Tax controversy in the post-shelter era

Tax Executive, The, May-June, 2007 by Lawrence B. Gibbs

I would like to share with you six observations about what our tax controversy dealings with the Internal Revenue Service in the post-shelter era may be like, and seek your reactions about what you believe we should expect from the IRS and how taxpayers and their representatives should respond.

My first observation, from which most of my remaining ones follow, is that the IRS today is in a full compliance mode, largely because of the IRS's response to tax shelters over the last five years, led primarily by former Commissioner Mark Everson. The Large & Mid-Size Business Division, with which most large companies interact, is placing primary emphasis on perceived tax non-compliance by large and medium-size businesses. Congressional oversight panels have made it very clear to the IRS that more emphasis on tax compliance by business is expected. Accordingly, we are likely to see LMSB use techniques it developed to deal with tax shelters in the foreseeable future.

LMSB's new Industry Issue Focus program will target specific issues for development, audit, and potential litigation because LMSB will have determined that these issues have the greatest tax compliance risk for large and mid-size companies. The development of this new program suggests that if your company has a significant, potentially difficult tax issue that LMSB characterizes as a Tier I, Tier II, or Tier III issue, you are likely to encounter the same IRS audit problems, confusion, and frustration we often experienced over the last five years in dealing with LMSB's coordinated, matrix management system for tax shelter issues. Thus, you may find it difficult to determine who in LMSB and Chief Counsel has authority for what and who is willing and has the capability to make good decisions about your significant, potentially difficult tax issues. In such an environment, we expect the knowledge we developed in the tax shelter era about how and with whom to deal in LMSB's matrix management to secure taxpayer-favorable decisions will be important.

Even if your company was never involved in a tax shelter and does not encounter this new IIF program, IRS announcements over the last year suggest the likelihood of heightened LMSB audit scrutiny of such diverse but relatively routine activities as transfer pricing, cost sharing arrangements, domestic and international restructurings, R&D programs generating tax credits, derivatives, executive compensation and other section 409A programs, costs qualifying for the Domestic Production Deduction under section 199, and issues raised by Schedule M-3 or FIN 48 disclosures. Clearly, a major portion of LMSB's future focus will be on international issues. Because of the increasing cooperation among the federal, state, and foreign tax authorities, stakes will undeniably rise for multinational companies in the post-shelter tax controversy area. I predict that as the IRS gets more and more pressure from politicians and the media to collect taxes already owed to avoid having to raise tax rates for compliant taxpayers (especially individuals who vote), the business community will find dealing with LMSB and its attorneys more demanding and potentially difficult than in the past. Let me explain why.

In my experience, attorneys in the IRS Office of Chief Counsel are playing an increasingly important role in many of LMSB's cases. During the tax shelter days, many of the listed transactions required Counsel's participation to develop the facts and law applicable to complex transactions, the terms of and closing agreements for any settlements, and the preparation for litigation of cases that could not be settled. With Counsel's assistance, LMSB became more adept and intrusive in its issue development by using more precise IDRs, summonses, and in some cases requests for tax accrual workpapers. These close working relationships between LMSB and their attorneys appear to be carrying over to post-shelter audits of companies' transactions to develop significant issues LMSB finds troublesome.

It may be difficult, at least initially, to identify who in Counsel is advising your LMSB audit team and what advice they are giving on significant issues. Depending upon the type and size of the issue, it often is as difficult as it is important to know whether Area Counsel attorneys in the field or Chief Counsel attorneys in the National Office are providing the advice given to your LMSB team. In some cases, we have seen increased tension between LMSB field attorneys and National Office attorneys over which of them will "call the shots." This tension may be the unavoidable result of LMSB's currency initiative because the desire for faster decision-making by LMSB audit teams may conflict with the more deliberate approach of the National Office attorneys. Accordingly, LMSB teams are turning seemingly more often to their field attorneys than to the National Office for advice, and the field attorneys appear to be more willing than National Office attorneys to provide support more expeditiously, even if the legal conclusions may be questionable or even at odds with other IRS positions.