2014-Issue 3—The Information Document Request (IDR) process that we have all followed in a typical IRS audit in the past has recently undergone some substantial changes that will require an evaluation of your current process for dealing with such requests and managing the overall audit process. In June, the Acting Commissioner of the Large Business & International Division (LB&I) of the IRS issued a directive to all division employees in response to a mandatory training completed by LB&I examiners and specialists over the summer. This directive announced that all IDRs issued after June 30, 2013 must comply with three fundamental principles addressed in the training:
- IDRs must be issue focused;
- IDRs must be discussed with the taxpayer; and
- Taxpayers and examiners must discuss the appropriate deadlines.
In addition to the training, the IRS is expected to issue updates to the Internal Revenue Manual outlining the new requirements and procedures. By updating the procedures around issuing IDRs and collecting responses, the IRS’s goal is to improve the speed with which audits take place, resulting in a universal streamlining of the IDR and data collection process. Historically, the arbitrary management and decisions around IDR issuance and timing from taxpayer to taxpayer have made it difficult to stick to audit plans and move quickly through the process. However, the actual impact of these new procedures on taxpayers, their personnel and the IRS may come with additional (and some unintended) consequences.
Issuance of an IDR
Historically, when a taxpayer’s return has come under examination, the IRS would issue one or more IDRs to request information substantiating positions. Under the new directive, LB&I has identified several requirements with the intent of streamlining and speeding up the process. Many of these are steps we have already taken in the past ourselves when working to manage the audit process, and include:
- Prior to issuing an IDR, the examiner must discuss with the taxpayer or its representative the issue that is being examined through the IDR, how the information requested is related to this issue, and why this information is necessary to satisfy the IDR.
- After this discussion, the examiner may determine what information will ultimately be requested in the IDR.
- In drafting the IDR, a separate, enumerated IDR must be issued for each issue. Each IDR issued must clearly state the issue being examined and that only relevant information is required to address that issue. The IDR must be written clearly and concisely, and it must be tailored to the taxpayer or its industry.
- Before issuing the IDR, the examiner will provide a draft of the IDR to the taxpayer and discuss the contents. At the end of the discussion, the examiner and the taxpayer will discuss a reasonable timeframe for response. If an agreement on the response date cannot be reached, the examiner may determine a reasonable response date at their discretion. The examiner must also include a date by which the answered IDR will be reviewed and a response provided to the taxpayer on whether the information received satisfies the IDR. All dates must be included in the final draft of the IDR issued to the taxpayer.
- Once the IDR is issued, the examiner will begin the IDR enforcement process if the information requested is not received by the response date.
While these new guidelines for issuing IDRs are meant to improve cooperation, communication and the speed with which audits are completed, the accompanying enforcement process contemplated under the directive is sure to create some friction between taxpayers and the IRS, as well as within the tax function of a company. The taxpayer’s consultation with the IRS on these matters must be taken seriously, and time will tell how the IRS and, perhaps more importantly, individual agents will execute on these new procedures. Some examiners may use these new guidelines to take an adversarial approach and make unreasonable requests despite the stated intent of the guidelines.
Thoughtful negotiation at the beginning of the audit process, and good, strategic communication and documentation throughout, will be necessary to prevent a delinquency that could lead to the rigid enforcement process contemplated by the directive’s enforcement procedures, discussed below. Preparing and storing tax files, work papers and other documentation in an easy-to-access format will be key since the delinquency process is now much shorter.
Assume that all tax personnel responsible for handling an issue under review may have moved on prior to the resolution of an issue, and that the audit will also require good recordkeeping and contemporaneous documentation in order to quickly respond to IDRs and avoid punitive action by the IRS. Whether the documentation is tracked through Excel or one of the commercial software products available for tracking IDRs and their responses, the time has passed for keeping track of these responses on the back of an envelope or in your head.
The Enforcement Process
The new enforcement procedures were originally planned to take effect on October 1, 2013, but have since been delayed until January 2, 2014 (Happy New Year!). However, rules have emerged from the training that outline the new delinquency enforcement process. The IRS has already begun to use these new enforcement rules for IDRs that meet the above requirements when issued. Thus the effect of the January 2 effective date is to necessitate that all IDRs that do not meet the issuance requirements be reissued in conformity with these requirements in order for the new enforcement procedures to apply.
In a departure from the existing guidelines, the new procedure takes a much more rigid approach to the handling of delinquent IDR requests. Prior to the issuance of the new directive, the existing enforcement procedures provided a great deal of flexibility for taxpayers and the IRS examination team to coordinate the IDR process and to contemplate and address issues with IDR responses as they arose. The IRS has found this sometimes leads to what it perceives as an abuse of auditing resources, resulting in the new directive.
New rules for examiners regarding the timing of delinquency proceedings following the due date of an IDR are therefore a key to the new procedures. Under the old procedures, senior corporate officers of a company might not be contacted until as early as 90 days after the original IDR due date. Prior to that, the due date of a particular IDR may have been extended more than once. LB&I now requires its examiners to seek assistance of counsel to issue a summons within 49 days from the time that an IDR becomes delinquent. If the delinquency procedure is applied, which can now happen as early as 35 days from the IDR due date, a summons can be issued.
