Comments on Notice 98-31, Service-initiated accounting method changes.

• Position: IRS Notice 98-31

On July 30, 1998, Tax Executives Institute submitted the following comments on Notice 98-31, relating to IRS-initiated accounting method changes. The comments, which took the form of a letter from TEI President Paul Cherecwich, Jr. to Commissioner of Internal Revenue Charles O. Rossotti, were prepared under the aegis of TEI's Federal Tax Committee, whose chair is David L. Klausman of Intel Corporation. Margaret A. Curry and Barbara Beckerman of General Motors Corporation and Loren Opper of Ford Motor Corporation contributed substantially to the development of TEI's comments. Also contributing to the comments were Keith R. Brockman of Sunbeam Corporation, George W. Fraley of Proctor & Gamble Company, Julianne V. Maggio of GE Capital Corporation, and Gary J. Wenzel of Mercedes-Benz of North America, Inc.

On May 15, 1998, the Internal Revenue Service released Notice 9831, which contains a draft of a proposed revenue procedure that, when promulgated, will govern changes in accounting methods initiated by the IRS under the authority of section 446(b) of the Internal Revenue Code.(1) The Notice describes the discretion the IRS may exercise in order to resolve issues involving accounting methods, as well as prescribing rules for resolving issues on a nonaccounting-method-change basis. The IRS invites comments on the proposed procedure and, accordingly, on behalf of Tax Executives Institute, I am pleased to submit the following comments.

Background

TEI is the principal association of corporate tax executives in North America. Our nearly 5,000 members represent 2,800 of the leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works -- one that is administrable and with which taxpayers can comply.

Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to the issues raised in Notice 98-31, relating to proposed rules for changes in accounting method initiated by the IRS.

Overview Of Notice 98-31

In Notice 96-40, the IRS solicited comments from taxpayers and tax practitioners regarding the rules governing implementation of accounting method changes, including whether the rules set forth in Rev. Proc. 92-20 should be revised. Many of the public comments submitted in response to the 1996 notice were incorporated into Rev. Proc. 97-27, relating to taxpayer-initiated changes in accounting method. In Notice 98-31, the IRS has dropped the other shoe, prescribing the procedures the IRS is to employ, as well as the consequences to taxpayers, when adjustments involving "timing" issues and accounting method changes are made in connection with an IRS examination or settled at Appeals or in litigation (hereinafter a "Service-initiated" change).

In Notice 98-31, the IRS sets forth a proposed revenue procedure that, when promulgated, will set forth the procedures for implementing a Service-initiated change in method of accounting. Section 1.02 of the proposed procedure states that its purpose is to provide:

terms and conditions for Service-initiated

changes [in

methods of accounting] that

are intended to encourage

taxpayers to voluntarily request

a change from an impermissible

method of accounting

prior to being contacted

for examination. Under

this approach, a taxpayer

that is contacted for examination

and required to

change its method of accounting

by the Service generally

receives less favorable

terms and conditions (for example,

an earlier year of

change and a shorter [sections]

481(a) adjustment period for

a positive adjustment) than

if the taxpayer had filed its

request to change before the

taxpayer was contacted for

examination.

The procedure mandates that the Examination Division (hereinafter "Exam") resolve all "timing" issue adjustments as accounting method changes, prescribes rigid guidelines for the resolution of method change issues by Exam, and otherwise circumscribes the authority of Exam to resolve accounting method issues.

The Notice professes that the proposed revenue procedure will not alter the authority of Appeals or government counsel to resolve or settle accounting method issues based on the hazards of litigation. Nonetheless, the Notice prescribes new rules governing the manner in which accounting method issues settled by Appeals or government counsel -- whether on an accounting-method-change basis or otherwise -- are to be finalized with, and subsequently implemented by, taxpayers.

