede these guidelines. See IRM 4.10.2.6.7.

  3. Specialists and specialist team managers will participate in the risk analysis.

  4. Technical advisers should be consulted during the risk analysis process to assist in identification of material issues and/or industry information.

  5. After all the LUQ items are identified, the examiner will prioritize them in terms of risk and materiality. See IRM 4.10.2.3.1 for the definition of LUQ items.

  6. Considering materiality is a critical step to limiting the examination scope. Proper use of risk analysis, including materiality, will result in examining the areas with greatest compliance risk.

  7. The taxpayer is encouraged to participate in the risk analysis and planning process.

  8. The decision to offer the LIFE process to a taxpayer will not be made until a full risk analysis is completed.

  9. If the team manager and a specialist team manager disagree on the scope of the examination with respect to a specialist’s activity on the LIFE case, the matter should be resolved as described in IRM 4.46.3.5, Management of Specialists.

4.51.3.3.4  (01-01-2007)
Defining Materiality for LIFE Examinations

  1. Materiality is an accounting concept which does not exist, for the most part, in tax law. Materiality is both a qualitative and quantitative concept used to identify those items most relevant and consequential in determining the correct tax liability. The materiality of an item may be measured in terms of its value and its relationship to another item of income, deduction, tax liability, credit, Schedule M-1 or Schedule M-2 adjustment, a balance sheet item or transaction as presented on a tax return, including supporting schedules.

  2. The process of evaluating materiality should be consistently applied, but the result will be different for each case. Absolute parameters cannot be established or used for every case because of the differing size, complexity and industry of the returns being examined, as well as the differences in the experience and professional judgment of examiners.

  3. In a LIFE examination, applying materiality principles is the most critical factor in limiting the scope of the examination. LIFE focuses on those issues most consequential to the overall tax liability, thereby, addressing the greatest compliance risks.

4.51.3.3.5  (01-01-2007)
Key Principles of Materiality and Other Considerations

  1. Dollar value is the first key principle of materiality. The size of an item has a direct impact on the evaluation of an item’s materiality. Without consideration for the timing, permanency or compliance nature of an item, a larger item will always be more material than a smaller item. This is because the larger item has a greater impact, positive or negative, on the overall tax liability. The size of the taxpayer will influence the determination of materiality.

    1. All other things being equal, a $500,000 item on an Activity Code 225 case will not have as much significance (materiality impact) as that same $500,000 item on an Activity Code 219 case.

  2. The second key principle of materiality is permanency. Given equal dollar value, an item which causes a permanent difference in tax liability is more material than one which will reverse itself in future periods.

    1. The return under examination reflects Qualified Research Expenditures of $5 million and a reserve for a one time employee bonus of $5 million. Any adjustment to this reserve would likely reverse in the subsequent year. Since the R & E credit is a permanent reduction of tax, it will generally be considered more material than the timing issue.

  3. The third key principle of materiality is timing. Timing issues are generally items of income or deductions that are reported in the wrong year. Before selecting an area for examination that is likely to result in a timing adjustment, consideration should be given to the number of years that income is deferred or an expense is accelerated. The longer the deferral/acceleration period, the more material the item.

    1. The taxpayer has deducted a capital expenditure. If the proper recovery period is 15 years, the item is more material than if the recovery period is 5 years.

    Note:

    IRM 4.10.2.6.1.1(6) states that examiners should not generally select issues that are likely to result in short-term timing adjustments. Timing issues with long-term, indefinite or permanent deferral features should be examined. Unplanned timing issues which arise as correlative adjustments during an examination of non-timing issues should be made if it is cost effective to do so.

  4. Examiners should consider Changes in Accounting Method in evaluating materiality principles. Timing issues include accounting method change issues. An examiner changing a taxpayer’s method of accounting will ordinarily make the change in the earliest open year and impose an IRC section 481(a) adjustment. In selecting accounting method change issues for examination, consideration should be given to the potential IRC section 481(a) amount and the impact on the return and future compliance if the taxpayer is allowed to remain on an improper method. If the impact is material, then consideration should be given to selecting the issue for examination. If the impact is not material, then consideration should be given to not selecting the issue for examination. If a timing issue is selected for examination, then the rules regarding Accounting Method Changes and the applicable Revenue Procedures may not be ignored.

    1. In considering whether a timing issue is material, the consequences of necessary adjustments to future years must be considered.

    2. In some instances the trend and duration of an item must be evaluated to determine the future compliance risk.

  5. There may be instances where the sheer size (dollar value) of an item will be so significant that even a short term deferral/acceleration becomes material.

  6. There are other considerations that may bear on the significance of an item. For some issues, the principles of materiality may be outweighed by other factors such as policy or compliance considerations. This could include tax shelters, industry or emerging issues, coordinated issues, fraudulent items or items contrary to public policy

    1. For example, if a company is deducting fines, penalties, or illegal payments, these items may be significant compliance items without regard to the other principles of materiality.

