Notice: Historical Content

This is an archival or historical document and may not reflect current law, policies or procedures.


       The IRSAC LB&I Subgroup (hereafter “Subgroup”) is comprised of a diverse group of seven tax professionals. The members of the Subgroup include attorneys and certified public accountants from prominent law and accounting firms, as well as the corporate tax departments of major companies. The Subgroup brings a broad range of experience and knowledge to the IRSAC, and is uniquely qualified to provide a perspective on behalf of LB&I taxpayers. The members of the Subgroup have been honored to serve on the IRSAC, and appreciate both the opportunity to submit this report and to assist LB&I in the accomplishment of its important work.
       The Subgroup enjoys a close working relationship with LB&I leadership. This relationship has given the Subgroup the opportunity to consult with LB&I on a variety of matters. LB&I has been extremely helpful in providing the information and resources necessary to develop our report.
       LB&I asked the Subgroup to focus its efforts this year on (1) the issue management process, (2) the new proposed form regarding uncertain tax positions, (3) the roll-out of the new Quality Examination Process, and (4) workforce integration. The Subgroup had the benefit of providing its comments on many of these topics in a “real-time” setting this year. We believe that this resulted in our comments being more timely and relevant and, thus, more useful to LB&I. The Subgroup appreciated the opportunity to provide comments in this format. In addition to the issues identified above, the Subgroup’s written report contains analysis with respect to two valuation issues that were prepared by the Small Business/Self-Employed Subgroup.
       With respect to the issue management process, LB&I asked the Subgroup to
comment on how the Industry Issue Focus, or “tiered” issue strategy, could be modified. The main stated goal of the “tiered” issue strategy was to gain consistency among taxpayers in resolving audits of significant issues for the IRS. Rather than consistent resolution, LB&I has recognized that the “tiered” issue strategy, in practice, has resulted in many issues remaining unresolved.
       Regarding uncertain tax positions, LB&I asked the Subgroup to comment regarding the new schedule on which those positions would be reported. This schedule is a “game changer” in terms of what information taxpayers are expected to report to the IRS, and the Subgroup does not agree with its implementation. Nevertheless, the Subgroup appreciated the opportunity to comment on the contents of the proposed form.
       With respect to the Quality Examination Process, LB&I asked for the Subgroup’s suggestions as to how to best inform taxpayers of the new process. The Subgroup offered thoughts as to how to successfully roll-out the process to taxpayers, as well as ideas for LB&I to consider in terms of monitoring that the process is being implemented in practice.
       As for workforce integration, within the last several years LB&I has added hundreds of new employees. Many of these employees are very seasoned individuals with many years of experience in the private sector. LB&I asked the Subgroup for thoughts as to how to best integrate these individuals into the IRS workforce and to leverage their substantial knowledge and experience.

Executive Summary

       The IRS established its Industry Issue Focus, or “tiered” issue program, in 2007 to identify and prioritize issues of high strategic importance and compliance risk. The goal was to improve consistency in the resolution of issues, reduce audit time, and better utilize IRS resources.
       In establishing the tiered issue program, the IRS attempted to leverage off its very successful programs used in prior years to challenge abusive tax shelter transactions. Many of these transactions were packaged and promoted as “uniform” transactions, with very little variance in facts. In turn, the centralized response utilized by the IRS to challenge these transactions was very successful.
       Many of the issues facing the tiered issue program are not similar in nature. Rather, there are significant factual differences among transactions and taxpayers. These nuances are not conducive to a uniform resolution approach and, therefore, the industry issue focus approach has faced significant challenges.
       The Subgroup believes that, although some issues identified in the industry issue focus strategy may continue to warrant a coordinated approach, LB&I already has an arsenal of tools that may be used to address the audit and resolution of these issues, without the added burden of a tiered issue designation.


