Prepared Remarks of Commissioner Douglas H. Shulman before Tax Council Policy Institute
February 15, 2012
I want to share some thoughts with you this morning about risk… and especially business tax risk. But first, let me make some general observations.
The World Economic Forum says, “We are living in a new world of risk.” It points to a number of factors, including globalization, economic uncertainty, growing multiplicity of actors and shifting power structures. Many of these risks are interconnected.
In the broadest sense, business risk is usually defined as any internal or external factor or circumstance that could have a negative impact on a company.
Of course, under this general rubric are the many different dimensions of business risk, such as market risk…credit risk…liquidity risk…accounting risk…legal and regulatory risk… geopolitical risk… reputational risk…competitive risk…operational risk…and of course, tax risk.
Today, I want first to focus on administrative tax risk which occurs when a taxing authority…be it the IRS or another country’s taxing authority…or both…may audit a corporation and make an assessment. Administrative tax risk can pose quite a challenge for the taxpayer. The good news is that we have a toolbox full of strategies and programs that are available to address and mitigate much of that risk. I will describe the contents of that toolbox shortly.
Second, I want to open a window on tax policy risk. Specifically, new laws can be enacted and statutes can change which may require a different tax planning strategy on the corporation’s part.
So, let’s start with administrative tax risk. Since I became Commissioner, one of my priorities has been reducing uncertainty for taxpayers by focusing on issue resolution. This helps mitigate administrative tax risk for taxpayers, including the largest corporate taxpayers, and creates efficiency for the IRS.
For our large corporate taxpayers, administrative tax risk involves their tax planning and the tax positions they take when there is some doubt as to the final outcome if challenged by the IRS or another tax authority. For the IRS, risk has traditionally entailed the possibility of not finding the issues and information we need, as well as complexity in the Code that can be exploited by those wanting to push tax planning beyond what is legally allowed.
We now have a suite of programs at the IRS that are designed to provide greater certainty, consistency and efficiency going forward for both our large taxpayers and the IRS. They are all focused on resolving issues, which takes uncertainty and risk out of the system.
First, is the CAP program, which is a risk management tool for taxpayers and the IRS, and which we made permanent earlier this year. At its simplest, CAP allows a taxpayer to work through all issues with the IRS before filing a return – eliminating the risk that we will challenge an issue post filing. The number of corporate taxpayers participating in the program has grown from 17 in the 2005 tax year – when the pilot began – to 160 today.
In recent months, I’ve been talking with CAP taxpayers, and the feedback I’ve gotten is that the paradigm of transparency and certainty is a welcome change in our tax system.
Another tax risk mitigation tool for both our large corporate taxpayers and the IRS is the Industry Issue Resolution Program – or IIR. It can help the IRS and corporate taxpayers reach administrable, commonsense solutions for uncertain tax areas.
For example, by using IIR, we resolved some long-standing controversies that had plagued the telecommunications, transmission and distribution industries for years. We see IIR as a very useful tool for issue resolution and continue to work on a number of new issues.
Fast Track Settlement is an additional resolution tool we’re encouraging our agents to use. Instead of finishing an audit and then going to Appeals, Fast Track allows a taxpayer to settle an issue with an Appeals officer during the audit process. We have witnessed an uptick in participation, which is promising, and are committed to expanding our ability to resolve issues more quickly with taxpayers who want to do so. The latest data is also most promising. It shows that 83 percent of the cases accepted into Fast Track resulted in a resolution.
Another tool we have for risk mitigation is information reporting. In recent years, a number of information reporting provisions have been enacted, including basis and credit card reporting. This type of transparency helps mitigate risk for the IRS and taxpayers. For the IRS, it allows us to select returns to review with the highest probability of non-compliance. We can then use our audit resources where compliance risk exists, and as importantly, not add burden to taxpayers where compliance risk is low. And through the prudent use of information returns, we take away audit risk for compliant taxpayers.
Our uncertain tax position initiative, when implemented as we have envisioned, will create more certainty for taxpayers – as we will get to the heart of any discussion much quicker – and mitigates risk for the IRS that an issue will remain hidden.
The program’s goal is to have a transparent discussion with corporations to resolve issues much quicker, and be more efficient in targeting taxpayers and issues with the highest risk of non-compliance. And here are the latest statistics on Schedule UTP. As of January 1, 2012:
- Approximately 1,900 taxpayers have filed Schedule UTP.
- Approximately 4,000 issues have been disclosed.
- Not surprisingly, the top three Code sections are Section 41, research tax credits… Section 482, allocation of income including transfer pricing… and Section 162, trade and business expenses.
