Prepared Remarks March 26, 2012 It has been some time since we have looked meaningfully at the CIC program. Last real work in this area was around currency. So I want to spend some time today about the future of the CIC program. It is my hope to reduce the resources we spend in CIC. I want to do that by becoming comfortable with the compliance levels of more taxpayers, thereby reducing the level of our involvement with these taxpayers. For those taxpayers that remain under audit or even cyclical audit, we still need to revise the CIC process. In short, my goal is to move the IRS away from a paradigm that has us permanently ensconced in most of your offices year after year, cycle after cycle. In order to move away from the current paradigm, I believe three preconditions exist. First, we need to develop a better feel for the compliance issues that we have to address within the large corporate sector. Second, we need to develop a better, more straightforward, working relationship with you. Third, we need to overcome some internal barriers within the IRS. I will start my discussion with some bad news, then discuss each precondition in turn. Finally, I will let you know where I would like to redeploy resources as we move from the traditional CIC. The IRS will remain present in the large corporate sector Let me start with the bad news. However this all plays out, we will maintain a visible and vibrant enforcement presence in this sector – even if we are able as I intend to take a different approach in auditing CIC taxpayers. The key reason is that we cannot afford not to be present. It sounds pedestrian, but we must maintain coverage in sectors where there is significant economic activity and revenue producing assets. Corporations with assets of $250 Million or over accounted for 95 percent of corporate assets, and 81 percent of total income reported on returns filed in FY 2011. And we continue to see the possibility of compliance risk in the large taxpayer community. According to SEC data, LB&I taxpayers are reporting large reserves due to uncertain positions as Unrealized Tax Benefits. Although we can’t tell whether these reserves relate to federal, foreign or state tax uncertainties, we need to pay attention to them. There are other reasons to continue our presence in your community but that will suffice. So we will remain, and remain active, in the large corporate sector. Identifying tax-compliance issues within the large corporate sector Let me now walk in turn through the three preconditions to moving from the status quo toward the paradigm that places less and less reliance on the traditional CIC program. The first of these is for us to develop a better feel for the compliance issues and who has them. It would be nice to spend less time with compliant taxpayers. We have already begun that work. We have taken steps to reduce the time spent looking for issues, and increased the time spent understanding and resolving them. You are already familiar with these programs, so I will spend only a couple of minutes on them. The IIR Program First is the Industry Issue Resolution Program. The IIR has been around since 2001, but has recently been re-invigorated. It is a senior member of our suite of programs aimed at identifying and resolving difficult issues uniformly and expeditiously. Its goal is to resolve frequently disputed or burdensome business tax issues that affect a significant number of taxpayers. IIRs are an excellent way to get lots of issues off the table. This will clear the underbrush and may let us move away from our intensive focus in some sectors. Right now we have five projects underway. Two address the insurance industry and other financial products. Three focus on “Unit of Property” for utility and cable companies. Another three projects are under consideration. Since the program’s inception, we have received 154 submissions, and have accepted 36. The IIR is not a tool that works for every issue, but it can save resources and provides certainty for issues that everyone really wants to resolve. CAP Our second effort helping us get to the point where we are comfortable that we can move away from CIC with respect to a given taxpayer is the Compliance Assurance Process, or CAP. CAP is now a permanent fixture with three phases. So what do the numbers show about the program? We started with 17 taxpayers in CAP in 2005. In 2011, we had 135. As we speak there are 159. And 10 taxpayers are in Compliance Maintenance. Our most recent figures – compiled in mid March – show the progress of this year’s cases. So far, we have closed a total of 38 CAP cases. Of these, 25 cases were no change; 11 were agreed, and two were unagreed. Let’s celebrate the no change number. In other areas I am responsible for, a high no change rate means we either failed to select the right taxpayer or we missed or mishandled issues. Here, we applaud the rate—now we need to lessen the burden on both taxpayer and the IRS to get to this result. UTP Our third program aimed at changing the CIC paradigm is UTP. Disclosure of uncertain tax positions is an important element in the IRS strategy to improve compliance through greater transparency. This transparency will allow us to focus on those taxpayers and issues we believe warrant the focus. It’s worth repeating that the Schedule UTP will be a tool that not only points toward returns that need auditing, but also away from returns that do not. That is where we need to be. This is still a new process, and as you know we have been proceeding carefully. Last May we set up a centralized review process for returns with the Schedule UTP. We wanted to identify and centrally collect all such returns and treat them according to uniform standards. In September we trained LB&I technical employees on UTP. And in December we completed the development of just-in-time training that examiners, managers, and specialists will take just before being assigned or starting an exam of a return with a Schedule UTP. We’ve been clear in our training that the schedule is not intended as a device to shortcut other parts of