The "tiered" issue management procedure (referred to herein as the tiered issue strategy) was created by LB&I in response to taxpayers’ concerns about the lack of consistency across LB&I in handling similar issues for different taxpayers across the
country. The intent was to have a centralized review by an Issue Management Team ("IMT") of those issues that LB&I viewed as major compliance challenges. The IMTs are led by Executive Issue Owners ("EIOs") and are comprised of IRS personnel with mixed talents and backgrounds.
       LB&I is revisiting the tiering strategy to identify how the strategy can be improved. Field examination teams ("the Field") have not consistently understood the strategy or applied it as envisioned. While the Field is responsible to work an issue, there is a perception that they do not have authority relative to tiered issues, especially Tier I issues (i.e., issues that pose the highest compliance risk across multiple LB&I industries and generally include large numbers of taxpayers, significant dollar risk, substantial compliance risk, or are high visibility). Because of this confusion, delays have occurred in resolving some of the issues.
       The current tiering strategy also is not well understood by some LB&I taxpayers. Some believe that the policy is one of "automatic adjustment" in the case of Tier I issues. In that vein, some taxpayers have received penalty Information Document Requests (IDR’s) with respect to Tier I issues while still under active examination and more than a year before even receiving a proposed adjustment. There also is a belief among some LB&I taxpayers that the Field (including the case manager) has no authority to resolve tiered issues. Rather, there is widespread belief that control is centralized with the "man behind the curtain." This leads taxpayers to fail to follow the rules of engagement and to seek discussions directly with the EIOs. Such case-by-case discussions are impractical due to the number of taxpayers with tiered issues and, in fact, are rarely granted.
       In addition, the tiered issue strategy has been faulted with extending the time of audits. There is a belief among many LB&I taxpayers that this is a result of greater and more frequent involvement of IRS Counsel in the audits of tiered issues. There is a belief that Counsel does not share the field’s timeframe in terms of closing an audit and frequently raises new issues late in the audit process.
       The LB&I Subgroup shares the concerns of both the IRS and taxpayers relative to the tiered issue strategy. While the goal of consistent treatment is critical, the process as it has been developed has overemphasized the control focus. Too many field personnel and taxpayers view tiered issues in a negative light, with the issues tainted before the first IDR is served. As a result, there is a lack of ownership by the Field and transparent dialogue between the Field and the taxpayer necessary to fully develop the facts and potentially resolve the issue.
        Several questions arise. The first is: why haven't the Field and taxpayers consistently understood the process and worked the issues constructively? The second is: what changes can be made within the existing process to improve it? The third is: should the entire strategy be abandoned?
        Relative to the first and second questions, the Subgroup believes that part of the problem is related to words used to describe the issues. For example, the Issue Tiering-LB&I link on the IRS.gov website describes the two broad categories of Tier I issues as "Recognized Abusive and Listed Transactions" and "High Risk Transactions." Under the latter category, the first item listed is "§118 Abuse." The use of such pejorative language immediately creates presumptions regarding the legitimacy of a taxpayer's treatment of any Tier I issue (even those as innocuous as §199 and §965 deductions). In some cases, this has led to taxpayers adopting a defensive posture and the goal of two-way transparency is defeated. Once an issue is designated as Tier I, resolution in some cases has become more difficult. The Subgroup believes that the process could be improved and better received if the language used to describe the issue categories and individual issues was “toned down.”
       The Subgroup believes another problem is that the current list of "High Risk Transactions" is an unusual combination of temporary and permanent differences, statutory incentives, perceived abuses, and potentially aggressive tax plans. For example, perceived abuses such as the use of §118 by partnerships and structured foreign tax credit generators are on the same list as statutory incentives like §199 (which is now in Tier I “monitoring” status) and §965. The latter two issues require audit guidelines and guidance, but that could be done through pre-existing processes and tools. Listing such issues as "High Risk" has the ability to change the approach of the Field when performing the examination, the reaction of taxpayers to IDRs, and the openness of related discussions.
       If the tiered issue strategy is continued, the Subgroup believes that the list of "High Risk Transactions" should be revised to separate "audit challenges" from potential abuses. LB&I has issued excellent materials highlighting the potential issues in post-filing research credit claims and non-compliance with §1441 withholding requirements, and has issued audit guidelines for §199 and §965 deductions. These areas may represent audit challenges, but the Subgroup believes that such challenges can be managed through memoranda to the Field, audit guidelines in the Internal Revenue Manual and guidance on technical matters.
       Similarly, the materials issued by LB&I on the §118 "abuses," mixed service costs, and repairs versus capitalization change in accounting method highlight areas that the Field needs to be aware of and provided with technical advisor contact information. The Subgroup believes these issues can also be successfully managed outside of the tiered issue strategy process.
       The other Tier I issues are foreign tax credit (FTC) generators, total return swaps (listed as part of §1441), and cost sharing. Cost sharing is very different in nature than FTC generators and total return swaps. While it represents an area of potentially aggressive taxpayer planning, it is ultimately a transfer pricing issue, and if executed on an "arm's-length" basis, is completely appropriate. The Subgroup believes that the Field should be able to work these factual and valuation-based issues given the guidance available to them in the recent comprehensive regulations, the Coordinated Issue Paper, the Audit Checklist and through various internal and external expert advisors.
       It appears that LB&I views FTC generator transactions and total return swaps as abusive. While taxpayers believe both types of transactions can be executed for valid business purposes and be completely appropriate, the IRS has clearly concluded that both types of transactions produce results that are unintended.
For example, generally once a transaction is labeled as an “FTC generator,” factual differences between taxpayers or transactions appear to be irrelevant. This is so, even though the IRS and the IMT recognize that certain transactions include features that more strongly support the argument that the transactions were tax motivated, including
circular flows of funds and nontraditional business and investment practices. Furthermore, the rules applied by the IRS regarding what defines a transaction as an FTC generator can be viewed as subjective. A transaction that has all of the same economic and tax effects can avoid the “FTC generator” label, and the entire Tier I bureaucracy, on the basis of a simple technical point (i.e., the transaction does not utilize a special purpose vehicle in its execution). Consistency can actually be defeated in this context. Finally, although the goal of the issue management strategy is consistent treatment among taxpayers, the Subgroup believes that there have been inconsistent settlements in this area that undercut the stated goal of consistency. The Subgroup believes that more dialogue is required between LB&I and the taxpayer community in order to correctly identify transactions that have been labeled as "FTC generators."
       In addition to FTC generators, the IRS has deemed several total return swap scenarios as abusive based on methods of execution that indicate pre-arrangement, agency, and lack of economic substance. Recent published guidance clarified the IRS position, but resulted in a change in audit tactics that was not helpful to taxpayers. With respect to total return swaps, recent legislative changes have addressed this issue going forward.
       The Subgroup believes that if LB&I continues the current Tier I issue management strategy, it would require additional analysis and dialogue. Examination teams generally find methods to resolve issues in a reasonable manner. However, as stated above, the real world result of an issue being designated as Tier I is that the case manager and examination team may not exercise their authority. Therefore, if
coordination of an issue is still deemed to be necessary, alternative methods outside the Tier I process may be preferred.