Previously, another meeting was required to determine if such a step was necessary. If the summons is not timely answered, the Department of Justice may be asked to begin court proceedings, at which point the process becomes public and subject to media scrutiny. The bottom line is that the timing with which IDRs are issued, responded to and deemed complete must be closely tracked by a taxpayer. This has always been the case, but under the new directive the stakes are raised more quickly and with less discretion by the agent on the ground.
Phase I: Delinquency Notice
If the examiner is unsatisfied with the taxpayer's response to the IDR:
- The examiner must discuss the IDR response with IRS and taxpayer personnel to determine what information is missing.
- The examiner must discuss the delinquency notice, ensuring the taxpayer understands the enforcement process if the delinquency of the response to the IDR is not addressed.
- Any additional time beyond a 15-day response window must be approved by an LB&I territory manager.
- The examiner must provide a copy of the delinquency notice and the IDR to an IRS attorney.
Time provided: Delinquency notice will be issued within 10 days of IDR response date; taxpayer response required within 15 days (unless territory manager approves otherwise).
Phase II: Pre-Summons Letter
If the examiner is unsatisfied with the taxpayer's response to the delinquency notice:
- The examiner must prepare a pre-summons letter with the assistance of the team manager, territory manager and IRS attorney.
- The territory manager will discuss the pre-summons letter and additional enforcement steps with the taxpayer if the delinquency of the response to the IDR is not addressed within the time provided by the letter.
- The pre-summons letter will be issued to a taxpayer representative who is one level of management higher than the representative previously handling the matter.
- Any additional time beyond a 10-day response window must be approved by an LB&I director of field operations (DFO).
Time provided: Pre-summons letter will be issued within 14 days of delinquency notice response date; Taxpayer response required within 10 days (unless DFO approves otherwise).
Phase III: Summons
If the examiner is unsatisfied with the taxpayer's response to the pre-summons letter:
- The examiner must prepare a summons with the assistance of the team manager, territory manager, DFO and IRS attorney.
- The examiner must issue the summons.
Time provided: Summons will be issued at the end of the pre-summons letter response period.
* all days provided are calendar days, not business days
To allow for the transition to the new enforcement rules, the LB&I is asking examiners not to issue delinquency notices until after February 3, 2014. However, some taxpayers are already reporting that IDRs are being handled under the new procedures.
These new procedures require the taxpayer client to take a series of precautionary steps to ensure the onerous delinquency process is never initiated. It has never been more essential that direct communication occur with the IRS during the IDR drafting stage and prior to the issuance of the IDR, as this may be the only window when the scope and the timeline of the IDR may be negotiated. Once the delinquency process begins,
LB&I examiners must follow the enforcement procedures unless a territory manager or DFO grants an extension, which is likely to happen only in extreme and unusual circumstances. Furthermore, since the new enforcement process requires the pre-summons letter to be sent to the taxpayer employee’s superior (e.g., if you are a VP of tax, to your CFO), employees and officers managing the audit process need to worry about managing not only the IRS, but, should they run afoul of the procedures, their supervisors within the company as well.
This dynamic certainly has the capacity to negatively affect the relationship between the taxpayer employee and the examiner, aggravating the process. As the new rules require IRS counsel to become involved earlier in the process, the taxpayer may need to contemplate involving counsel as early as possible as well, which may not have been the case in the past. Only time will tell.
In the early days of the implementation of the IDR directive, the consultation phase with the IRS must be taken seriously, and thought and care must be given to evaluate how the IRS may carry out these new procedures. While some examiners take a very adversarial approach from the beginning, making unreasonable requests, others, understanding the gravity of the enforcement provisions, may look to work collaboratively with taxpayers early on.
The key is to not take a wait and see approach, as the ground rules, timelines and trust built at the very beginning of an audit have the potential to impact the audit overall. A taxpayer should plan on negotiating extra time to fulfill requests based on the time of year, both for the taxpayer and for the IRS (e.g., year-end close, the holidays, etc.). Take the time up front to evaluate the challenges that may exist in providing certain information quickly. And while you are evaluating, perhaps agree to provide information that will be easier to locate and present earlier in the process, while agreeing to get back to the IRS on more difficult data to compile when you have a concrete sense of what it will take to deliver.
Agreeing to a timeline when you are unsure how long it will take to procure the information is asking for a shaky relationship with the audit team, so communication about these burdens that might not be obvious to the IRS is key, and communication of these issues is required — time spent educating the examiner on the nature of the business may save even more time spent looking for unnecessary details.
Alvarez & Marsal Taxand Says:
The best defense to an IRS audit begins long before the first IDR arrives. Appropriate document retention policies and procedures for creating documentation that will support your company’s positions at audit are key. While always a best practice, with the rollout of the IDR directive in the new year, organizing this data in a readily accessible format has never been more important. Pulling a binder off the shelf is always preferred to scrambling at the last minute. Once the audit starts and IDRs are issued pursuant to the directive, the difference made by these approaches may have significant consequences. Thoughtful negotiation of the scope and timeline, accompanied by the steadfast preparation and tracking of IDR responses, may be the only thing standing between your company and an IRS summons.
As provided in Treasury Department Circular 230, this publication is not intended or written by Alvarez & Marsal Taxand, LLC, (or any Taxand member firm) to be used, and cannot be used, by a client or any other person or entity for the purpose of avoiding tax penalties that may be imposed on any taxpayer.
The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.
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