Thank you for the introduction. Let me start by commending you for honoring Doug Shulman. I think that Steve Miller and Beth Tucker would join me in saying that Doug had an extraordinarily positive influence on tax administration generally, on the IRS as an institution, and on those of us who had the privilege of working directly with him.
I’d like to share with you some of what we as IRS leadership are focusing on these days, with particular attention to the issues that you are involved in.
We are in the middle of filing season, which is always top of mind for us. We faced some tough challenges in rolling out filing season after Congress passed a bill on January 1st containing a number of retroactive tax changes. It wasn’t easy, but thanks to the hard work of many of our employees, we were able to allow most taxpayers to file their returns beginning January 30th. Others had to wait, including those claiming depreciation deductions, and many business credits, but as of March 4, we were able to begin accepting all returns.
Budget issues are also receiving considerable attention. The IRS budget for Fiscal Year 2012 was a significant reduction from the previous year, so the agency has been very focused on cost savings and efficiencies. The Continuing Resolution passed last fall has kept the IRS at the 2012 budget level since the beginning of the 2013 Fiscal Year last October. That CR runs out March 27, so we still face uncertainty as to the rest of the fiscal year.
Like nearly every other government agency, the IRS is also coping with the funding reduction imposed by sequestration. The first steps have involved hiring freezes, reduced grant funding, and cutbacks in areas like travel and training. But because our greatest expense by far is employee pay, it appears that a number of furlough days will be necessary. But no furloughs will occur at IRS before summer, so there will be no furlough effect on the filing season.
With respect to our interactions with the large business community, much of our work is focused on issue management – that is, finding ways to resolve issues more efficiently and earlier in the process.
Part of that strategy is placing emphasis on selecting issues for audit that will have the broadest impact on compliance, regardless of entity type or size. As a result, there will be less emphasis on the size and corporate structure of taxpayers in the designation of cases for review, and more emphasis on the nature and complexity of the issues presented.
This does not mean that we will stop auditing large taxpayers. It does mean that we will conduct examinations with processes and designations that lead to the most efficient and effective use of our limited resources. There are several initiatives currently in process that we hope will contribute to these efficiencies.
For example, LB&I expects to implement revised procedures around Information Document Requests, or IDRs, that will be designed to improve taxpayer collaboration on setting deadlines and to clarify measures to be taken in response to missed deadlines.
LB&I is also continuing its centralized review processes for the Schedule UTP. Part of that effort is to identify areas where additional procedures, instruction, or guidance may be needed. As an update, here are some of the data points from our two years of experience with the Schedule UTP:
- The data as of December 2012 showed about the same number of UTP filers for tax year 2011 as for 2010: 1,783 for 2011 versus 1,761 for 2010.
- 83% of the 2011 filings came from IC taxpayers not subject to continuous audit.
- 4,120 tax positions have been disclosed for 2011.
- 47% of 2011 filers had only one position to disclose.
- It appears that Sections 41, 482, and 162 will continue as the top Code sections.
And remember that we will have a new group of UTP filers for 2012. It will be interesting to see what tax positions these taxpayers disclose.
Institutionally, I think the Schedule UTP has also helped to prevent a couple of scenarios that I was worried about a few years ago. One problem scenario was where the IRS continued not to ask for any information that was developed for financial accounting, which would likely have led to mounting criticism from outsiders who assumed that the workpaper information was the key to the kingdom. Another problem scenario was one where the IRS would be seeking boxes and boxes of workpaper information, including deliberative process information. That would certainly have led to our getting pulled into work product doctrine cases all over the country and entangling us in a difficult set of policy arguments around tax advice and financial accounting. By crafting the Schedule UTP and policy of restraint protocols, the IRS was able to find a workable way through both of those potential problems.
The Compliance Assurance Process, or CAP, is also evolving. We started with 17 corporate taxpayers in the pilot program in 2005. Today we have 169. We also have 19 taxpayers in our “pre-CAP” phase to help them prepare for entry into CAP.
There is now a CAP maintenance program, designed for taxpayers who have been in CAP for several years, have fewer complex issues, and have established a track record of working cooperatively with us. We have identified 49 taxpayers who qualify for CAP maintenance, and we will be sending letters soon inviting them into this phase of the program. If all 49 accept the terms we offer, nearly 30% of the CAP population will be in the maintenance phase.