       The Subgroup does not believe that the current tiered issue strategy should be continued. The manner in which the process to manage the strategy has developed has led to less transparency in the development of issues, which is in direct contrast to the direction LB&I is pursuing through the new Quality Examination Process (formerly known as Joint Audit Planning) and the Compliance Assurance Program. We believe that the current process can result in taxpayers being on the defensive at the very beginning of an examination and can result in inadequate factual development and more unagreed issues.
       Certain issues require more dialogue at the industry level and may require continued management on a coordinated basis. The Subgroup could see a need for a continuation of the current issue management strategy for these types of issues until a new coordination process can be put in place.
       As a final note, the Subgroup reiterates that it supports consistency. However, consistency must be accomplished through methods that provide some flexibility on the basis of differing facts and circumstances. The issue management strategy as currently applied does not afford enough flexibility and, therefore, should be discontinued.

Executive Summary

       Earlier this year, the IRS announced that it would require certain taxpayers to report their uncertain tax positions (UTP) with their tax return. To that end, the IRS released a draft Schedule UTP and accompanying instructions, followed by a final Schedule UTP (the Form) issued on September 24, 2010. This schedule represents a significant change in terms of the type of information that taxpayers are expected to provide to the IRS.
       The Subgroup does not agree with this change in IRS position or the issuance of this schedule. In addition, the Subgroup believes that there are significant challenges to overcome to make sure that examination teams utilize the information contained on this new schedule in a reasonable manner.
Nevertheless, the Subgroup welcomed the opportunity to provide technical comments on the schedule itself, as set forth below.


       The Subgroup reviewed the draft and the final form and instructions for Schedule UTP. Our comments will be limited to the content of the Form itself; however, it should be noted that the Subgroup does not concur with the decision to issue the Form. We question how this form can help the IRS in overall administration, since it applies to only a minority of LB&I taxpayers. In addition, the Subgroup believes that the Form is unnecessary for taxpayers that are participating in the Compliance Assurance Process (CAP), since those taxpayers have already pledged a substantial amount of transparency with respect to their tax positions. We encourage the expansion of the CAP program; however, it is difficult to see how the Form could be constructive with respect to CAP taxpayers. We are encouraged that Announcement 2010-75 provides that the IRS will address Schedule UTP compliance in upcoming CAP guidance expected to be released shortly.
       Furthermore, the Subgroup does not believe that the new disclosure will provide the results desired by the IRS. We believe that it will only lead to less transparency and communication between taxpayers and IRS examination teams, more controversies and longer cycle times. In addition, we believe the IRS should be mindful of the increased number of controversies that will arise once state and foreign tax authorities adopt a similar disclosure requirement, since it could lead to more mutual agreement procedure cases and foreign tax credit claims.
       Moreover, it is imperative that the IRS use the information collected on Schedule UTP in a thoughtful and judicious manner. The Subgroup is concerned that examination teams may use the information reported on Schedule UTP as a checklist to facilitate determining deficiencies as a matter of course. To avoid such a result, examining agents must be thoroughly trained regarding the information reported on the schedule, and a division within the National Office should be given the task of monitoring the use of such information. Announcement 2010-75 describes that the IRS issued contemporaneously with the announcement a directive concerning the use of the Schedule UTP by the IRS and its examinations and research personnel. We believe that the directive is a useful first step in providing direction to the agents and encourage the IRS to seek input from taxpayer groups once tax audits begin on returns that contain the Schedule UTP.
       Finally, the IRS should remain cognizant that this form represents a significant change in the type of information that taxpayers are expected to provide. As such, this increased mandatory transparency that is being forced upon taxpayers should be matched by increased transparency on behalf of the IRS. For example, the IRS could engage in more open and informal dialogue with taxpayers, provide more guidance in a timely manner, or advise taxpayers as to when IRS counsel or technical advisors are involved with an issue.