  7. Certain transactions or events may be of such a nature that it is difficult to associate a dollar amount for materiality without significant audit work. The fact that there is no specific dollar amount associated with an issue should not exclude it from consideration under LIFE. Examples include:

    1. A taxpayer who has experienced a number of mergers and acquisitions during the cycle

    2. Non-deductible personal expenses or shareholder distributions

    3. Employment tax compliance, and

    4. A division, branch, or subsidiary that has significant transactions involving a tax haven entity.

  8. The examiner should consider the relationships of all items considered in the risk analysis to other items on the return. This is a helpful tool in visualizing the materiality of an item whether it is permanent or a timing issue.

    1. An example would be the relationship of a deferred income account to gross receipts or accounts receivable.

  9. There may be instances where the absence of an item may be material in and of itself.

    1. An example would be personal services performed for an S Corporation without a deduction for Officer’s Compensation on the return.

  10. The determination of whether or not an account or other item on the return is material is dependent on the examiner’s professional judgment. There is no economic or mathematical formula or standard that should be applied to any case, industry or within any group, territory, or other organizational segment to determine whether an amount is material in a LIFE examination. The examiner and team manager will have to weigh all the facts and circumstances in assessing materiality to set the scope for the LIFE examination.

4.51.3.3.6  (01-01-2007)
The Scope of the LIFE Examination

  1. Setting the scope for LIFE is a two-step process.

    1. First, the risk analysis is completed and the examiner prepares a list of LUQ items that would represent the scope if a traditional, full scope examination were to be conducted. The scope is not determined or restricted by any dollar value threshold. Then the examiner applies the materiality concepts, discussed above, to prioritize these items and pare down the examination scope to those issues that present the greatest compliance risk.

      Note:

      If this prioritization reveals a significant number of material issues, then LIFE may not be appropriate for this examination. The impact of eliminating one or more material issues must be balanced with the overall compliance of the taxpayer (or accuracy of the return.)

      Note:

      If this prioritization reveals that the taxpayer would be in substantial compliance of its tax liability by working a smaller number of issues than the full list identified in a) above, then LIFE may be appropriate for this examination.

    2. The next step is separate and distinct if LIFE is appropriate. 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 or affirmative issues raised by the taxpayer.

      Note:

      See IRM 4.51.3.4.7 for more details on claims and affirmative issues.

  2. The examiner will provide the list of LIFE issues to the taxpayer in order to facilitate discussion of the decision to enter the LIFE process. See IRM Exhibit 4.51.3-2, Establishing the LIFE Examination Plan and Setting Thresholds for Expanding Scope.

  3. Unless worker classification is specifically listed as a LIFE issue, it will not be examined and will not create a safe harbor under Section 530. Questions on worker classification and other employment tax issues should be discussed with the local Employment Tax Manager.

  4. Once set, the scope may not be expanded unless:

    1. A newly identified issue exceeds materiality thresholds identified in the MOU or

    2. The issue is an exception to the materiality thresholds identified in IRM 4.51.3.4.3(8).

    Any such expansion requires team manager’s approval.

  5. After the LIFE MOU is signed, the team manager may approve waiving any or all of the following examination steps:

    1. The mandatory income probe,

    2. Minimum Inventory Checks, and

    3. Mandatory Compliance Checks (the requirement to verify filing of and reviewing payroll, excise, and pension returns, verify filing information returns and Forms 8300, Cash Transaction Reports.) See IRM 4.10.2.6.2 , Examination of Income, IRM 4.10.2.6.3, Required Filing Checks, and IRM 4.10.2.6, Inventory Checks.

      Note:

      When income or inventory is a selected issue, the respective minimum steps may not be waived.

  6. The team manager must approve the waiver. A sample checksheet is provided at IRM Exhibit 4.51.3-3.

  7. In the event the LIFE examination is terminated, the team manager must determine what portion, if any, of the mandatory examination steps should be performed. This decision must be documented in the case file.

  8. Review of prior, subsequent, and related income tax returns may not be waived.

  9. LIFE may be used when a return is designated as a single-issue examination or when a project limits the number of issues to be considered. Alternatively, the examiner may choose to perform a traditional, limited scope examination.

  10. LIFE does not impact the depth at which issues are examined.

4.51.3.3.7  (01-01-2007)
The LIFE Examination Plan

  1. After the MOU is signed, the examiner will prepare a single examination plan for the LIFE examination in the manner provided in IRM 4.46.3.4.3, Step Five - The Examination Plan. No plan will be prepared for the full list of identified issues which would represent the scope if a traditional, full scope examination were conducted.

