Prepared Remarks of Commissioner Douglas H. Shulman before the American Bar Association
September 15, 2012
I have always found fall to be a very exciting time of the year. The book is closed on another summer; schools and universities have reopened; Congress reconvenes after its August recess and businesses and governments get back to hard work.
But this is not your typical fall in Washington. It’s a very tricky and anxious time for our nation as we peer over the edge of the so-called fiscal cliff.
Between now and January 1st our elected leaders and officials must wrestle with and try to come to a consensus on potential automatic spending cuts and tax laws that have expired or will soon expire. These are issues that will affect us profoundly at the IRS.
Indeed, the next 3½ months promise to be a virtual hive of activity when it comes to the major tax provisions facing a December 31 deadline.
Some of the more prominent include the 2001 and 2003 income tax cuts and the payroll tax holiday. However, layered upon these are the so-called “tax extenders,” such as the state and local sales tax deduction, and also the Alternative Minimum Tax – or AMT – patch. These provisions have already expired and must be dealt with before tax returns can be filed next year. The biggest and thorniest problem for the IRS and next year’s filing season is the AMT patch.
Tight budgets also make it tough for the IRS to provide the quality of service and positive interactions that we want with taxpayers. We also have more responsibilities on our plate as we move to implement major pieces of legislation including the Affordable Care Act and FATCA.
However, even in this time of partisanship and fiscal brinksmanship, I’ve been very proud that the IRS has been able to stay above the fray. We’re not getting distracted …we’re staying focused on our strategic goals…many of which challenge the status quo.
I am a big believer that major institutions must always be looking forward, innovating, and willing to challenge the status quo. In addition to being good stewards of this important institution, I hope that we have been doing just that during the years I have been at the IRS. And today I want to talk about a few places where we have challenged some of the built-in assumptions about the way our tax system runs.
For example, even before I became Commissioner, I was aware that the relationship between the IRS and large corporate taxpayers was frequently unconstructive. There was often protracted trench warfare where cases were not resolved during the examination process and ended up in Appeals or the Courts. Again and again, we spent an inordinate amount of time fighting timing issues and often missed other key issues. It was a terrible waste of time and resources for both the taxpayer and the IRS.
One of the assumptions built into this dynamic was the so called “adversarial relationship” between the IRS and the taxpayer. This was one of those “givens”…the relationship would never change.
I challenge this basic assumption. The historic framework for the nation’s tax laws is a system of voluntary compliance. Our tax system is set up in such a way that taxpayers fill out their own returns. This self-assessment system reflects the fact that it is the taxpayer, and not the IRS, who possesses all of the information relevant to tax liability. We then use information reported by the taxpayer to make judgments about issues to pursue, and returns to audit. Inherent in this system is the basic assumption that the taxpayer will be forthcoming and the government does not need to be an “adversary” in most situations.
But given the recent trajectory of the relationship, the naysayers did not think we could find a place where we could resolve issues earlier for companies that wanted to do so with the promise of greater certainty, consistency and efficiency.
To begin this transformation, I staked out a number of goals in the transformation process. We needed to work smarter…we needed to be more efficient…we needed to create innovative strategies for issue resolution that are less time and resource intensive for both the IRS and taxpayers.
This evolving relationship begins with a reminder of the IRS’ mission and our responsibilities with respect to our large corporate…and indeed, all taxpayers. Our job is to apply the tax laws as written, without putting a thumb on either side of the scale – without favoring either the government or the taxpayer. Our mission is to collect the proper amount of tax and to efficiently use our compliance tools to foster ongoing compliance by taxpayers. This is the key to balanced and fair tax administration.
We now have a suite of different strategies, tools and programs we’ve been applying over the past few years to achieve these goals. At first blush they may seem unique and unrelated…with all of their different acronyms and structures. But if you look deep into their genetic blueprint you will see the same goal at their center…Issue Resolution. That’s what binds them together…that’s their shared purpose.
So let me take a few minutes to discuss this discrete, yet related family tree of issue resolution programs that form the core of our large corporate taxpayer strategy.
First, is the CAP program, which we made permanent last year. Simply put, the goal of the program is certainty and transparency…resolving issues with the IRS before a return is even filed.
One of the big changes in CAP is that you no longer have to be invited to join the program. Any corporation that meets the program’s requirements and wants to enjoy the benefits of open, cooperative, and transparent interactions can now apply.
The number of corporate taxpayers in the program has grown from 17 in the 2005 tax year – when the pilot began – to 161 taxpayers this year. We’ve also matured the program. There’s now a pre-CAP program that will provide interested taxpayers with a clear roadmap of the steps required for gaining entry into CAP.