Disclosure with intent to litigate

       The requirement to disclose items that are not reserved because of intent to litigate is meant to cover positions where the reserve is zero because the taxpayer is willing to litigate. The premise is that if the position were instead settled with the IRS, then there would presumably be a need to reserve. We recommend that disclosures of such positions be eliminated. First, the underlying documentation may not exist for many taxpayers because the application of the rules governing accounting for uncertain tax positions varies among those taxpayers reporting under U.S. Generally Accepted Accounting Principles (GAAP) and those reporting under International Financial Reporting Standards (IFRS) or other standards, and, in fact, even varies among taxpayers using U.S. GAAP. Simply stated, many taxpayers will not have as part of their accounting workpapers a table that indicates the chances of sustaining a position in court, versus in Appeals or in the Field, and such documentation would need to be created in order to comply with the Form. The final Schedule UTP instructions do not address our objection relating to documentation but merely states: “The Service expects that a corporation would continue to document its decision in the same way as it substantiates any decision not to record a reserve in its financial statements.” To reiterate, there is no required documentation under U.S. GAAP or IFRS which calls for such an analysis. Disclosure of expectation to litigate positions would require taxpayers to take steps in preparing their tax provisions that are not being done today.
       Second, if the taxpayer and its independent audit firm have concluded that there is no need to set up a reserve for a matter, we question if the cost of providing this information outweighs the benefit.

Maximum tax adjustment (MTA)

       Some highly certain positions, those with 80-90 percent certainty, may still be reserved in situations where a taxpayer is willing to accept a nuisance settlement at Appeals to avoid litigation. The Subgroup was concerned that the maximum tax adjustment required in the draft of the Form would overstate the importance of these issues. We commend the IRS for eliminating the MTA in the final version of the Schedule UTP.

Administrative practice

       The draft form required disclosure of items with no reserve due to the expectation that, under administrative practice, these items will not be adjusted by the IRS. Although there may be significant items that fall into this category such as status classification questions for Registered Investment Companies and Real Estate Investment Trusts, there are also many such items that would not concern the IRS, such as capitalization of repairs or fixed assets below a set dollar amount. We commend the IRS for removing the requirement to disclose these items in the final version of the Form.

Unable to obtain information

       The Form provides a box to check in Part I and Part II if the taxpayer was unable to obtain information from related parties sufficient to determine if a tax position is an uncertain tax position. We recommend that the instructions provide further explanation of when this box should be checked. The instructions could state: “For example, it is intended to be used when a taxpayer’s controlling shareholder prepares the income tax reserves but does not inform the taxpayer.”

Unit of account

       Page one of the general instructions of the draft Form stated: “A tax position is based on the unit of account in the audited financial statements in which the reserve is recorded. A tax position taken in a tax return means a tax position that would result in an adjustment to a line item on that tax return if the position were not sustained. A line item on a tax return may be affected by multiple units of account, in which case each unit of account must be reported separately on Schedule UTP.” The final sentence was changed in the final instructions to read: “If multiple tax positions affect a single line item on a tax return, report each tax position separately on Schedule UTP.” We recommend that “item” be replaced by “item(s)” each place it appears so that it is clear that a unit of account may impact more than one line item on a return.

Temporary items

       The Form includes codes so that tax positions are marked as either temporary or permanent. The final instructions provide that: “A corporation or a related party records a reserve for a U.S. federal tax position when a reserve for income tax, interest or penalties with respect to that position is recorded . . .” We understand the intention is to require the disclosure of reserves for interest on temporary differences. In Example 6 of the instructions, which illustrates a reserve recorded for a temporary difference, an expenditure was made in 2010 and a reserve was recorded in 2010 due to uncertainty of whether it should be deducted in 2010 or amortized over five years. If the reserve was recorded due to potential interest only, however, the most likely scenario would be that the reserve would not be recorded until 2011, since the due date of a calendar 2010 tax return is in March 2011 and interest would not accrue until that date. Accordingly, we recommend that Example 6 be deleted from the instructions.

Use of Part I versus Part II

       The draft general instructions on page one stated that a tax position is required to be reported on a Schedule UTP for a year if, at least 60 days before filing the tax return, a reserve has been recorded with respect to that position. Page two of the draft instructions further stated that if the decision to set up the reserve was made within 60 days of filing a tax return, then the position must be reported on Part I of the Schedule UTP for the current year or on Part II of the Schedule UTP for the next tax year. We initially recommended that the option to disclose a tax position on Part I of the current tax return, where determination was made within 60 days of filing the return, be referenced on page one of the general instructions. However, Announcement 2010-75 provides that the instructions clarify that a tax position is reported on Schedule UTP once (1) a reserve for a tax position is recorded and (2) a tax position is taken on a return regardless of the order in which those two events occur. On page one of the instructions, under reporting current year and prior year tax positions, the instructions provide: “Do not report a tax position on Schedule UTP before the tax year in which the tax position is taken on a tax return by the corporation.”
       The examples in the instructions appear to confuse the reporting issue. In Example 6, regarding a temporary item, a taxpayer establishes a reserve in 2010 due to uncertainty as to whether an expenditure should be deducted in 2010 or amortized over five years. The taxpayer did not provide reserves in any of the years 2011 to 2014 with respect to the issue. The instructions conclude that the taxpayer has taken a position in its tax return in each of the years 2010 through 2014, but should disclose the position on Schedule UTP for 2010 only, since it did not record a reserve for this position in 2011 to 2014.
       In Example 7, regarding a permanent item, a taxpayer establishes a reserve in 2010 for an amortized deduction to be claimed over five years due to uncertainty of whether any deduction or amortization may be allowable. The instructions conclude that the corporation has taken a position in its return in each of the years 2010 through 2014 and that the tax position must be disclosed on a Schedule UTP for each of the years 2010 through 2014. It further notes that the result would be the same if, instead of recording the reserve in 2010 for all of the tax positions taken in each of the five years, the corporation records a reserve in each year that specifically relates to the tax position taken on the return for that year.
       The only distinction between Examples 6 and 7 is that Example 6 deals with a temporary item, whereas Example 7 deals with a permanent item. If the intention is that the timing of taking the tax position on the return triggers the disclosure, not the timing of the reserve that should be specifically stated.

