TEI testimony on 2003 tax return filing season and the IRS budget for fiscal year 2004: April 8, 2003.

• Position: Tax Executives Institute

On April 8, 2003, Tax Executives Institute testified before the Subcommittee on Oversight of the House Committee on Ways and Means on the 2003 tax filing season and the Internal Revenue Service's budget for the fiscal year beginning October 1, 2003. TEI's testimony is reprinted below.

Background

Tax Executives Institute was established in 1944 to serve the professional needs of in-house tax practitioners. Today, the Institute has 53 chapters in the United States, Canada, and Europe. Our 5,300 members are accountants, attorneys, and other business professionals who work for 2,800 of the largest companies in North America and Europe; they are responsible for conducting the tax affairs of their companies and ensuring their compliance with the tax laws. Hence, TEI represents the business community as a whole, and our members deal with the tax code in all its complexity, as well as with the Internal Revenue Service, on almost a daily basis. TEI 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.

The companies that employ TEI's members have almost without exception been assigned to the IRS's Large and Mid-Size Business (LMSB) Division. The largest 1,600 taxpayers within LMSB are subject to ongoing audits as part of the Coordinated Industry Case (CIC) program. The Institute's testimony is largely based upon our experience with this segment of IRS operations.

We are pleased to offer our views on the enforcement challenges within LMSB, the IRS Budget for Fiscal Year 2004, the use of private collection agencies for collection of federal taxes, proposals regarding disclosure of corporate tax returns and requiring CEOs to sign income tax returns, and simplification of the complex tax system and its effects on our system of tax administration.

The Components of an Effective Enforcement Strategy

A successful enforcement strategy has the following characteristics:

* Clarity. The ability to understand the tax law--and to comply with it in an efficient fashion--is a critical component of an effective tax system. Taxpayers must understand their responsibilities and commit resources to comply with the law in as efficient a manner as possible. Sadly, the current law--which is marked in many cases by complex, ambiguous provisions that often may produce unintended consequences--leaves much to be desired. We recognize that true simplification begins with the Internal Revenue Code which we address below, but there are ways in which the law can be made simpler by the IRS. For example, the Treasury and IRS are to be commended for the inclusion of de minimis rules and safe harbors in the recent regulations on the capitalization of expenditures. We also believe the consultative process used by the government before issuing the proposed regulations--last year the government used an advance notice to invite comments on a broad range of issues--will produce final rules that reduce compliance and administration costs and minimize uncertainty and controversies to the benefit of taxpayers and the government.

* Confidence. Taxpayers must have confidence in the integrity of the tax system. The law must be applied evenhandedly, and taxpayers must believe that no one is getting a better "deal" upon audit. An effective enforcement strategy must be equitable and ensure that similarly situated taxpayers are being treated alike.

* Competence and Continuity. An effective enforcement strategy also depends upon a committed, well-trained, and stable workforce. It is not enough to announce new procedures and policies from the National Office; there must be buy-in from the field to make the policies work. In addition, field personnel must know and understand the tax law and how it relates to the businesses they audit. Qualified individuals must also be recruited to take the place of the many seasoned agents who will be retiring over the next few years.

* Currency. TEI's members generally work for companies that are under continual audit by the IRS. Both the taxpayer and the IRS have a common goal of completing these audits in a fair, timely, and efficient manner. Several innovative procedures--such as Fast Track Mediation and Settlement, Accelerated Issue Resolution, Early Referral to Appeals, and Limited Issue Focused Examination--have been introduced in the last two years to improve the examination process and promote currency. An effective enforcement strategy must promote the efficient use of government and taxpayer resources during the course of an audit. The lack of currency in audits creates significant recordkeeping burdens for taxpayers. If taxable years are closed in a timely manner, there is less need to retain records relating to those years.

Implementing an Effective Enforcement Strategy

LMSB has shown a refreshing openness to trying new and different ways of doing business. More than a year ago, the division announced several "pre-filing" initiatives, emphasizing the need to resolve issues before a return is filed. This increased attention on "front-end" activities--by the use of pre-filing agreements and industry issue resolution techniques --potentially could reduce contentious audits and prolonged litigation.

In order to substantially complete its change in focus from post-filing to pre-filing activities, the IRS must improve the currency of its audits. Thus, we are pleased with LMSB's recent announcement of its limited issue focused examination or "LIFE" initiative. It is an innovative process to focus government and taxpayer resources on the most significant issues on a taxpayer's return. The new initiative requires the execution of a formal memorandum of understanding between the taxpayer and the IRS that will govern key aspects of the examination, including the imposition of a dollar threshold on a case-by-case basis below which issues will not be raised.

The use of materiality standards in examinations is an approach that TEI has long supported, and we commend LMSB for thinking outside the box to resolve the significant backlog of cases within the division. The LIFE initiative holds great promise for creating an atmosphere where the examination process is less time-consuming and more efficient for all parties.

As the IRS has acknowledged, the new approach represents a major culture shift for LMSB. Critical to its success is the involvement--and training--of IRS field personnel. Without a commitment from the examination team and their supervisors, the new procedure could well be viewed as the latest "flavor of the week," i.e., a mere reworking of other initiatives without an underlying change in philosophy. Reports from our members seem to indicate that not all specialists are yet on board with the new approach. However, we understand that LMSB has begun training its agents in the new process and remain hopeful that the LIFE process will succeed in institutionalizing "best practices" for IRS examinations and providing consistency in the treatment of taxpayers.

Other innovative approaches to resolving issues may be found in IRS's use of new settlement initiatives. In October, the IRS announced proposed settlement options in three groups of tax shelter cases: corporate-owned life insurance (COLI), section 302/318 basis-shifting transactions, and contingent liability transactions. These cases have the potential for clogging the tax system, consuming undue resources, and preventing LMSB from making progress on other important issues.

The three initiatives offered taxpayers an opportunity to settle these issues in a timely manner and were intended to bring the cases to a comprehensive resolution, based on the IRS's assessment of the strength and weaknesses of its legal positions. Although some may disagree with that assessment, the process demonstrates a willingness to let taxpayers resolve a contentious issue and move on. We understand, for example, that the COLI initiative has resulted in the resolution of nearly all outstanding cases. We understand that the IRS is working on settlement options for several other transactions and we encourage the agency to continue its undertaking to resolve issues on a wholesale, rather than a "retail" or case-by-case, basis.

Possible Barriers to an Effective Enforcement Strategy

1. The IRS Budget for Fiscal Year 2004

   One barrier to...