- 19 percent of all issues disclosed are transfer pricing issues.
Each of these programs has an element of transparency and faster issue resolution woven through them. If taxpayers want to mitigate administrative risk, one way to do so is to assume that a tax authority will eventually get to the bottom of any transaction or tax position. Given the assumption of full disclosure, the taxpayer has a choice to make. If the business taxpayer feels that the risk/reward calculus is one that is beneficial to the company, then the taxpayer should take that position. However, that same taxpayer should not assume we won’t find an issue; that type of thinking only creates new risk and uncertainty.
The multinational setting in which most large corporations operate today poses significant administrative tax risk. Corporations often deal with multiple countries on a single issue. And more and more, we see US multinationals being challenged by foreign taxing authorities. And because different countries approach issues in different ways, this raises the stakes on the need to collaborate.
Let me give you an example of how we are working to help mitigate risk in the international context. I am the Chair of the global body of tax authorities called the FTA. We have been very focused on governments moving from information sharing to real, coordinated action. To that end, recently, the U.S.led an effort to develop a protocol for joint audits, where two or more countries conduct a single audit of a taxpayer.
We thought that the benefits for both governments and taxpayers of a joint audit could be substantial. It could reduce taxpayer burden – especially for large multinational corporations that must face audits in multiple jurisdictions on the same set of transactions. It could provide these taxpayers with a timesaving and less resource- intensive way to address the tax consequences of a transaction on a bilateral or even multilateral basis. And just as important to a swift resolution of issues, the joint audit could provide certainty for the taxpayer today and in the future.
At the same time we were developing a protocol for joint audits through the FTA, I asked our IRS team to find opportunities to start some joint audits immediately.
We started several joint audits, and let me talk about one. This year, we conducted a joint audit with another country of one of our CAP taxpayers that involved a transfer pricing issue. We resolved the issue bilaterally for the CAP year, and we also were able to provide the taxpayer with a bilateral Advance Pricing Agreement to cover future years. And we did this all in six months.
This result hits on many of the elements of our future vision for a well-functioning tax system in a global environment.
- Transparency: We started with a CAP taxpayer, who had already agreed that in exchange for opening their books to us, we would provide certainty before a return is filed.
- Real Time: We resolved a complex issue in six months, in this case moving the competent authority process into the audit – this represents a huge contrast between a normal competent authority process which typically takes place long after the tax year or years in dispute.
- Certainty: We resolved the issue for the current year, but as importantly, through an Advance Pricing Agreement, agreed on a transfer pricing methodology for future years. This creates an environment in which the business does not have potential adjustments and planning uncertainty hanging over its head, and we know the issue is being dealt with correctly.
- Coordinated action between two governments: Unlike past practices, where each government might have negotiated hard after an audit adjustment was proposed by one of them, in this case, the two governments worked together cooperatively to reach a mutually-acceptable principled resolution.
The results of this joint audit were a win for the taxpayer and a win for us. And it mitigated risk in a substantial way.
I would be remiss if I did not include guidance as a way to reduce business tax risk.
We typically think of guidance as removing uncertainty from return positions. However, guidance can also remove uncertainty and risk from business transactions and business decisions themselves.
For example, earlier this month, we proposed regulations that would provide a framework under which Individual Retirement Accounts could purchase “longevity annuities” or “longevity insurance.” A longevity annuity is an annuity that begins providing a fixed payout beginning at, say, age 85, thus helping ensure that a person will not outlive his or her retirement assets.
Under the proposed regulations, a longevity annuity that meets fairly simple minimum requirements could be purchased by someone’s IRA, but the minimum distribution requirements for the IRA would only be calculated with reference to the IRA’s other assets. Until now, the required minimum distribution rules have been a real obstacle to the use of longevity annuities in IRAs.
This guidance we issued will reduce risk and uncertainty for people who develop products to help people make ends meet in retirement, and in this case, it helps facilitate a product that can reduce the risk that our senior citizens will run out of money at the end of their lives.
Let me turn to tax policy risk. As much as we and other nations can help mitigate risk through administrative tools, and as much as the IRS and our colleagues at the Treasury Department can help create certainty and mitigate risk through guidance, no discussion of tax risk would be complete without an acknowledgement of the significant effect that tax laws themselves have on taxpayers. It is obvious that Congress has the ability to profoundly change the tax game and its rules through tax legislation.
As we all know, there is growing consensus on the need for comprehensive tax reform. This is a subject that has been discussed by many policymakers, and I won’t discuss the broad and global issues of tax reform today. Rather, let me make a few observations.