Transition rule

       Page one of the instructions, under the heading “Transition Rule,” provides that a corporation is not required to report on Schedule UTP a tax position taken in a tax year beginning before January 1, 2010, even if a reserve is recorded with respect to that position in audited financial statements issued in 2010 or later. The transition rule on page one does not address the case when a reserve is recorded in a year beginning before January 1, 2010, but the tax position is taken in a tax year beginning in 2010 or later. It merely references Example 8, which does illustrate this case. Example 8 uses the facts in Example 7 mentioned above except that the corporation recorded the reserve and made the expenditure in 2009 and concludes that the tax position must be reported on Part I of Schedule UTP for each of the years 2010 to 2013.
       Furthermore, in Example 9, there appears to be an inconsistency between the general transition relief rule (i.e., no requirement to disclose positions taken in a tax year before 2010) and a situation involving the utilization of carryforwards (i.e., a position that becomes embedded in a Net Operating Loss (NOL) [or credit] carryforward should be considered a "position taken" in both the year the position arises and again in the year that the carryforward is utilized). This point is especially important for clarification, since many taxpayers have such carryforwards from recent years.
       The Subgroup believes that having part of the transition rule embedded in an example could lead to misinterpretation. We hereby request that the instruction on page one set forth the transition rule for both the case when the reserve is recorded pre-2010 and a tax return position is taken in post-2010 as well as the case when the tax return position is taken pre-2010, and no tax reserve was recorded pre-2010. In addition, we recommend that the general transition relief rule be clarified with respect to Example 9 in the instructions, so that it is clear that a pre-2010 position is not reportable on Schedule UTP merely due to the fact that it is embedded in an NOL or credit carryforward for 2010 or a later tax year.


       As stated above, the Subgroup does not agree with the decision to issue the Schedule UTP; however, it appreciates the opportunity to provide technical comments regarding the form as set forth above. More importantly, the Subgroup stresses that the information provided on the Form must be used in a reasonable manner and encourages that this increased transparency on behalf of taxpayers be reciprocated by the IRS.

Executive Summary

       With respect to the Quality Examination Process (“QEP”), LB&I asked for the Subgroup’s assistance in determining the best methods to communicate the QEP to taxpayers. The Subgroup suggested various techniques and methods to help with a successful roll-out of the QEP.


       In June of this year, LB&I introduced a new examination process known as the QEP. The QEP is the result of a joint effort between the IRS and taxpayers that is intended to improve communication, coordination, and resolution of audits.
The predecessor of the QEP, the Joint Audit Planning Process, had similar laudable goals in terms of providing a framework for audits to run smoothly and efficiently. The Joint Audit Planning Process, however, faced significant hurdles in its actual implementation. In light of those challenges and in order to improve the process, LB&I decided to review the Joint Audit Planning Process internally, as well as partner with taxpayers and various professional organizations externally.


       In terms of delivering communications to taxpayers about the implementation of the QEP, the Subgroup suggested that the QEP should be highlighted at the general meetings of various groups and professional organizations, such as the Tax Executives Institute, the American Institute of Certified Public Accountants, and the American Bar Association. The Subgroup also recommended pursuing articles in the professional tax publications to supplement the IRS news releases. The Subgroup believes that LB&I has been successful in publicizing the roll-out of the QEP. The LB&I Commissioner even released a six-minute video introducing the QEP (as recommended by the Subgroup and others).
       Although the external roll-out has been a success, the IRS should be mindful that, arguably, an even more important facet to a successful QEP is its roll-out internally within the IRS. One of the problems with the prior Joint Audit Planning Process was that it was not implemented in practice. Rather, it was oftentimes viewed as a discretionary guide of some good ideas and suggestions regarding how to conduct an audit.
       Accordingly, examination teams and taxpayers should attend QEP training together, which would allow both sides to hold each other accountable under its standards. Prior to each audit beginning and any IDRs being issued, the examination team and taxpayer should be able to go through the training together, and execute a form acknowledging that this occurred. Furthermore, the training should include the specifics of what the QEP entails. Instead of simply mandating that the audit plan should be developed and that the taxpayer should be involved, the training should specify how and when the audit plan should be developed.
Finally, to ensure that QEP standards are being implemented, a senior IRS employee (for example, Territory Manager, Director of Field Operations, or Industry Director) should solicit taxpayers’ opinions at the close of an audit. This can be, perhaps, in the form of a letter sent to the taxpayer at the close of an audit to inquire as to whether, in the taxpayer’s opinion, the QEP standards were followed.