  2. The manager will update the estimated completion date to reflect any change resulting from the adoption of the LIFE process.

4.51.3.3.8  (01-01-2007)
Examining Prior, Subsequent and Related Returns

  1. The LIFE process only applies to the returns specified in the MOU. If, in the course of any LMSB examination, the examiner makes a determination to examine a related, prior, or subsequent year return, a decision must be made whether it is appropriate to use the LIFE process, a traditional, full scope examination or a traditional, limited scope examination for that return.

  2. If the LIFE process is utilized, a full risk analysis must be documented in the workpapers. If additional years are added to the examination after the LIFE process is begun, either a new MOU may be executed for the new years and/or returns or pen and ink changes may be made to the MOU as initialed by the team manager and taxpayer.

  3. If the LIFE process is not used in the examination of a prior, subsequent, or related return, Aging Reason Code 22 should be used to show that the return is related to LIFE if the return is picked up after the LIFE process is started and on account of information obtained during the LIFE examination. See IRM Exhibit 4.51.3-4 for examples showing when the Aging Reason Code 22 should and should not be used.

4.51.3.3.9  (01-01-2007)
LMSB Quality Measurement System (LQMS)

  1. LQMS evaluates the quality of examinations based upon various auditing standards. Proper utilization of the LIFE process will facilitate meeting these standards. LIFE requires the examiner to perform a full and robust risk analysis before determining the issues to be examined. Appropriate specialists should always be involved in the risk analysis process when selecting issues and establishing threshold(s) of materiality for their areas of concern. Once the risk analysis has identified all material items and the scope is limited to the LIFE examination plan, the LQMS reviewer will not require any further explanation for items not included in the LIFE examination. The key to meeting the standard is ensuring all material issues were identified and the decision to limit the scope is documented.

  2. The steps that the examiner takes in risk analysis, determining scope and setting threshold(s) should be documented in the workpapers. Managerial involvement must also be documented in the workpapers whenever the manager:

    1. Signs the MOU

    2. Approves waiver of any Mandatory Compliance Checks

    3. Approves any scope expansion during the LIFE examination, and

    4. Terminates the LIFE process.

4.51.3.3.10  (01-01-2007)
Joint Committee Cases

  1. The fact that a case is examined under the LIFE process should have no bearing on its acceptability to the Joint Committee. The examiner and team manager should adequately document the risk analysis and LIFE scope limitation.

  2. A referral for an on-site review is mandatory for all Coordinated Industry Case (CIC) examinations designated as LIFE examinations that require a report to the Joint Committee on Taxation.

  3. Once a case has been designated as LIFE, it may not be surveyed even though a case may otherwise qualify for Joint Committee survey procedures. See IRM 4.36.1 for further information on the Joint Committee review process.

4.51.3.3.11  (01-01-2007)
Territory Managers Reviews of the LIFE Process

  1. Both Industry and Field Specialists Territory Managers will consider LIFE in their operational reviews of examination groups. In evaluating open cases, they will assess whether the LIFE process is being properly considered for and used in LIFE and Non-LIFE examinations.

  2. No additional operational reviews are required on account of LIFE.

  3. Territory Managers have discretion to determine the number of LIFE and Non-LIFE cases to be reviewed in any operational review.

  4. Territory Managers should have interviews with the Team Manager and Team Coordinator or agent regarding both LIFE and non-LIFE cases.

  5. Territory Managers should consider the differences between IC and CIC cases in determining if field decisions on LIFE and non-LIFE cases are appropriate.

  6. Territory Managers should evaluate each case separately based on its merits.

  7. These reviews will address the following aspects of the LIFE cases:

    1. Discussing LIFE with the Taxpayer

    2. Risk analysis and Issue Selection

    3. Proper Completion of the LIFE MOU

    4. Accountability for timely completion of items specified in the MOU

    5. Consideration of termination where appropriate

    6. Proper use of ERCS codes for tracking the results (Not Field Specialists)

  8. These reviews will address the following aspects of the Non-LIFE returns:

    1. Discussing LIFE with the Taxpayer

    2. Risk Analysis and Issue Selection

    3. Limited Scope, LIFE, or Full Examination

4.51.3.4  (01-01-2007)
4.51.3.4 THE LIFE Memorandum of Understanding (MOU)

  1. This paragraph explains the MOU.

4.51.3.4.1  (01-01-2007)
Introduction and Scope of the LIFE Examination

  1. The LIFE Memorandum of Understanding (MOU) is the cornerstone of a LIFE examination. It governs key aspects of the examination and establishes clear roles and responsibilities for the examiner and taxpayer. However, the MOU is not a legally enforceable agreement.

  2. Use of the MOU is a mandatory provision of the process. To ensure consistent use of the LIFE process, the MOU provisions, responsibilities and language may not be changed.