One key attribute of this country, which leads to trust and better outcomes, as well as accountability, is our democratic tradition of making large scale policy decisions in the light of day – with a lot of public debate on the issue. Major tax legislation, in particular, is almost never simply enacted in the form proposed. Instead, our legislative processes create a lot of room for public comment and input on major tax proposals. Even when the process does not include hearings and markups, affected parties usually have ample opportunity to express their views. And where tax regulations are involved, there are formal processes for notice and comment.
I think this tradition of public discussion, proposals submitted by multiple parties, and input from the public is a risk mitigation tool for the broader tax system. Whether it be public interest groups, companies or individual taxpayers – there is a place for everyone to comment on how a policy will affect them. While we take this for granted in this country, it is a key attribute of this nation which should not be overlooked.
Now, as IRS Commissioner, I’m at the intersection of where public policy meets reality, or implementation. From this vantage point, let me make some observations about ways to reduce risk through tax legislation.
Let me stress from the outset that this is not rocket science. It’s about basics. It’s about certainty and consistency, which inherently reduce risk in any system.
One attribute of our tax system that adds uncertainty is its impermanence. Short term provisions, that sunset but are then often extended, have an unsettling effect on both clarity and stability.
In 2010, the Joint Committee on Taxation identified more than 130 tax provisions that were set to expire at the end of 2010, with approximately another 70 to sunset at the end of 2011. And 40 more tax provisions are set to expire at the end of 2012. This year, we actually had a tax provision that was set to expire in two months.
A perfect example of uncertainty for business taxpayers caused by expiring provisions is the Research and Experimentation tax credit. Its purpose is to foster innovation and technological development while spurring economic growth and competitiveness.
However, for the past 30 years, it has been extended 14 times, many of those retroactively, for periods ranging from six months to five years. Such persistent uncertainty about the future availability of the R&E credit diminishes its incentive effect as taxpayers often do not know if they can depend on the credit when making decisions on future investments in research and development.
President Obama has proposed to make the R&E credit permanent, thereby eliminating the year-to-year uncertainty and improving the credit’s effectiveness.
Another trend that adds risk to the system is the retroactive reinstatement of tax provisions. This creates confusion for taxpayers, and makes it very difficult for the IRS to implement. We have seen provisions expire for almost an entire year, only to be reinstated at the end of the year. While the IRS muddles through and does its best by rushing through revised forms and instructions, last-minute retroactive extensions cause significant taxpayer confusion, with a clean-up that often drags on for many months. The most recent visible example of this was the expiration of the estate tax at the end of 2009, which was then reinstated at the end of 2010. Upon reinstatement, Congress gave taxpayers the option of using either the 2009 or the new 2011 rules for 2010. This kind of result is not optimal.
Finally, passing legislation with immediate effective dates adds operational risk to the IRS and makes it hard for taxpayers to plan properly to take advantage of tax benefits. When effective dates are set far enough ahead, it allows IRS to develop the necessary guidance and instructions for taxpayers to understand the provision, and for implementation to go smoothly for taxpayers and the IRS. Appropriate lead time helps the IRS to set up customer service operations, and put in place the appropriate compliance systems so people don’t game the system. This is how it should work, but often doesn’t.
A year ago we actually delayed the opening of tax filing for 6.5 million Americans, from January 14th to February 14th because of late tax law changes. That meant 6.5 million people, including school teachers who wanted to take a deduction for classroom supplies that they paid for themselves, had to wait an extra month to get their refund. In any public policy arena, policymakers should strive to give those implementing a law enough time to do it right.
Now, any changes to the tax code create winners and losers. As a friend said to me when I took this job: The tax code and the IRS are a big deal because we’re talking "real" money. Changes to the tax code, even when the goals are agreed upon – like simplicity or stability – are hard because inevitably it means more money for some and less for others. And I will leave specifics of any proposals to our nation’s elected leaders.
Let me conclude by observing that risk is not inherently bad or something to be avoided. Positive change often involves risk taking. It comes down to how you view and manage risk in a balanced fashion…where the risks are well thought out and are in line with the reward. As Teddy Roosevelt said, “Risk is like fire: If controlled it will help you; if uncontrolled it will rise up and destroy you.”
We at the IRS have dedicated ourselves to creating innovative new paths that will help both businesses and the IRS resolve issues, which helps to mitigate risk and achieve our shared goals of certainty, consistency and efficiency. I think we can all agree that these are goals that, if achieved, would benefit the entire tax system.
Thank you for listening and I would be happy to take a few questions.