       LB&I should continue to highlight the benefits that the QEP will deliver to both taxpayers and the IRS. The Subgroup believes that the implementation of the standards expressed in the QEP will improve the efficiency and resolution of audits. To that end, LB&I should continue to monitor whether the QEP standards are being implemented by examination teams through the method identified above by the Subgroup.

Executive Summary

       A sound enterprise is premised on deploying the right people to the right tasks, now and in the future. Tax administration is no different. This general principle forms the basis for our assessment and six recommendations below.


       We understand from our conversations with IRS personnel that the current economic climate translates into an unprecedented pool of job applicants, in terms of both quantity and quality. We also understand from these conversations that the IRS has been successful in hiring, and so far retaining, many highly qualified candidates – e.g., some eight hundred (800) experienced tax professionals have joined LB&I in the past year or so. We applaud this development and recommend that the IRS continue to actively recruit experienced applicants, especially candidates who have received quality training in the private sector.

       Our feeling is that applicants with experience in the private sector bring to the IRS not only their acquired knowledge of substantive tax rules and industry practices, but also a very "real world" perspective on how taxpayers behave and operate; this additional perspective can only help communication between the IRS and taxpayers. Compare this to the reverse scenario, where an experienced IRS person leaves a government position for a position in private practice or in industry. That person’s employer will generally utilize the person in a role that capitalizes on his or her acquired knowledge of substantive rules, as well as his or her knowledge and experience with IRS rules and procedures for working with taxpayers. A private-sector employer who fails to capitalize on the experiences and knowledge of a former IRS employee is simply wasting potential.

        In connection with our assessment and recommendations, we reviewed the following materials: (1) IRS Highlights Job Opportunities for New Grads on YouTube, IR-2010-81, July 6, 2010, and the videos referenced therein (which we viewed on YouTube); and (2) the 2009 National Agreement II between the Internal Revenue Service and the National Treasury Employees Union. In addition, we interviewed a number of IRS personnel.


       We identified the following challenges the IRS faces in integrating experienced practitioners into the IRS and, more generally, maintaining and improving the quality of the IRS workforce. We also learned that the IRS has already addressed these matters to a great extent.

       First, many of the experienced hires possess highly specialized, technical tax and business knowledge. Most of them are not trained as auditors, however, and do not possess knowledge of IRS procedures. We asked ourselves: "What procedures should the IRS use to train experienced practitioners in their missing skill sets?" In particular, we were concerned that practitioners who have many years of experience may have little patience with lower-level tasks and training. In response to our inquiries, we learned that the IRS individualizes its training regimen to round out a new hire’s skill set, as opposed to using a one-size-fits-all approach that all new hires must endure. In particular, the IRS uses online training modules (e.g., Centra and MicroMash) to custom tailor a training plan between a new hire and his/her training instructor, which can then be implemented on an individualized basis. Thus, in the case of experienced hires, the IRS does not utilize the same training that it uses for new agents it hires right out of school, but instead makes available expedited training courses to quickly get experienced practitioners up to speed on the skills they need to complete audits.

       Second, agents who have many years of private-sector experience will likely want to progress more quickly in their IRS career than perhaps their counterparts fresh out of school. We recommended that the IRS identify impediments within its system, such as seniority rules for promotion, which may inhibit experienced hires from advancing as quickly as they would like. In response, we learned that experienced hires can enter the IRS at a more senior "grade", rather than at entry level, and they can also advance more quickly by participating in executive training programs. As in the private sector, faster promotion tracks are also available to those who are geographically mobile.

       Third, we inquired about IRS efforts at developing a system for quickly and efficiently tapping into the specialized skill sets possessed by its experienced agents, whether that experience was acquired at the IRS or previously in the private sector. In particular, we believe that the IRS and taxpayers would benefit enormously if the IRS could draw on the experience and knowledge base of its newest hires from the private sector; to repeat, these new hires bring not only their acquired knowledge of substantive tax rules and industry practices, but also a very "real world" perspective on how taxpayers behave and operate. In response to our inquiries, we learned that skills assessments are currently "soft knowledge" possessed at the local level, where the local supervisor or training instructors know what an employee can do well. We also learned that the IRS hopes to develop a new, nationwide skills database that would apply during the training period (i.e., during approximately the first year of IRS employment).

       Fourth, we considered that an agent who has the specialized skills required for a particular audit may not live near the location of the audit. Mindful that geography represents a similar and significant challenge for private sector employers, we inquired what the IRS might do to bridge the geography gap. We learned that, to overcome geography as an impediment to getting the right people on the right tasks, the IRS employs audio and video conferencing, faster promotion tracks for geographically mobile employees, and targeted hiring in particular geographies.