Another part of case resolution is the Appeals process, which is available when issues are not resolved during the examination process. During my time as Chief Counsel, we have spent significant time articulating and communicating rules and expectations for providing legal advice to Appeals officers in a manner consistent with the principle of Appeals independence. Appeals wants to have the best possible advice from our technical specialists and litigators, and we want to provide it. There may be certain Counsel lawyers whose Appeals contacts are subject to ex parte restrictions due to their involvement in the examination phase, but there will always be qualified Counsel available to provide frank assessments of strengths and weaknesses to Appeals officers. And it should be remembered that Appeals officers are free to follow or not follow advice and recommendations from Counsel.
Another development in Appeals is a project that took on the name of the Appeals Judicial Attitude and Culture Project. One of the key issues addressed by that effort was the question of how to deal with instances where new facts or arguments are presented after a case gets to Appeals.
Now, when Appeals receives new information, the case will go back to the LB&I examination function – except for the rare instance where the information was requested by Appeals. Where Appeals does retain jurisdiction after receiving new information or arguments, LB&I will be given an opportunity to review and comment. This policy reinforces the quasi-judicial role of Appeals by ensuring that Appeals employees are not doing the investigating. That should be left to LB&I.
Another business tax enforcement area of focus involves flow-through entities. In Fiscal Year 2011, 74% of LB&I returns were partnership and Subchapter S returns. For LB&I and SBSE together, the percentage is 80%. Those operating divisions are developing a strategy to address this significant inventory. The strategy is focused on ways to assess risk and ways to identify the highest-risk returns; enhancing relevant expertise for Revenue Agents; and increasing collaboration across IRS business divisions on passthrough issues.
IRS focus on passthroughs has also led to a legislative proposal that was included in the administration’s budget proposals last year, and which we expect will again be proposed this year. Under the proposal, partnerships of 1,000 or more partners would have their tax issues resolved at the partnership level, under rules that today apply to so-called electing large partnerships. Specifically, an adjustment would be resolved by adjusting a large partnership’s current income, so that the tax effect would be seen by the current generation of partners and not the historic set of partners that existed during the year being examined. In addition, the proposal removes the current early deadline for K-1 forms for electing large partnerships, which we hope will make elections for partnerships between 100 and 1,000 partners more attractive. This would achieve significant simplification, especially for partnerships with owners that are themselves partnerships, often running up multiple tiers.
Another significant issue management initiative is in the area of transfer pricing. You have seen that LB&I has a new position of Director for Transfer Pricing Operations, which oversees both the Transfer Pricing Practice and the Advanced Pricing and Mutual Agreement program. Because the old APA program was previously a function within Chief Counsel, I have watched APMA with particular interest. I have been pleased that the hoped-for benefits of putting the AP part together with the MA part appear to be coming true, through hard work, improved procedures, and application of more robust resources than in the past.
Now I’m going to pivot a bit from an LB&I perspective to more of a Counsel perspective, to focus on some guidance priorities. As I considered what to highlight here, one thing that stood out for me was the number and scope of big, multi-year projects that have occupied our attention. Much of this kind of staged rollout activity was baked into statutes that we were charged with implementing – I am thinking here of merchant card reporting, basis reporting, FATCA, and the Affordable Care Act. All of these initiatives rely heavily on information technology, both for the government and the private sector, and technology just doesn’t happen overnight.
Basis reporting for equities is now a familiar part of the tax reporting landscape. We will soon expand basis reporting from equities to debt and options, under regulations that are nearing finalization. And the IRS is starting to actually make use of merchant card reporting, in ways that recognize how different that information is from traditional third party reporting. I’ll come back to FATCA and ACA in a moment, but first let me turn to a few other topics, starting with the Return Preparer Initiative, another big project with a multi-year, staged rollout.
