IRS enforcement-Navigating the changing IRS … under the Internal Revenue Code or applicable state...

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.


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.


Today’s presenters

Pat ChabackRichard FultzFrank NgJohn RisacherMike Semes

IRS update: changing environment of IRS enforcement


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.


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%


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.


LB&I organizational chart


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


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)


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


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


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


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.


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


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


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.


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


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


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


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


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


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


PFA issues in FY 2012


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.


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


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.


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


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


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


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.


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


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


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


► 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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IRS enforcement-Navigating the changing IRS … under the Internal Revenue Code or applicable state...

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