       Fifth, given that the pay scale at the IRS has traditionally been lower than in the private sector, we explored what the IRS might do to retain its experienced agents, so that they do not join or return to the private sector once the economy improves. We learned that, to retain its best people, the IRS has in place a system of retention bonuses, improved opportunities for advancement, and executive training programs.

       Sixth, some organizations are facing a demographic bulge that could result in a large number of employees retiring at approximately the same time in the near future. Without an adequate succession plan, such a mass exodus could cripple the organization’s capabilities. We learned that the IRS has begun to consider the demographic bulge issue, and as a partial response, has instituted a rehired-annuitant program whereby the IRS can rehire an employee and thus retain talent that might otherwise retire.


       First, we commend the IRS for using training modules and customized training plans. This is an excellent process for quickly integrating new, experienced hires from the private sector, and also for the new hires’ job satisfaction. We recommend that the IRS continue to pursue this methodology and invest in it further, e.g., by developing more training modules on an as-needed basis.

       Second, to challenge and motivate new hires from the private sector, and also to meet what is likely many of these new hires’ professional expectations, the IRS should continue to create programs and opportunities for rapid advancement. For example, the IRS should identify any remaining seniority-based metrics for promotion, and consider whether these are still useful or necessary.

       Third, the IRS should consider developing a skills database that lasts beyond the training period – perhaps something as simple as (1) an intranet of online "bios" that include an employee’s subject matter and industry expertise, or (2) an intramural blog or bulletin board where technical knowledge and industry expertise can be shared. Any IRS employee could then use this database to seek out another person within the organization who may have specialized skills. Once this database is developed, the IRS should encourage and incentivize its employees to utilize the resource.

       Fourth, a nationwide skills database, one which lasts beyond the training period, is the first step in learning where the talent resides and where the skills are needed. A nationwide database matching may also result in staffing agents on assignments that better utilize their individual skill sets independent of geography, as opposed to limiting the agents to whatever assignments may be available in their geography (i.e., their posts of duty).

       Fifth, in addition to its other retention incentives, the IRS should focus on particular nonmonetary incentives and messages, including, for example, the appeal of government/public service, the lower work-hour demands, and the opportunity for cutting-edge taxation assignments.

       Sixth, the IRS should conduct a demographic bulge assessment of its workforce, not only for the IRS as a whole, but also at a more granular level based on functionality and (assuming it continues to be relevant) geography. To the extent consistent with applicable employment laws and union obligations, we also recommend that the IRS take advantage of the current, unprecedented applicant pool to round out its age demographics so that projected retirements occur in a smooth, staggered – as opposed to a cliff-effect fashion.


Executive Summary

       IRS efforts at implementing the valuation reform provisions of the Pension Protection Act (and valuation provisions in other statutes) suggest a lack of coordination and consistency in Service policies, practices and procedures with respect to appraisers and appraisals. In one situation, for example, a unit of IRS established an appraiser penalty enforcement process without knowing that another unit of IRS had failed to define a key safe harbor provision without which enforcement is inappropriate. Such conflicts and inconsistencies could be avoided if an office or individual at IRS were assigned responsibility for overseeing appraisal policies on a Service-wide basis.

Background and Analysis

       Unlike accountants and tax attorneys whose services and activities intersect virtually all provisions of the Internal Revenue Code and regulations, appraisers and tax-related valuations play a much narrower role in our tax administration system. Because IRS policies and practices pertaining to tax-related appraisal and those who perform them are established in various IRS venues, there are often inconsistencies and/or gaps in these policies and practices. Following are three examples of this lack of coordination and focus on the role of appraisers in tax administration that should illustrate the point.
       One involves the subject matter of the first item noted above, i.e., the failure of IRS to define a critical exception to valuation misstatement civil money penalties before it embarked on a process for imposing such penalties. In October of 2009, it became publicly known that on August 18, 2009, the IRS’ Office of Servicewide Penalties (OSP) issued to IRS examiners, Revenue Agents, Estate and Gift attorneys and Tax Compliance Officers, detailed procedures for assessing civil money penalties against appraisers for valuation misstatements under IRC section 6695A (SBSE Memorandum 04-0809-015). It did so without knowing or recognizing that the IRS had failed to define the safe harbor exception to such penalties contained in 6695A (c). Without such definition and guidance, appraisers were effectively denied a realistic opportunity to assert, in response to a valuation misstatement enforcement action, the safe harbor defense Congress provided them. Appraisers and other stakeholders inadvertently learned of OSP’s internal enforcement document and were able to intervene to stop enforcement proceedings pending resolution of the safe harbor and one other issue. But, this represents an internal, inadvertent yet avoidable, IRS misstep based on the absence of coordination and information sharing between two separate IRS venues – one which was responsible for establishing enforcement processes and another which was responsible for defining and implementing a key statutory provision.
       A second example involves the IRS’ decision two years ago (subsequent to the enactment of the Pension Protection Act’s robust appraiser penalty provisions) that its new tax return preparer penalty regime should include appraisers as nonsigning return preparers. The appraisal organizations advised those at the IRS responsible for establishing the new return preparer penalties that appraisers were already covered by the penalty provisions of the PPA and that imposing a second layer of penalties on them was punitive and would not advance their compliance purposes. Nevertheless, final IRS regulations included appraisers if they met the requirements established for nonsigning preparers.
       A third example involves the IRS Commissioner’s praiseworthy program to register, competency test and regulate the tax preparer community in order to foster greater tax compliance. Again, with the different process used by appraisers whose valuations are material for tax compliance, this program or parts of this program do not conform easily.