  3. The list of LIFE issues will be attached to the MOU.

4.51.3.4.2  (01-01-2007)
Periods to be Examined

  1. The MOU is specific to a taxpayer. For this purpose, a taxpayer is an entity whose tax liabilities are reflected on a single return. A taxpayer includes a parent corporation and all of the subsidiaries whose tax liabilities are reflected in the subject consolidated return.

  2. Separate legal entities may not be combined on the same MOU. A consolidated subsidiary is considered the same legal entity as its parent.

  3. The MOU may cover any number of tax periods or types of tax. If additional years are added to the examination after the LIFE process is begun, either a new MOU may be executed for the new years and/or returns or pen and ink changes may be made to the MOU.

  4. The LIFE examination will not include employment tax returns unless specifically identified in the MOU.

4.51.3.4.3  (01-01-2007)
Establishing and Adhering to Materiality Thresholds for Scope Expansion

  1. Materiality thresholds are established in the MOU to limit scope expansion by either the examiner or the taxpayer after the MOU has been executed. This is necessary to maintain focus on the issues selected for the LIFE plan and to complete the examination timely.

  2. The materiality threshold(s) must be stated as a dollar amount. This may be based on the lowest dollar value for each type of issue included in the LIFE plan or another amount based on the examiner’s professional judgment.

  3. The materiality threshold(s) may be established (or applied) either on the basis of the total consolidated return or any other segment thereof (such as a subsidiary, legal entity, or division within a subsidiary).

  4. A materiality threshold(s) may apply to a type of issue (for example, permanent, timing, expense, income, credit, etc.), any tax return line item, tax attribute, or a combination of any of the above.

  5. The establishment of a materiality threshold(s) will not impact the examiner’s responsibility to verify the proper computation of tax liability.

  6. A threshold(s) set for one period or taxpayer should not be automatically extended to either another taxpayer or another period for the same taxpayer. A separate risk analysis must be performed for each examination.

  7. Setting a materiality threshold(s) for scope expansion does not impact the depth to which a selected issue will be examined. Once an item, account or transaction is included in the examination plan, the manner in which the item is examined is not governed by the materiality threshold. Each item within the account may be reviewed, regardless of dollar amount, or a sample of items within the account may be reviewed. The threshold does not limit the amount of any adjustment that may be proposed, whether it increases or decreases tax liability.

  8. The following transactions or types of transactions will not be subject to a materiality threshold and can be examined regardless of when they are identified: tax shelters, coordinated issues, fraudulent items, items contrary to public policy, worker classification issues, executive compensation, and LMSB Field Directive issues.

  9. Although every attempt should be made to adhere to the materiality thresholds, both parties reserve the right to correct obvious computational/mathematical or accounting errors/omissions. These corrections must not be technical or legal in nature and should require little time to resolve. An example of this might be an inverted Schedule M-1 entry.

  10. If during the course of the examination, it is found that a stated accounting policy or practice has not been followed, the scope of the examination may be expanded for this issue without regard to the materiality threshold(s)

  11. If a non-disclosed abusive tax shelter or listed transaction is discovered during the course of the examination, the IRS will expand the scope of the examination to include the issue.

  12. Managerial approval is required for any scope expansion.

4.51.3.4.4  (01-01-2007)
Terminating the LIFE Process

  1. If either party to the MOU consistently fails to meet its commitments under the MOU, termination of the process may result. Such failures include, but are not limited to:

    1. Not adhering to IDR response times

    2. Not providing complete IDR responses

    3. Not entering into issue resolution discussions timely

    4. Not entering into issue resolution discussions timely

    5. Filing claims without supporting documentation

    6. Filing claims above the threshold(s) after the date specified in the MOU

    7. Not adhering to other commitments included in the MOU, and/o

    8. Not disclosing an abusive tax shelter or listed transaction.

    Note:

    A single failure on the part of the taxpayer will not necessarily result in termination. However, if the failure is egregious, a single failure or omission could result in termination. See IRM Exhibit 4.51.3-5 for a matrix that addresses whether certain taxpayer actions should result in termination

  2. A taxpayer may terminate the process. If this occurs, the reasons for such termination should be documented in the workpapers or historical files. The examiner should consider this information in future cycles when deciding whether to offer the LIFE process.

  3. Prior to terminating the LIFE process, the parties should attempt to resolve any problems in the conduct of the examination. If the problems are not resolved, either the taxpayer or team manager may notify the other, either orally or in writing that the LIFE MOU has been terminated.

  4. After the MOU is terminated, the scope may be expanded to include any issue(s) identified in the initial full risk analysis and any new material issue(s) discovered during the LIFE examination that resulted in the termination of the process.