the audit process. We are not auditing the Schedule UTP. We’ve also instructed our agents to use the Schedule UTP information with other tools, such as the Quality Examination Process. And how is it going? We have received the first filings of Schedule UTP returns for corporate taxpayers with assets exceeding $100 million. Let me give you some highlights, as of January 1, 2012. Approximately 1,900 taxpayers have filed a Schedule UTP. An estimated 79 percent of returns with Schedule UTP were filed by industry taxpayers other than CIC. Approximately 4,000 issues were disclosed. Returns filed by a CIC taxpayer with a Schedule UTP averaged 3.1 uncertain tax positions per Schedule. Returns filed by an IC taxpayer averaged 1.9 positions. An estimated 53 percent of all Schedule UTP returns filed included only one or no uncertain tax positions. An estimated 19 percent of all issues disclosed are transfer pricing issues. The top three code sections are IRC 41, 482 and 162 (research credits, location of income and deductions among taxpayers, and trade or business expenses, respectively). Review of the Schedule UTP Concise Descriptions The Schedule UTP instructions require that a compliant Schedule UTP include a concise description of each reportable uncertain tax position. We reviewed more than 4,000 concise descriptions, and found that the overwhelming majority did provide facts sufficient to apprise us of the tax position and the nature of the issue. So our first finding is that the community generally met the descriptive requirement. Thank you. Only 133 - or about 3 percent - failed to satisfy the requirements. We will be in touch with the taxpayers with the inadequate concise descriptions. We won’t require any further action on the 2010 Schedule UTP. This is a year to get comfortable. But by sending a notification, we do intend to ensure that future filings from these taxpayers follow the instructions, and we intend to let the taxpayers know that their future returns will be reviewed. I also want to mention that too many of these failed disclosures were prepared by the large accounting firms. I am not sure how that happens. I said in my introduction that taking a different approach to auditing CIC taxpayers requires us to have a better feel for compliance issues in the LB&I arena. IIR, CAP and UTP are important tools in getting us to that state. Rebalancing the IRS – corporate taxpayer audit relationship Let’s move to the second precondition before we can move out of your offices and that is the need to rebalance the IRS – taxpayer relationship. This effort must impact the entire process – including examination and issue resolution, both in exam and appeals. While we are much more current today than in the past, the exam process and interactions between examiners and taxpayers have not kept pace with these changes. Bit by bit, and over time, the standard process of opening and bringing an exam to final closure has turned into what are really two separate and distinct processes. First there is the audit. Then, when that is finally concluded, too often there is Appeals. And in both processes, too many unfortunate practices have sprung up. Unfortunate because frankly two extended processes to reach resolution of issues is too costly, especially when the extension is not required for fairness. I can say from my seat, the resources are not available for this to continue. The IRS cannot afford it and with shrinking corporate resources, I don’t think you can either. So what practices am I talking about? In some exams, cases are not fully developed and are closed unagreed. Taxpayers then take these cases to Appeals. In some cases, Appeals, at the taxpayer’s request, considers new facts or new arguments that were not presented or addressed in the examination and based on this new information, cases are resolved. There are a number of reasons for this and I am sure how you view it depends on where you sit. For example, if you ask revenue agents why they think this happens you might hear them say that taxpayers do not give them the information they need on a timely basis, and as a result they cannot fully develop cases in the time provided to close the examination. If you ask taxpayers, they might say that they cannot respond to requests for information timely because the requests do not make sense, reflect a lack of understanding of a taxpayer’s business or are too broad. You may also hear them say that they present new information – facts or law – in Appeals because their examiners were not interested or open to it. Like most issues of this nature, I am sure the truth is likely somewhere in the middle – but regardless of who is more correct – what is clear to me is that this needs to change. So how are we going to address it? I believe we need to set new expectations both for our examiners and for taxpayers about how an audit should proceed. We need a common understanding of the process and both taxpayers and examiners need to adhere to it. What does this mean? It means a robust exam planning process where agents and taxpayers discuss issues and the plan to audit them. It means agents have a meaningful discussion with taxpayers about IDRs and the issues related to them in advance of issuing them to taxpayers. It means that during the planning process, taxpayers and examiners agree to IDR response timeframes and those timeframes are adhered to. And if agreed upon timeframes are not met, taxpayers should expect a summons. As a normal and expected part of the examination process, the IRS should summons information that is not provided on a timely basis. It also means that we should not consider facts or legal arguments for the first time in Appeals. LB&I is currently talking with Appeals about this issue. LB&I is requesting that Appeals send back cases when taxpayers bring significant new facts or information to light for the first time during the Appeals process so that LB&I can consider these facts and arguments as part of the examination. Now of course Appeals remains, as it must, independent of my office, but I support change in