And we now have a CAP maintenance phase that’s intended for our large corporate taxpayers who have been in CAP for several years and have established a track record of working cooperatively with the IRS. We have a real-time dialogue with these taxpayers. They can resolve tax issues upfront and obtain certainty before finalizing their financial statements and making regulatory filings.
Over the past year I’ve been talking with CAP CEOs, and the feedback I’ve gotten is that the paradigm of transparency and certainty is a welcome change in our tax system.
Another important tool in our issue resolution family of programs is the Quality Examination Process which replaced the Joint Audit Planning Process. QEP promotes focused exam plans with the core elements being mutual communications, involvement and engagement.
QEP allows us to engage and involve our large corporate taxpayers throughout the examination process…from the earliest planning stages right through resolution of all issues and completion of the case.
We’ve completed our first year of QEP and Heather Maloy, the Commissioner of our Large Business & International division, and her senior team engaged in a review of closed cases in order to get a real feel for the level of technical quality exhibited in our current casework. They will use the results to ensure that we are focused on the right issues with corporate taxpayers and that our work remains high quality.
Fast Track Settlement is an additional resolution tool we’re encouraging our agents and taxpayers to use that allows taxpayers to resolve an issue with an Appeals officer during the audit process. We’ve trained our technical employees how to use Fast Track, and have removed internal barriers that may have discouraged its use.
While the numbers of participants may still be small, last year they grew by 50 percent…which is promising.
Another important tool in our toolkit that resolves uncertainty is the Industry Issue Resolution Program – or IIR.
This is a tool we’ve been using more and more with good results. By using IIR, we resolved some long-standing controversies that had plagued the telecommunications and transmission and distribution industries for years.
And this year, we used IIR to allow insurance companies to elect what is effectively a safe harbor for partial worthlessness deductions for certain complex securities in an insurance company’s portfolio. This relieves both the company and the IRS from the burden of having to independently value these securities.
We see IIR as a very useful tool for issue resolution and continue to work on a number of new issues in a variety of areas.
Let me now turn to our uncertain tax position reporting requirement which I believe will drive transparency and faster issue resolution. Schedule UTP gets to the heart of information we need, while respecting a taxpayer’s internal analysis and deliberations. It moves us towards our shared objectives of efficiency, certainty and consistency.
And I want to pause for a moment to recognize and thank the ABA for its thoughtful and constructive comments and suggestions on the initial Schedule UTP proposal. I think we have a better final product because of them.
Let me highlight just a few examples of the important changes we made based on stakeholder feedback. There’s the phased-in implementation of the schedule for corporations with assets under $100 million…the elimination of the requirement to calculate and include a maximum tax adjustment for each position…and the elimination of administrative practice positions.
Of great note, we also clarified and strengthened the policy of restraint. We adopted a policy that we will not seek documents that would otherwise be privileged, even though the taxpayer has disclosed the document to a financial auditor as part of an audit of the taxpayer’s financial statements.
Successfully implementing UTP rests on our working together to streamline, improve, and change the way we carry out our responsibilities in a manner that will save resources and achieve certainty sooner for taxpayers and the IRS. And I want to continue to stress that you need to raise issues with us when you see them.
Before leaving Schedule UTP, let me point to one of its attributes that often doesn’t get the attention it deserves. That is its deterrent effect. Taxpayers who in the past took aggressive positions – those that may not be sustained if challenged by the IRS – sometimes played hide-and-seek, hoping we would never find the issue. Schedule UTP will likely help stop corporations from pushing the envelope too far. Knowing that they will have to report the position will make them think twice before entering into it.
Another element of our issue resolution strategy is our Advance Pricing Agreement program and the Mutual Agreement programs, which we combined this year into a new program called APMA, for Advance Pricing and Mutual Agreement.
APMA is aligned with our transfer pricing practice. For bilateral APAs, we determined that a streamlined approach, where one professional leads the development and negotiation of a bilateral case, improves our ability to resolve bilateral matters much more efficiently.
Next up is our changing approach to international tax issues that also pivots around the central point of issue resolution. But first, I want to frame this discussion with my belief that government needs to understand business objectives if it’s going to be able to do its job.
We need to understand where companies are making legitimate decisions to manage tax exposure and where they may push the envelope too far…and we need to avoid putting undue burdens on companies. I think this approach is critical to our interactions with large corporations operating in a global environment.
Historically, IRS pursued international issues through the lens of individual code sections…and that must change. For example, when a US corporation shifts income to a low-tax jurisdiction, you have to look at the entire structure that was created to accomplish this. You have to understand the overall planning paradigm. You have to ask the questions that get right to the heart of the matter.
What’s motivating the company? What are the benefits? What are the most aggressive positions? How are they managing tax exposure? In other words, why are they trying to do this?
Put another way, we’re shifting our approach to be more strategic, and to view taxpayers through the prism of their business objectives and tax planning strategies.
