IRS enforcementNavigating the changing IRS landscape
14 May 2013
Eighth annual domestic tax conferencePage 1
Disclaimer
► Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & YoungGlobal Limited located in the US.
► This presentation is ©2013 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young and its member firms expressly disclaim any liability in connection with use of this presentation or its contents by any third party.
► The views expressed by panelists in this session are not necessarily those of Ernst & Young LLP.
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Circular 230 disclaimer
► Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.
► These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice.
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Today’s presenters
Pat ChabackRichard FultzFrank NgJohn RisacherMike Semes
IRS update: changing environment of IRS enforcement
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FY 2012 IRS enforcement results
► IRS enforcement revenue collected was $50.2b, down from $55.2b in FY 2011
► The large corporate audit coverage rate was 17.78%, up from 17.64% inFY 2011.
► Partnership audit coverage was 0.47%, up from 0.40% in FY 2011.► The IRS increased examination across all categories of business returns by
more than 12% in FY 2012.► The largest increases were audits of flow-through entities — partnerships and
Subchapter S corporations.► There was a reduction in the IRS budget of $305m in 2012.
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Enforcement shift to examining mid-market companies
► The difference in the number of companies examined from FY 2011 to 2012 (by asset class):► $10m — $50m — dropped by almost 3%
► But, for mid-market companies:► $50m — $100m increased by about 2%► $100m — $250m increased by over 6%
► And for higher asset companies► $250m and higher — increased by about 2%
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Large Business & International (LB&I) division realignment
► Effective 1 October 2012, LB&I realigned its industry groups with contiguous geographical boundaries.
► The field specialists (engineers, financial products specialists, computer audit specialists) were realigned into one of the industry groups.
► Employment tax specialists became part of the small business/self-employed division.
► IRS is seeking to gain greater operating efficiencies.► This may result in new executives and managers responsible for your audits.► Two distinct management lines were created — domestic and international.
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LB&I organizational chart
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LB&I domestic realignment map
CA
RI
NJ
MANH
VTME
NY
PAOH
WV
WY
CO
NMAZ
UT
ID
NV
OR
WA
AK
MT
DE
HI
VA
NC
SC
DC
NE
KS
GAMS
OK
TX LA
FL
AL
MD
Communications, technology, media
Natural resources construction
Heavy manufacturing and pharmaceuticals
Financial services
KY
IN
AR
MO
IAIL
MNND
SD WIMI
Retailers, food, transportation and health care
Manhattan
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LB&I Transfer Pricing practice
Nanette Hamilton Executive Assistant,
Technical
Nanette Hamilton Executive Assistant,
Technical
Sam MarucaDirector,
Transfer Pricing Operations
Sam MarucaDirector,
Transfer Pricing Operations
Carla Langland Executive Assistant, Operations (acting)
Carla Langland Executive Assistant, Operations (acting)
John Kaffenberg IPN Manager
John Kaffenberg IPN Manager
Howard Berger Senior Tax Advisor
Bill Morgan Senior Economic Advisor
Eli Hoory Special Projects Deputy
Bob Cole Special Projects Deputy
Stan Perry Special Projects Deputy
Dick McAlonan Director, APMA Dick McAlonan Director, APMA Transfer Pricing practiceTransfer Pricing practice
Nancy Bronson Territory Tax
Manager (West)
Tom Ralph Territory Tax
Manager (Central)
Matt HartmanTerritory Tax
Manager (East)
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LB&I: FY 13 strategic areas of focus
► Execute a professional examination on behalf of the US Government► Revise and rename the quality exam process► Consider changes to the Coordinated Industry Case (CIC) program► Consider a process that better leverages the knowledge of specialists► Continually improve and innovate LB&I programs and processes
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LB&I focus guide: continually improve LB&I programs and processes
► Champion continuous process improvement at all levels within LB&I to increase efficiency and effectiveness, better leverage limited resources, and eliminate unnecessary steps
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LB&I focus guide: consider changes to the CIC program
► Consider moving away from the historic designation of cases as CIC or Industry Case (IC) based on the size and corporate structure of the taxpayer, and focus instead on the nature and complexity of the issues presented
► Select and audit issues that will have the broadest impact on compliance regardless of entity type or size
► Consider moving toward grades not based on case assignments but instead based on expertise, work advising and training on complex and difficult issues
CICIC
Issue-based
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TY 2011 schedule UTP statistics as of December 2012
► 1,783 taxpayers filed Schedule UTP for TY 2011, up from 1,761 at the same time in TY 2010.
► IC taxpayers account for 83% of returns filed with Schedule UTP.► 4,120 tax positions were disclosed in 2012.► CIC taxpayers averaged 3.8 uncertain tax positions per Schedule UTP. ► IC taxpayers averaged 2 uncertain tax positions per Schedule UTP. ► 47% of all Schedule UTP returns filed included only one uncertain
tax position.