  5. The examiner should document the termination in the workpapers and indicate the reasons for the termination.

  6. The team manager will:

    1. Approve the extent of any scope expansion, including mandatory compliance checks

    2. Revise the estimated completion date to allow for the expanded scope

    3. For Coordinated Industry Cases (CIC), the Coordinated Examination Management Information System (CEMIS) database must be updated, and

    4. Update the ERCS Aging Reason Code to 21.

4.51.3.4.5  (01-01-2007)
Expected Examination Completion Date

  1. The examiner will indicate the expected examination completion date on the attachment to the MOU.

4.51.3.4.6  (01-01-2007)
Schedules of Agreed Rollover and Recurring Issues

  1. LIFE requires the taxpayer to provide computations for all agreed rollover and recurring issues/adjustments from prior cycles. This includes the impact of any closing agreements or Appeals settlements executed between the taxpayer and IRS whether completed before or during the examination. The date for delivery of this schedule of issues must be specified in the attachment to the LIFE MOU.

  2. The unagreed rollover and recurring issues may be included in the scope of the LIFE examination plan, but the taxpayer is not required to provide these computations to the examiner. If an issue is pending resolution in Appeals (or other venue), it is classified as an unagreed issue for purposes of the LIFE process. If at some point during the course of the examination, a resolution to the issue is reached, the resolution may be used in the current examination under the authority provided by Delegation Orders 236, Settlement Offers and Closing Agreements in CEP Cases Where Appeals has Effected a Settlement, and Delegation Order 247, Settlement Offers and Closing Agreements in CEP Cases on ISP and IFASP.

    Note:

    A recurring issue is an issue that appears in the current cycle that had been examined in the previous cycle. A rollover issue is an adjustment that is generated in the current cycle as a result of issues adjusted in a prior cycle.

4.51.3.4.7  (01-01-2007)
Claims and Affirmative Issues

  1. Filing claims and affirmative issues expands the scope of any examination. The examiner must, at a minimum, review each claim or affirmative issue to determine whether to accept it or examine it.

  2. To promote the timely completion of the LIFE examination, the taxpayer must agree:

    1. Not to file a formal claim or affirmative issue below the materiality threshold(s) and

    2. To file all claims above the materiality threshold(s) within a specified number of days following execution of the MOU.

  3. The materiality threshold(s) may not be met by combining multiple issues into a single claim or affirmative issue. For this purpose, an issue must be defined consistently with the terminology used in the MOU for the applicable threshold(s). For example, if the MOU describes a threshold for timing issues, each timing issue in the claim must meet the threshold. The claim may not meet the threshold by combining more then one timing issue. Similarly, a claim will not meet the threshold by combining a timing issue(s) with another type of issue.

  4. Materiality thresholds do not apply to claims filed:

    1. In a Qualified Amended Return as defined in Treasury Regulations section 1.6664-2(d) or

    2. Before the MOU is signed by the taxpayer.

  5. Positive or negative adjustments may be made to any issue selected in the LIFE examination plan regardless of the time frames for filing formal and informal claims or the materiality threshold(s) specified in the MOU.

  6. For example, an examiner or a taxpayer selected Legal Expenses in the LIFE plan. The examiner issues an IDR for questionable items within the account. The taxpayer reviews the account and discovers an adjustment decreasing his liability. He brings this to the attention of the examiner when he provides the rest of the information requested. This is not a claim or affirmative issues for the MOU restrictions on claims. If the taxpayer had discovered a potential adjustment in his favor in an unrelated account while researching that IDR, this would be subject to the MOU restrictions on claims. In addition, the agent can propose adjustments for LIFE issues (in this example, legal expenses) above or below the threshold amounts.

  7. When determining whether a claim or affirmative issue is above the threshold, the dollar amount of the issue must be above the threshold, not the resulting tax affect of the issue.

4.51.3.4.8  (01-01-2007)
Information Document Requests (IDRs)

  1. The MOU requires the parties to specify a time frame for responses to IDRs. Each IDR must contain the due date of the response.

  2. If a particular IDR involves obtaining records that will be outside the normal response time, the taxpayer and examiner may agree to provide a distinct response date for a particular IDR. This could be a practical consideration for information located overseas or at a subsidiary that had been sold, etc.

  3. If, for any reason, the taxpayer determines that a response date cannot be met, the taxpayer should notify the examiner immediately. In such instances, the taxpayer and examiner should work together to ensure the examination proceeds in a timely manner.

  4. The examiner should timely review the taxpayer’s responses for completeness and discuss them with the taxpayer, if necessary.

  5. The LIFE process is consistent with the IDR Management Process as outlined in IRM 4.45.13.4.8.

4.51.3.4.9  (01-01-2007)
Resolution of Notices of Proposed Adjustment – Form 5701 (NOPA)

  1. The LIFE process requires that both the examiner and the taxpayer assume certain responsibilities for resolving issues at the earliest possible opportunity.