this area and will work with Heather Maloy and Chris Wagner to see what we can do. As part of this effort, we will provide refresher training on IDR writing and partner with counsel in training on the summons processes. We need to move forward on this and we need to do it right. These changes are important and while they may be difficult to implement in the short term, I believe they will make the process more efficient in the long run, without impacting taxpayer rights. And, as I say, I do not believe we are on a sustainable or justifiable path in the current examination and appeals process. We need to have all parties bring their best to the process as early as possible. Barriers within the IRS I have said there are three pre-conditions before we can leave your offices. With IIR and CAP in place, and as programs such as UTP mature and take hold, and the audit relationship improves, we will be in a position to move away from the traditional CIC audit process. We will be at that point when large corporate taxpayers’ issues are transparent to us, and when issue-targeted audits are working in the large corporate community. That is the vision I mentioned in my introduction. But before we can accomplish it, we have the third precondition. And I believe the last of the barriers we need to overcome resides within the IRS. First, our internal examination processes have become burdensome and time-consuming for agents. These processes have taken too much of an examiner’s time away from core audit functions. We have a re-engineering process currently underway to eliminate much of this administrative burden and allow examiners to have more time to spend on core examination activities. Another barrier is how our work is graded and we need to recognize and acknowledge this fact. In the past, the highest grades have gone to those that work on CIC cases. So there has been an incentive to do CIC work and stay with it to receive a higher grade. We are actively looking at alternatives to this grade structure that focus on the nature and difficulty of the issues and not the size of the case an agent is assigned to work. And we need to look at our culture around end dates for cycles to ensure there is adequate flexibility for agents and taxpayers. Finally, we have taken, and will continue to take, steps to increase the technical expertise and commercial awareness of our employees. One of the most significant ways we are doing this is through the establishment of issue practice groups and international practice networks. These groups and networks provide a structure for bringing together subject matter experts who share knowledge, develop and maintain technical expertise, and enhance collaboration on issues throughout LB&I. They provide a robust network of expertise that agents can tap for answers to technical questions. I must say that there is something compelling in the use of peer networks. I believe they will work much better than the tiered process and that agents will support and seek out help in this fashion. During my tenure in LB&I, I supported the tiered process as the preferred method for consistency and quality. I was wrong—this is a much better way forward. A significant change to CIC – and then what? So let’s assume that all these three preconditions are met. That is, we develop a better feel for the compliance issues and who has them. We develop a great new working relationship on examinations. We overcome the internal barriers to changing our approach to CIC. As a result, we leave your house and lower the amount of our time devoted to CIC. What then? What to do with these resources? Let me walk through a couple of areas I want LB&I to pursue. International First, we will continue our ramp up on international. It is an increasing part of the overall economic activity of your community. And as you know we have started that ramp up. For example, in 2001, we had 3,762 revenue agents in domestic operations. We had zero in Global High Wealth, and 13 in international operations. Ten years later, in FY 2011, we had 2,867 in domestic operations, 71 in global high wealth, and 856 in international operations. By the way, in 2010 we had 259 in international, so you can see that most of the growth is very recent. And it isn’t over yet. We don’t have an unlimited budget at the IRS, so to continue to ramp up the international operation we have recently offered buyouts and will shift resources to international, hiring around 300. So as to international, I think our intentions are clear. Move into the mid-market I also want us to move more deeply into the mid-market – those firms and partnerships between $10 and $250 million in assets. Up to now, our presence in the mid-market – where we currently have about 11.9% coverage – hasn’t been as robust as we would like it to be. But I believe many mid-market corporations may have the same issues as larger entities and perhaps additional issues as well. As UTP transitions into more segments of the community this may become clearer. Move into flow-throughs And we need to move more deeply into flow-through work across the IRS. We are seeing a significant increase in the percentage of flow-through filings, and we need to pay attention to it. Financial products Finally, I need to find more resources to up our game on financial products. We have much to do here. We have to do a better job of understanding these products. And then we have to begin drawing lines through guidance. So those are the places I would spend some of the resources currently committed to CIC. In short, you should expect to see more IRS activity and more agents at work, in the international arena, in the mid-market, in pass-throughs, and in financial products. Conclusion Let me wind up. This is our path forward. Heather and her team have done a superb job and have us on the right path. We are at the tipping point of great change and I will use whatever influence I have to see us stay on that path and succeed. I look forward to working productively with you as the plans I have discussed unfold. Thank you for your kind attention.