That staged rollout has now stalled following the government’s District Court loss in the Loving case. With assistance from the Justice Department, we are continuing to contest the notion that the program lacks statutory authority. But one point deserves emphasis, which is that the requirement for a paid preparer to obtain a PTIN and to include it with all prepared returns is separately authorized in Section 6109, and is not being challenged in the Loving case. The ability to associate returns with their preparers facilitates much of the activity that holds the greatest promise for improving the quality of millions of returns. Some of that activity involves IRS contacts with preparers; that will continue this season and into the future.
Another significant and longstanding guidance project is the regulation dealing with capitalization and repair issues for buildings, equipment, and other tangible property. That regulation is undergoing further changes, as foreshadowed by Notice 2012-73. That Notice identified the de minimis rule, the safe harbor for routine maintenance, and the disposition rules as areas of likely change where stakeholder comment would be particularly helpful. There was a good response and you should anticipate changes in each of those areas in regulations that we hope to publish by the middle of 2013. We also recognize that there are special accounting method change issues arising from how this regulation has rolled out in phases, and I expect those will be addressed contemporaneously with the publication of the regulations.
On the FATCA front, we now have final regulations. Perhaps as significantly, the intergovernmental agreement or IGA concept has moved dramatically into reality. There is more to come, including more IGAs, more development of information exchange protocols, revised withholding and reporting forms, and FFI agreement language and processes. But the broad timetables are set and we appear to be on a path to a new way of doing things when it comes to using global financial practices to prevent tax fraud.
The Affordable Care Act, of course, has its own timetables coming into greater focus as we move later and later into 2013. I personally break down our guidance efforts here between items related to, first, health insurance coverage, particularly the exchanges; second, new tax regimes enacted in ACA; and third, new health policy regimes with a tax component, for example nonprofit hospital rules. I pay the most attention to items that are related to health insurance, especially exchanges; and to items where stakeholders need guidance immediately.
We now have at least proposed guidance out on almost all of the building blocks for 2014, including on the premium tax credit, employer penalties, and individual penalties. There are two critical information reporting regimes for employers and insurers that are receiving the highest priority as we speak. Although this reporting will not actually occur until the first quarter of 2015, we recognize that system designers need to know as soon as possible the data they will need to capture during 2014. Part of our effort now is to provide our expected data items in the upcoming proposed regulations as a list that we expect not to change as the 2015 reporting season approaches. That means being careful that this list of items will do the job for 2015 filings. These projects are in the final stages of review, and I hope you will be able to see them soon.
We also have some significant draft proposed regulations that are getting priority based on the effective dates of the relevant provisions, including a provision restricting compensation deductibility for health insurers, and statutory changes affecting nonprofit hospitals. And finally, some of our most critical and complex proposed regulations will need to be finalized as the year goes on, including rules affecting individual and employer penalties; Section 6103 information safeguards for exchange related information flows; and the rules on the new net investment income and additional Medicare taxes.
Let me conclude with some comments on the potential for significant tax legislation, because I am often asked about possible IRS roles in Congressional consideration of tax reform.
The IRS traditionally consults with the Treasury Department on tax administration aspects of administration budget proposals, and it is not unusual for a Treasury budget proposal to have its origin in IRS suggestions. We are also quick to respond to the tax writing committees and their staffs when they want to access IRS experience. Treasury Tax Policy is the voice of the administration on possible legislative changes, but they value and freely access our input.
At the moment, both tax writing Committees have charged their staffs with the preparation of detailed background information and sometimes even policy drafts on tax reform subjects. This is the kind of process that is most conducive to IRS being able to impart our concerns. On the other hand, we have seen other kinds of tax processes, where bills happen quickly and are driven by high level negotiations, that make it difficult to include IRS input.
The thing that I would like to remind policymakers of is that stability in the tax law has its own value as a reform. Many of our most serious tax administration challenges come from the rapid pace of change and from uncertainty regarding the fate of temporary provisions. On this point, there is actually good news to report from the January 2013 ATRA legislation, because it changed several significant tax laws from temporary rules to permanent rules. From a tax administration viewpoint, enacting permanent alternative minimum tax rules is an extremely significant change.
Now I know that you can’t have tax reform without changing the law. But you can have tax reform that reduces or even eliminates expiring provisions; and you can form a consensus among policymakers to have a high bar for enacting major changes in the years following reform. Stability could be the best tax reform of all.
I’ll close on that thought. Thank you again for inviting me.