  2. The examiner will issue a NOPA as soon as reasonable grounds for an adjustment have been established.

  3. The taxpayer agrees to respond to the NOPA within a number of days specified in the MOU. This response will indicate agreement or disagreement with the NOPA and state all relevant facts and legal arguments.

  4. Both parties to the MOU should continually engage in discussion for the purpose of resolving any factual or technical differences in their positions.

  5. Both parties acknowledge that Alternative Issues Resolution tools should be considered as appropriate.

Exhibit 4.51.3-1  (01-01-2007)
The LIFE Memorandum of Understanding

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MEMORANDUM OF UNDERSTANDING between INTERNAL REVENUE SERVICE and ______________________________________ LIMITED ISSUE FOCUSED EXAMINATION (LIFE) ________________________________________________

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LIFE MOU Attachment (or Continuation)Expected examination completion dateRollover and Recurring adjustmentsClaimsNotices of Proposed Adjustment (NOPA's

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Instructions for Completing the MOUGeneral InformationDocument HeaderParagraph 1:Section (A) - Periods to be Examined and Targeted Timeframes:

Exhibit 4.51.3-2  (01-01-2007)
Establishing the LIFE Examination Plan and Setting Thresholds for Expanding Scope

This Exhibit shows the steps the examiner will go through from risk analysis to setting the LIFE examination plan and threshold(s) for scope expansion. This is not intended to provide a format for risk analysis or evaluating materiality of a particular issue or set of issues.

Step 1: Identify LUQ Items.

SAIN Description Amount
102 Accounts & Notes Receivable $2,000,000
103 Inventories - Section 263A $12,000,000
106 Loans to Shareholders $9,500,000
108 Other Investments $14,000,000
215 Accounts Payable $9,750,000
218 Loans from Shareholders $7,000,000
219 Long Term Obligations - Mortgages $1,250,000
219 Long Term Obligations - Deferred Compensation $600,000
401 Sales - Deferrals $15,000,000
401A Sales Returns and Allowances $4,000,000
408 Royalty Income $1,100,000
510 Cost of Sales - Soft Drink Rebates $8,000,000
512 Compensation of Officers $4,000,000
514 Repairs $500,000
525-02 Professional Fees & Services $1,250,000
526-19 ISO 9001 Certification $200,000
526-21 Miscellaneous $750,000
601 Net Operating Loss Deduction C/B Claim $6,000,000
608 Reconciling Schedule M (12 entries) $18,000,000
702 Intercompany Allocations - Reg. 1.1502 amount unknown
703 Merger and Acquisition Issues amount unknown
various Personal use items of shareholders and officers amount unknown

Note: Any issue on this list could be added to the examination plan if LIFE is terminated.

Step 2: Complete the risk analysis to determine which issues would be included in the traditional, full scope examination plan. The two columns to the right are illustrative of the decision-making process. They are not intended to represent a model for making decisions in the risk analysis. Various factors, other than dollar amount, would be taken into account, before deciding which issues would be included in a traditional, full scope examination plan.

SAIN Description Amount Included in Audit Plan Not Included in Audit Plan
102 Accounts & Notes Receivable $2,000,000 X  
103 Inventories - Section 263A $12,000,000   X
106 Loans to Shareholders $9,500,000 X  
108 Other Investments $14,000,000 X  
215 Accounts Payable $9,750,000   X
218 Loans from Shareholders $7,000,000 X  
219 Long Term Obligations - Mortgages $1,250,000   X
219 Long Term Obligations - Deferred Compensation $600,000 X  
401 Sales - Deferrals $15,000,000 X  
401A Sales Returns and Allowances $4,000,000   X
408 Royalty Income $1,100,000   X
510 Cost of Sales - Soft Drink Rebates $8,000,000   X
512 Compensation of Officers $4,000,000 X  
514 Repairs $500,000 X  
525-02 Professional Fees & Services $1,250,000 X  
526-19 ISO 9001 Certification $200,000 X  
526-21 Miscellaneous $750,000 X  
601 Net Operating Loss Deduction C/B Claim $6,000,000 X  
608 Reconciling Schedule M (12 entries) $18,000,000 X  
702 Intercompany Allocations - Reg. 1.1502 amount unknown   X
703 Merger and Acquisition Issues amount unknown X  
various Personal use items of shareholders and officers amount unknown X  

Step 3: Use key principles of materiality and other considerations to pare down the scope of the examination. Then provide the taxpayer a list of issues that would be included in a LIFE examination. Attach this list to the MOU.

