Avoid a Tax Probe by Knowing IRS Agenda

Any company wanting to avoid a tax examination by the Internal Revenue Service may find it helpful to know what’s on the agency’s agenda these days. Speaking at a June 16 Webcast hosted by PricewaterhouseCoopers, IRS Service Team Director Frank Rodjius offered some inside perspective.

Right now the agency is focusing on three key topics, he said: transfer pricing, hybrid structures, and withholding taxes.

Shulman

IRS Commissioner Doug Shulman has previously stated that transfer pricing—the prices a company records for goods and services when its subsidiaries do business with each other—is one of the most difficult areas for tax authorities and taxpayers, but a primary IRS concern nonetheless. “It’s been our experience that transfer pricing is a compliance area in which the IRS commences significant resources,” Rodjius said.

Advance pricing agreements, which are binding contracts between a company and tax agencies, are “an excellent tool … to use in resolving transfer pricing controversies,” he said. Such deals can give a company assurance that the IRS won’t up-end its transfer policy; for global corporations in particular, “you really eliminate uncertain tax positions in this area.”

The IRS is also focusing on hybrid structures, whether they be financial instruments or corporate entities. Regardless of their forms, the underlying purpose is either to exclude income from taxation or to obtain double deductions or foreign-tax credits, Rodjius said. He noted that hybrid structures are a “Tier 1” audit concern, which is the formal label the agency places on high priorities.

Another Tier 1 issue is withholding taxes. The IRS has increased its compliance efforts for withholding rules and established six examination groups nationwide “dedicated to the audit of withholding issues,” Rodjius warned. “We’re finding a lot of problems in this area, especially if companies are trying to get withholding taxes back.”

“It’s been our experience that transfer pricing is a compliance area in which the IRS commences significant resources.”

—Frank Rodjius,

IRS Service Team Director,

PricewaterhouseCoopers

Many times, he said, a company will file a Form 1042, reporting taxes that it originally expected to be subject to withholding. Then, upon re-examination, the company will argue that the IRS made a mistake and will file a Form 1120-F claiming a refund for withheld taxes. But recently, the IRS has bolstered its international audit force and started requiring more details in Form 1120-F for foreign entities, so this issue is “very alive and well with the IRS, and is currently on their radar screen,” Rodjius said.

Another hot topic in the international arena is the reporting of foreign bank and financial accounts, known as “FBAR” in the tax trade. If a person has a financial interest in, or signature authority over, one or more foreign accounts and the aggregate value of those accounts tops $10,000 sometime during the calendar year, he or she is required to report the account to the Treasury Department under the Bank Secrecy Act.

“Foreign financial accounts” can include a bank account, brokerage account, mutual fund, or other type of financial account. A United States citizen can have a foreign account, but civil and criminal penalties may apply for failure to file FBARs when required. The due date for FBARs is June 30 of every year.

Resolution Processes

The IRS is also bolstering several initiatives to save time and resources on its audit process. One example is the Compliance Assurance Program, which allows taxpayers to get certainty about their tax obligations at the time their return is filed—an idea dear to the heart of corporate tax executives everywhere. “This program really reduces the time and expense of an IRS examination,” Rodjius said. The bad news? The program, which currently has more than 100 Participants, is by IRS invitation only.

NOPA APPEALS OPTIONS

The following bullet points on “Notice of Proposed Adjustment (NOPA)

Appeals Options” are from the GNJ Webcast, “IRS Hot Topics and Managing an IRS Examination Effectively”:

Fast-track settlement (Issue or case)

Issue or case can be expected to be

resolved in less than 120 days.

Appeals officer mediates settlement

and can use settlement authority.

If agreement not reached, TP can

request traditional Appeals process

after 30-day letter issued.

Either party can withdraw at any

time during the process.

Early referral (Issues)

Case not expected to be completed

before Appeals decides issue.

Appeals will not consider the issue

again if the case closes unagreed.

If agreement not reached, TP and

Appeals can request mediation.

Exparte applies—TP must be

invited to participate in any meeting

between Appeals and LMSB.

Source

GNJ Webcast: Managing an IRS Examination (June 16, 2010)

Alternative dispute resolutions are also a high priority with the IRS, Rodjius said. The IRS typically resolves its disputes either with fast-track settlements or early referral to appeal boards. The goal of fast-track settlements is to eliminate the appeals process, by keeping the case within the jurisdiction of the IRS Division of Large and Mid-Sized Business. While the process must be completed within 120 days, the average is 63 days, Rodjius said. In addition, 85 percent of cases get resolved “fairly successfully,” he said, “so this is a very useful tool to resolving tax disputes.”

The early referral to appeals works in a different manner. By sending a dispute straight to a tax appellate officer, the officer might decide the issue before the case gets resolved. In that instance, the appeals officer will not consider the issue again if the original case goes unagreed.

If agreement is not reached, the taxpayer can request mediation. Finally, an ex parte rule applies, meaning the taxpayer must be invited to participate in any meeting between the appeals officer and the LMSB Division.

If alternative dispute resolution fails, the IRS will send a letter to the taxpayer with a copy of the exam report and advise him of his appeal rights. The taxpayer then has 30 days to decide whether to agree with the adjustments (in which a tax will be assessed), or request consideration by an appeals officer. The appeals process is an alternative to tax court. Eighty-five percent of cases are resolved on an agreed basis, Rodjius said.

Managing the Exam Process

The LMSB Division introduced a new program in April, the Quality Examination Process, designed to strengthen communication with taxpayers and improve the consistency of the examination practices. IRS Service Team Director James Dever, who also spoke during the Webcast, reviewed the three phases of the QEP initiative:

Planning Phase. Identifies certain activities that, if followed, will focus the examination team on developing an effective examination plan. Depending on the nature of the exam to be conducted, some of the following may be more applicable than others:

Pre-exam analysis;

Initial planning meeting;

Subsequent planning meetings;

Taxpayer orientation;

Exchange of additional transactional and financial information; and

Finalizing the exam plan.

Execution Phase. Stresses the importance of ongoing dialogue between the examination team and the taxpayer throughout the exam. Some areas that will require this ongoing communication are as follows:

Changes to examination scope;

Ongoing monitoring process;

Discussions of issues;

Information document requests.

Resolution. Present throughout the exam, the examination team is responsible for fully and completely developing issues and reaching agreement about the relevant facts of the taxpayer. To accomplish this, examination teams will address the following areas:

Confirm the facts;

Engage specialist and experts;

Issue resolution strategies;

Other issues;

Determine areas of agreement or disagreement.

Final steps and issuance of the evaluation report.