       The IRSAC recommends that IRS actively consider a change in its organizational structure that would lead to creation of an office to serve as a clearinghouse for all policies, practices and procedures involving appraisers and tax-related appraisals. The imprint of tax-related appraisals on tax administration, while important, is sufficiently small to make creation of such a clearinghouse feasible.


Executive Summary

       Section 6695A(c) of the Pension Protection Act of 2006 (PPA) establishes a safe harbor against the imposition of civil money penalties for valuation misstatements. It provides that no valuation penalty shall be imposed if the appraiser can establish that the value in the appraisal was “more likely than not the proper value.” While this phrase may have meaning in other tax administration contexts, it has yet to be defined or guidance provided by the IRS in the context of valuation misstatements. Given the complete absence of such guidance, appraisers are effectively denied a fair opportunity to assert the safe harbor defense against valuation misstatement penalty actions under 6695A. Accordingly, such enforcement of penalties should take into consideration the fact that these professionals do not have a safe harbor process on which to rely and that final valuation determinations are often very different from the appraised value for reasons unrelated to the valuation. For instance, most disagreements between taxpayers and the IRS involve a number of issues and final settlement is a negotiated agreement, the individual aspects of which are not separately negotiated. In addition, the IRS should consider the valuation method used by the appraiser, evaluating it for the reasonableness of the method and whether the application of the method was reasonably applied to the facts. Guidance should be developed with a combination of internal and external stakeholder participation. 69

Background and Analysis

       The Pension Protection Act of 2006 contains tax related appraisal provisions designed to improve the integrity and reliability of tax-related appraisals and to hold those who perform them accountable. IRC §6695A provides for civil money penalties on those whose valuations are found to contain “substantial” or “gross” valuation misstatements.
        Determinations of whether an appraisal results in a substantial or gross valuation misstatement are based on certain statutory percentage tests. A substantial valuation misstatement exists under Chapter 1 if the claimed value of the property is 150 percent or more of the amount determined to be the correct amount of such valuation. For estate and gift tax purposes, a substantial valuation misstatement exists when the claimed value of property is 65 percent or less of the amount determined to be the correct. A gross valuation misstatement under Chapter 1 occurs when the claimed value is 200 percent or more of the correct value.
       The amount of the valuation misstatement penalty imposed on any person with respect to an appraisal shall be equal to the lesser of (1) the greater of (A) 10 percent of the amount of the underpayment or (B) $1,000 or 125 percent of the gross income received by the person for the preparation of the appraisal.
Importantly, in the legislation Congress established a safe harbor exception against a valuation misstatement penalty (§section 6695A(c)) which states that “No penalty shall be imposed under subsection (a) if the person establishes to the satisfaction of the Secretary [Treasury thru IRS] that the value established in the appraisal was more likely than not the proper value” (bolded for emphasis).
       However, the meaning of the phrase more likely than not the proper value has not been defined in the context of an appraisal or other valuation. IRS regulations are replete with phrases like “realistic possibility,” “substantial authority,” and “more likely than not.” For example, in 2008 Treasury and IRS proposed regulations concerning tax preparer penalties in which the standard of conduct return preparers must meet to avoid the imposition of penalties moved from the “realistic possibility” standard to one requiring the return preparer to demonstrate a “reasonable belief that the position taken would more likely than not be sustained on its merits” to the final existing standard of “substantial authority.” During this rulemaking process, the phrase “more likely than not” was defined to mean that the preparer analyzes the pertinent facts and authorities and, in reliance upon that analysis, reasonably concludes in good faith that the position has a greater than 50 percent likelihood of being sustained on its merits.
       How does that interpretation apply to a valuation? What authorities or practices and procedures can be used to sustain such an argument? To date the IRS has provided no guidance as to the meaning of this safe harbor phrase, thereby effectively denying appraisers the opportunity to exercise this crucial penalty exception.


       The IRS should initiate a proceeding for the purpose of defining, or providing clear guidance on, the meaning of the safe harbor exception, “more likely than not the proper value.” The IRS should partner with appraisers and other external stakeholders involved in tax-related valuation issues to develop appropriate protocols, guidelines and examples for the exercise of the safe harbor provision.
       Until such definition and/or guidance is operative, IRSAC recommends that 6695A valuation misstatement enforcement be used only in extreme cases involving only the valuation issue.