SAIN Description Amount
106 Loans to Shareholders $9,500,000
108 Other Investments $14,000,000
218 Loans from Shareholders $7,000,000
401 Sales - Deferrals $15,000,000
512 Compensation of Officers $4,000,000
601 Net Operating Loss Deduction C/B Claim $6,000,000
608 Reconciling Schedule M (12 entries) $18,000,000
703 Merger and Acquisition Issues amount unknown
various Personal use items of shareholders and officers amount unknown

There is no set number or percentage of issues from the traditional, full scope examination plan that should be included in or excluded from the LIFE examination plan. If it does not make good business sense to limit the scope of the examination, LIFE should not be used.

Step 4: Establish threshold(s) for expanding the scope of the examination.

These thresholds must be a dollar amount. With certain exceptions identified in the MOU and IRM, thresholds restrict the taxpayer's ability to file claims and raise affirmative issues as well as the examiner's ability to raise new issues. Examiners may not raise additional issues, even above these threshold(s) without the approval of the team manager. The threshold(s) may be the lowest dollar amount selected for each type of issues in the LIFE plan or another amount based on the examiner's professional judgment.

Exhibit 4.51.3-3  (01-01-2007)
LIFE Mandatory Review Items Waiver Checksheet

LIFE Mandatory Review Items Waiver Checksheet
Taxpayer Name Periods:
Description Date Waived Y/N Mgr. Initials
Prior and Subsequent year returns (Cannot Be Waived) N/A N N/A
Related Returns; review of income tax returns for related entities/taxpayers (Cannot Be Waived) N/A N N/A
       
Gross Income Probe (IRM 4.10.4.3.4)      
Minimum Inventory Checks (IRM 4.10.2.6.4)      
       
       
Required Compliance/Filing Checks: (IRM 4.10.5)      
Employment Taxes (940s, 941s, 943s)      
Questionable W-4s      
W-2      
Form 1099 Series of Information Documents (can not be waived for examinations involving financial institutions)      
Form 8300s and CTRs      
       
       
Other Returns      
Excise Taxes      
F-5500 Pension returns      
F-5471 Information Return of US Persons      
F-5472 Information Return of a 25% Foreign Owned Corporation      

Exhibit 4.51.3-4  (01-01-2007)
Instructions for ERCS Aging Reason Code 22

Aging Reason Code 22 should be added to ERCS for any return that is picked up as a result of a LIFE examination. Aging Reason Code 20 will continue to be used for the returns that are covered by the LIFE MOU. Aging Reason Code 22 is used when the related pick up was not included on the LIFE MOU and where you determine it is not appropriate to enter into a new MOU or amend the existing MOU. Examples where the Aging Reason Code 22 should be used: 1. You use LIFE to examine a Partnership with three non-corporate partners. It is non-TEFRA. There is an adjustment that must be carried over to the partners’ returns. After you inspect the returns, you decide there are no other issues. You perform a traditional, limited scope examination to make the flow-through adjustment. You should not amend the MOU to include these returns. Just update the Aging Reason Code 22 as soon as you secure controls over these returns. 2. You use LIFE to examine a corporate return. The taxpayer files a claim for a prior year for a carryback from one of the years in the LIFE MOU, but it does not meet Joint Committee requirements. That prior year was not included in the MOU. The claim was filed during the period for filing claims below the materiality threshold as provided in the attachment to the MOU. The return had previously been examined and your inspection shows no issues that were not considered. You should add the claim to your LIFE audit plan and perform the steps necessary to examine the claim. You should not amend the MOU to include this return. Update the claim return to Aging Reason Code 22 as soon as you secure controls.3. You use LIFE to examine a corporate return. The corporation has a sole shareholder. Your review of the expense accounts included in the LIFE examination plan shows that the corporation is paying significant personal expenses of the shareholder. Your review of the shareholder returns shows potential tax shelter transactions. You begin a traditional, full scope examination of the shareholder’s return. You should not amend the MOU to include this return. Update the shareholder return to Aging Reason Code 22 as soon as you secure controls. 4. You use LIFE to examine a corporate return. It is a Joint Committee case. The MOU has the loss year return and three carryback years. Your adjustments result in credits being freed up to a fourth prior year. The return had previously been examined and your inspection shows no issues that were not considered. You perform a traditional, limited scope examination to adjust the fourth prior year. You should not amend the MOU to include this return. Update the Joint Committee case to Aging Reason Code 22 as soon as you secure controls.