The end game is to develop a way of organizing our international compliance programs to:
- Identify the highest compliance risks among our taxpayer base;
- Work cases as effectively and efficiently as possible;
- Not waste our time and yours on taxpayers and issues that do not pose compliance risk; and
- Find appropriate ways to resolve cases as soon as possible.
This may sound obvious to many, but the point is to recognize the obvious drivers of tax behavior and to then ensure we strategically align our resources, and train our people, consistent with tax planning strategies of taxpayers, such as income shifting, deferral planning, foreign tax credit management and repatriation.
When we are successful in making this shift, we will do our job much better and companies will benefit from a more meaningful and focused dialogue about issues.
As we shift to these new approaches, we also recognize that we need to fulfill our obligation to understand the taxpayer’s business better than we have in the past…to be open with the taxpayer about the issues being reviewed…to approach the issues with a balanced view of strengths and weaknesses…and to work with taxpayers to plan and prioritize the examination process.
To recap, whether it’s our approach to international issues… our UTP initiative… or the CAP and Industry Issue Resolution programs… all of our major corporate programs are focused on working smarter to resolve issues faster and focus on areas of highest risk.
And I want to share with you a great, real-life example where many of these issues came together. And that’s the international joint audit.
We are now moving from information sharing to more coordinated action among government tax authorities on a global basis. For the past several years, I have been the chairman of the main global body of tax authorities, which is comprised of my counterparts from 43 nations, including those from all G20 nations. In 2011, we embarked on a project to conduct joint audits of multinational companies with the goal of reducing administrative burden on a company and helping increase compliance.
Last 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 upcoming filing, 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 – which on its face may seem like a long time – but is nothing compared to what the taxpayer and taxing authorities would have spent without the joint audit process.
This result hits on many of the elements of our future vision for a well-functioning tax system in a global environment.
First is 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.
Second is timeliness. We resolved a complex issue in six months, in this case moving the competent authority process into the audit. This is a huge contrast from a normal competent authority process which typically takes place long after the tax year or years in dispute.
Third is 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.
And fourth, we had 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.
Before I wrap up, I want to loop back to something I mentioned at the beginning of my speech…challenging the time-honored assumptions in our tax system, such as there will always be an adversarial relationship between the IRS and taxpayers.
There are two additional ones I ask you to think about today. The first is the assumption that we must do almost all of our work with taxpayers after they file a return. Now, CAP turns that notion on its head for large corporate taxpayers, but for most other taxpayers this remains the paradigm. Whether you’re an individual or a corporation, you file your taxes and then we at the IRS do our “look back.”
As some of you know, I’ve launched the “Real Time Tax” exploratory effort to move away from the “after-the-fact” business model toward real-time upfront matching of third-party information, such as W2s and 1099s. If the data on the return does not match our records, a taxpayer could be given the opportunity to correct the return before it’s processed.
My theory is that this is better for taxpayers and the overall tax system. Taxpayers won’t get a notice from us years after they filed their returns. This is a real game-changer as it could help ensure more accurate returns and far less of the troublesome back-end auditing. And, it would help our efforts to combat refund fraud.
The second sacred assumption is the speed of refunds. Obviously, taxpayers want to get their refunds as soon as possible. And the speed of taxpayer refunds is one of our performance metrics. Our technology and programs like e-file are designed around issuing refunds quickly, and we have made great strides in this area.
So over the years, refunds were delivered faster and faster. However, we need to balance our desire for fast refunds with our need to protect the integrity of the tax system against refund fraud. As issues like identity theft have continued to rise and perpetrators have tried to use the tax refund system to commit fraud, we have implemented new filters to detect fraudulent returns and new processes for handling returns.
These efforts have paid off. So far this year, we have stopped more than 3 million returns for review. Of those that we have reviewed, 90 percent have been determined to be bad. This year to date, we have stopped $15 billion in fraudulent payments from going out the door as compared to $11 billion over the same period last year.
There’s a growing consensus – both in the US and overseas – that the balance may need to be re-examined. So, going forward, I think we need to rethink the speed of refund paradigm. I’m the first to admit that this is a very delicate and difficult balancing act but we should not and cannot shy away from the challenge.
To conclude, I believe our job as public servants is to maintain and nurture institutional strengths, while pushing the organization away from complacency and towards a willingness to challenge the status quo. It’s about looking forward, working smarter and innovating. That’s what we have been trying to do at the IRS while I have been Commissioner.
As I approach the end of my five-year term, I believe more than ever before that the way to make everything I have talked about work is to increase the dialogue between the private sector and IRS personnel. We need to spend time understanding your business and business objectives. More robust dialogue is in both of our interests. While this will take investments on both sides, I think it will lead to a healthier US tax system in the long run. Thanks for listening and I would be happy to take a few questions.