The rules are propounded in elaborate detail, intimating that the procedure constitutes the exclusive means for resolving accounting method issues. Specifically, various new rules are prescribed concerning the form and content of closing agreements to implement any settlement resolving Service-initiated accounting method changes. These include the form and contents of notice to the taxpayer describing the new method of accounting, the year of change, the [sections] 481(a) adjustment amount, and the number of taxable years over which the [sections] 481(a) adjustment is to be taken into account (the "spread" or adjustment period). In addition, procedural rules are prescribed for resolution and settlement of disputes based on compromise terms and conditions for a change in method. Procedures for implementing nonaccounting-method change settlements, including "alternative timing" and time-value-of-money settlements, are also prescribed. Finally, default procedures are set forth and apply where the settlements or closing agreements fail to comply with specific rules contained in the procedure.

In many respects, issuing public guidance on involuntary, Service-initiated changes in accounting methods is navigating a course in uncharted waters. Hence, we commend the IRS for undertaking to provide rules in an area filled with uncertainty for taxpayers and IRS. As important, we commend the IRS for affording taxpayers and practitioners the opportunity to comment on the guidance before the rules are issued in final form. We believe that the thorny issues raised by Notice 98-31 will benefit from public scrutiny, and, as a result, we offer the following comments on specific issues raised by the Notice.

Rule Prohibiting Exam From Making Taxpayer-Favorable "Timing" Adjustments Contravenes the Authority and Mission of IRS

Section 2.04 of the proposed procedure provides in part:

Consistent with the policy of

encouraging prompt voluntary

compliance with proper

tax accounting principles,

the Service ordinarily will

not initiate an accounting

method change if the change

will place the taxpayer in a

position more favorable than

the taxpayer's position

would have been had the taxpayer

not been contacted for

examination.

TEI believes that it is improper for the IRS to refrain from initiating changes to a return simply because the change is favorable to the taxpayer. Such a policy is inconsistent with the authority and mission of the IRS and cannot be justified by the purported rationale. Indeed, the statement portends a policy of selective, even abusive, enforcement of the Code and Treasury regulations.

Treas. Reg. [sections] 301.6201-1 provides that "the district director is authorized and required to make all inquiries necessary to the determination and assessment of all taxes imposed by the Internal Revenue Code.... The district director is further authorized and required...to make the determinations and the assessments of such taxes." In addition, section 7602 of the Code and Treas. Reg. [sections] 301.7602-1(a) authorize the IRS to examine any books, papers, records, or other data "for the purpose of ascertaining the correctness of any re turn." Moreover, IRS Policy Statement P-4-7 states that "it shall be a [Service representative's] duty to determine the correct amount of the tax, with strict impartiality as between the taxpayer and the Government." (Emphasis supplied.)

Any return that contains erroneous treatment of an item or reflects an impermissible method, regardless of whether the item or method operates to the disadvantage of the taxpayer, is an incorrect return.(2) TEI submits that, in accordance with the Code and regulations, the IRS should make all adjustments, including taxpayer-favorable adjustments, necessary to correct a taxpayer's return. The proposed policy contravenes the IRS's mandate and its professed objectives of fairness and impartiality as well as the thrust of the just-enacted IRS Restructuring and Reform Act. Moreover, it is questionable whether the courts will sustain the view enunciated in section 2.04.(3) Finally, the policy is inconsistent with the IRS's mission statement, i.e., "to collect the proper amount of tax revenues... in a manner that warrants the highest degree of public confidence in [the IRS's] integrity, efficiency and fairness."

Accordingly, TEI recommends that section 2.04 of the proposed procedure be revised to provide that where an incorrect item or method is discovered during the course of an examination, the IRS will correct the item or method regardless of whether the adjustment increases or decreases taxable income. Should the IRS adhere to the position set forth in the proposed procedure, it cannot help but foster taxpayer cynicism about the fairness of the system. Indeed, rather than encourage compliance with proper tax accounting methods, the lack of taxpayer-favorable adjustments for "timing" issues on...