Examples where the Aging Reason Code 22 should not be used: 1. You are simultaneously working two cycles with three tax periods in the first cycle and two tax periods in the second cycle. The first cycle was worked using traditional, full scope process. You started the second cycle to improve currency. After a full risk analysis, you and the taxpayer entered into a LIFE MOU for the second cycle. As a result of information you obtained in year two of the first cycle (traditional examination), you pick up three shareholders’ returns for all five years of the examination. You perform traditional, limited scope examinations to make the required adjustments. Since the returns were not opened as a result of the LIFE examination, you do not update them to Aging Reason Code 22. 2. You are performing a LIFE examination of a corporate taxpayer for years one through four. An Employee Plans specialist opens an examination of plans for years four, five and six independent of the LIFE examination. Since the returns were not opened as a result of the LIFE examination, you do not update them to Aging Reason Code 22. 3. You use LIFE to examine a corporate return. The taxpayer files a claim for a year not included in the MOU. It is not a carryback or carryover from a year in the MOU. The claim was filed during the period for filing claims below the materiality threshold as provided in the attachment to the MOU. Your inspection shows no other issues that were not considered. You should perform a traditional, limited scope examination to consider the claim. You should not amend the MOU to include this return. Since the returns were not opened as a result of the LIFE examination, you do not update them to Aging Reason Code 22.

Exhibit 4.51.3-5  (01-01-2007)
Termination: Taxpayer Behavior and its Consequences

This table is presented as a general guide. In all instances, the examiner and team manager should use care in making the decision to terminate the LIFE process. These examples are intended to show that the termination should be considered when it is obvious that a taxpayer’s behavior pattern threatens the timely completion of the examination.

Computations for agreed rollover and recurring issues

Taxpayer (TP) Behavior Consequences/Team Action
TP provides all required data, at the mid-point of the exam, but it will not have negative impact on RAR date. This is not consistent with agreement, but since there will not be an impact on RAR date, limit action to discussion.
TP indicates that the person assigned to complete this area has left the company and they will not be able to supply until after projected RAR date. The reasons for the delay or the TP’s intentions are unimportant. The projected RAR date is negatively impacted and the LIFE exam should be terminated. Scope should be expanded based on original risk analysis

Information Document Requests

Taxpayer (TP) Behavior Consequences/Team Action
Several less significant IDRs are a few days late Remind TP of obligation to meet response dates; no impact on scope of exam
One or more IDR responses are or will be delinquent; projected RAR date may be affected Discuss with TP immediately, indicating LIFE process is in jeopardy. LIFE process may be terminated unless situation is corrected.
Frequent or consistent failure to meet agreed upon IDR response times – will delay RAR date LIFE exam should be terminated immediately. Scope should be expanded based on original risk analysis.

Notice of Proposed Adjustment (NOPA)

Taxpayer (TP) Behavior Consequences/Team Action
You have issued a number of NOPAs (5701). TP takes exception to one and has provided a position paper and additional facts to support. Cooperation on this and other areas has been good, but the RAR date may be exceeded. Since the TP is cooperative, the possible extension of the RAR date is acceptable. Continue to try to resolve even if RAR date is delayed.
You have issued 10 NOPAs. Several are for issues presently in Appeals for a prior cycle. The facts are the same. TP indicates they do not want to discuss issues in Appeals Since these issues were previously identified as unagreed, this does not affect the LIFE process. TP must provide some position for the unagreed issues promptly.
During the 12th month of a projected 24th month LIFE exam (four year cycle), you issue a NOPA for a high dollar emerging issue. TP indicates there are industry-wide implications and wants to delay discussion for "a few months" . TP says there are additional facts but cannot articulate them or specify a date when they will be provided. Any delay beyond several weeks is contrary to the LIFE process. There is no guarantee the RAR date will not be affected. You should inform TP the LIFE exam is in jeopardy.
Same example as above. As you approach the 20th month, the TP remains unwilling to discuss or provide data to resolve the LIFE exam. LIFE exam should be terminated immediately. Scope should be expanded based on original risk analysis.

Claims and Affirmative Issues

Taxpayer (TP) Behavior Consequences/Team Action
TP indicates that after the MOU was signed, they found several small issues that will reduce taxable income. The issues were not identified in the LIFE exam plan. They want you to incorporate them into the RAR. TP recognizes they are below the materiality threshold, but says they have a fiduciary responsibility to shareholders. This is a clear violation of the LIFE process. If the TP insists on having these adjustments made, the LIFE exam may be terminated and the scope expanded accordingly.
TP indicates they have come across an error made when a schedule M was prepared; a debit was recorded as a credit. The dollar amount is just below the materiality threshold. While below the materiality threshold, if you are satisfied this is just an obvious error, the adjustment could be included in the report.
At a mid-point meeting, the TP indicates that a "big" CPA firm has been working with them to prepare a claim for the FSC. TP indicates that they will give you the 1120X with a "ball park" number that can be refined as the computations are completed. They have been in discussions with the firm for some time. The agreed upon date for filing claims has passed. At this point, you have no idea what the impact will be on the closing date. Even if we assume the claim will exceed the materiality threshold, the TP has violated the LIFE process. The TP knew the claim would be filled months ago and the computations are not complete. LIFE exam should be terminated immediately. cope should be expanded based on original risk analysis.

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