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Increasing Compliance Assurance Process (CAP) taxpayer participation
► 2005: first CAP year ► 17 taxpayers in CAP
► 2012: last CAP year► 161 taxpayers in CAP► 10 taxpayers in Compliance Maintenance► Pre-CAP not published
► 2013: current CAP year► 169 taxpayers in CAP► Of which, 153 return participants from 2012 CAP year► 16 taxpayers in Compliance Maintenance► 19 taxpayers in Pre-CAP as of January 2013
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CAP phases
► The IRS and the taxpayer develop a plan to eliminate open years within a set time frame.
► They work in a cooperative and transparent post-file environment.► The ultimate goal is meeting the selection criteria and progressing to the
CAP phase.
Pre-CAP phase
► The taxpayer and the audit team work in real time environment to identify and resolve issues prior to filing (same as current CAP process).
► The taxpayer works with the audit team by identifying transactions and providing information to resolve material issues.
► The taxpayer receives full acceptance if all material issues are disclosed and the tax return filing is consistent with agreed tax treatment.
CAP phase
► The IRS will adjust the level of review work and time applied. ► The level of review will be adjusted based on TPs unique experience in CAP
and history of compliance and risk.► Material transactions and issues are periodically disclosed.
Compliance maintenance
phase
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Is CAP right for you?
► Annually, taxpayers can apply for acceptance into the CAP phase between1 September and 31 October.
► Taxpayers can apply for pre-CAP at any time.► For CAP, if currently under examination, the taxpayer must not have more
than one filed return that has not been closed in examination and one unfiled return for the year that has most recently ended (the return for which is not yet due).
► IRS invites CAP taxpayers into the CAP Maintenance phase.
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LB&I focus guide: execute a professional examination
► Transparency with taxpayers in all aspects of an examination► Issue information documentation requests (IDRs) that are issue-focused ► Issue IDRs with clear, agreed-upon time frames for response► Use available audit tools, including international practice groups (IPGs) and
international practice networks (IPNs)► Use available resolution tools to resolve issues as early in the process► Send well-developed cases to appeals► Refer all cases to LB&I where new facts or arguments are presented
in appeals
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LB&I focus guide: revise and rename the quality exam process
► Revise and standardize the road map for a professionally executed LB&I examination that is efficient, effective and transparent
IDR process
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Quality examination process (QEP)
► Introduced to improve efficiency of audit process to improve taxpayer engagement and maximize the effectiveness of the IRS’ relationships with taxpayers
► Required on all new IRS audits started after June 2010► Components of QEP:
► Plan the audit, improve communications► Execute the audit plan, streamline the process► Resolve issues, identify resolution opportunities
► Opportunity for taxpayers to take proactive actions in the management of an IRS audit and planning
► New emphasis on earlier resolution of tax issues and use of alternative dispute resolution options
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Anticipated IDR process changes
► Current process — 150 days► Delinquent IDRs:
► Conferences and follow-up with taxpayer required at 15, 30, 45 days from the original response date
► 90 days delinquent a joint IDR status meeting required with Territory Manager, IRS Counsel, Team Manager and senior corporate officers of the taxpayer► Discussion of whether a summons or 982 formal document request issued
► Pre-summons letter issued
► Anticipated process changes:► Issue-focused IDR► Discussions on each IDR and agreement on response date between examiner
and taxpayer► IDR swiftly enforced if agreed-upon response date is not met
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IRS promoting alternative dispute resolution (ADR) options
Under exam
Pre-return filing:► Compliance assurance process► Pre-filing agreement ► Industry issue resolution ► Private letter ruling► Advance pricing agreements
Audit process (post-filing):► Limited issue-focused exam► Accelerated issue resolution ► Early referral appeals ► Fast-track settlement ► Competent Authority Process► Rapid Appeals Process (in Appeals)
Post-appeals process:► Mediation ► Arbitration
ADR Provides value through:► Lower admin costs► Speedier resolution► More favorable ► Settlements
Before thereturnis filed
Appeals
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Pre-filing agreement (PFA)(Rev. Proc. 2009-14)
► Enables taxpayers and the IRS to resolve, before the filing of a return, the treatment of an issue otherwise likely to be disputed in post-filing examinations
► If successful, results in a closing agreement: ► An agreed-upon methodology may be used for up to four subsequent years
► Provides full resolution of issue earlier than traditional return filing and examination
► Benefits taxpayer and IRS by improving the quality of tax compliance while reducing its costs, burdens and delays
► Affords heightened certainty for financial statement
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PFA issues in FY 2012
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Resolution approaches: fast-track settlement (FTS) (Rev. proc. 2003-40)
► FTS uses mediation techniques to help IRS and the taxpayer settle an issue in a 120-day time frame:► It gives LB&I personnel and LB&I taxpayers an opportunity to mediate their
disputes with an appeals official acting as a neutral party.
► If any issues remain unresolved at the conclusion of the FTS process, the taxpayer retains all applicable appeal rights.
► Once an agreement is reached through FTS and the session report is signed, the settlement cannot be modified.
► 83% of cases accepted into the program resulted in agreement.
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LB&I focus guide: consider a process that better leverages specialists
► Consider having examiners, with the advice of specialists, examine issues currently being examined exclusively by specialists
SpecialistsIRS
examiner
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Formation of issue practice groups (IPGs) and international practice networks (IPNs)
► On 17 August 2012, the IRS announced the termination of the tiered issue process.
► It created IPGs for domestic issues and IPNs for international issues. ► All prior industry director directives (IDDs) relevant to the tier issues are
withdrawn and should not be followed by examiners:► Some IDDs are still in effect according to informal IRS communications.
► IPGs are led by IPG coordinator with one or more full-time subject matter experts (SME), part-time SMEs who spend less than 25% of their time as Collateral SMEs and an IPG analyst.
► IPNs will be centrally managed by dedicated full-time international issue coordinators.
► Establishment of internal knowledge sharing network.
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Domestic IPG: more to come
► Partnerships and TEFRA► RICs, REITs and REMICs► S-Corporations
and cooperatives► Non-life insurance► Compensation
and benefits► Penalties► Deductable and capital
expenditures
► Corporate distribution and adjustments
► Corporate income and losses
► Business credits► Energy credits► Life insurance► Financial instruments► Inventory and 263A► Methods of accounting
and timing
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New IPNs
► IPNs will focus on international issues and will replace the tiered issue process.
► The IPNs will report to Mike Danilack, Deputy Commissioner LB&I (International).
International business compliance inbound
Income shifting
Inboundfinancing
Repatriation/withholding
RepatriationIncome shifting
Deferralplanning
FTCmanagement
International business compliance outbound
International individual compliance inbound
Jurisdiction to tax US activities US investments
Foreign corporations
Offshore arrangements
Foreign tax credits
International individual compliance outbound
Jurisdiction to tax
Pass-thruentities
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International enforcement priorities
► Continued emphasis on offshore back account compliance► Increase audit coverage of international and cross border issues, particularly
in the transfer pricing area► Chapter 3 withholding agents (Form 1042)► Foreign-controlled corporations ► Form 1120F filers and non-filers► International partnerships (1446)► FIRPTA withholding agents
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States with ‘bright-line’ or economic nexus standards
NY
KY
WA
OR
VA
NJ
DE
VT
MD
RI
CT
AK
MA
ME
PA
OHIN
MIWI
MT
AL
CO
IA
FL
ND
SD
KS
OK
TX
TN
GASC
NCAZ
UT
ID
WY
CA
NM
LA
AR
MS
ILWV
MO
NH
MN
NENV
States adopting bright-line nexusEconomic nexus by statuteEconomic nexus by case law (intangible holding company)Special cases
HI
CA — Sales > $509.5k
WA — Sales > $250k
MI — Sales > $350k
OH — Sales > $500k
MTC — Sales > $500k
NY (and NYC) —Sales > $1,000 (credit card banks only)
Caution: Other states have, through audit or questionnaires, asserted economic nexus.
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Summary of recent nexus decisions
Case Tax type State Court/Trib. Winner Reversed?Barnesandnoble.com Sales and
use taxNew Mexico NM appeals State Yes
ConAgra Brands Income West Virginia WV supreme Taxpayer Yes
Jack Daniels Properties
Income Iowa IA Div. Admin Hrng.
State N/A
Scioto Insurance Income Oklahoma OK supreme Taxpayer Yes
Washington Mutual Bank Oregon DE bankruptcy Taxpayer N/A
J. McIntyre Machinery, Ltd.
[Not a tax case]
New Jersey U.S. supreme Defendant Yes
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Alternative apportionment
► UDIPTA Rule 18► Determining when Rule 18 relief is appropriate► Common Rule 18 situations:
► A Corporation does business in a state but does not apportion any income to that state
► The factors in the standard formula are mismatched to the time when the income is generated
► The single distortive factor► Misclassification of a business segment► Proving the reasonableness of an alternative apportionment methodology
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Managing state tax risk to create value
Insight► Audit trends► Legislative trends► Judicial trends► Industry issuesHindsight► Root cause analysis► Refunds/look-backs► Leverage to futureForesight► Leverage past to benefit future► Learn from historyGovernmental relationships► Essential to success► Transparence and integrityTechnical proficiency► Calculated creativity► Quantitative and qualitative skillsProactive approach► Anticipate issues► Leverage knowledge
TacticsStrategies
Controversy and risk
management thinking
Insight
Hindsight
Foresight
Governmental relationships
Technical proficiency
Proactive approach
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► Understanding the taxing agencies’ views, goals and objectives is essential to the formulation of negotiation strategies that will ultimately result in favorable settlement alternatives acceptable to both parties.
► The financial reporting impact of a tax issue is a critical component of the overall objective of managing tax risk.
► Vigorously delving into thequantitative side of a taxissue spawns additionalsupport for existing positions and leads to new arguments.
► Because taxes are legislative creations, every tax issue possesses a potential political dimension to consider.
► It is pointless to undertake a tax issue without a thorough understanding of the relevant business operations and objectives.
► Business reputationis invaluable and irreplaceable and, therefore, must be preserved.
Political and
governmental
Tax issue
Financial reporting andquantitative
Business andreputation
Every tax issue is multidimensional
Questions and answers
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