Under tough new IRS rules, tax departments could receive “delinquency notices” or even summonses if they fail to meet deadlines established for IDRs. However, there are a number of measures CFOs and tax departments can undertake to ensure they do not run afoul of these requirements and receive an unwelcome enforcement action.
IDRs are the IRS’s informal way of collecting information during the course of an audit. The IRS has also always had the authority to issue summonses and seek enforcement of such summonses in court, although their use remains relatively infrequent. That may change, however, as the IRS’s new policy regarding IDRs that are deemed delinquent dramatically decreases the discretion of the front-line IRS agent to extend deadlines. It also implements a strict three-step process that ultimately culminates in the issuance of a summons.
Last year, IRS agents in the Large Business & International Division of the IRS were trained on a new IDR process intended to improve the efficiency of the IRS’s information gathering process. Specifically, for all IDRs issued after June 30, 2013:
(1) the IDRs must be issue focused,[1]
(2) the IDRs must be discussed with the tax department in advance, and
(3) the agent and the tax department must discuss and determine a reasonable timeframe for response.
While these changes were overwhelmingly viewed as taxpayer-friendly, when they were announced on June 18, 2013, the IRS also indicated new enforcement procedures would be forthcoming.
A Chilly Response
The IRS first announced the new enforcement procedures in a directive issued on November 4, 2013. The rigidity of the new procedures was met with objections from taxpayers and agents. As a result, slightly revised procedures were issued on February 28, 2014, effective March 3, 2014, with the first delinquency notices to go out April 3, 2014. This change gives companies the opportunity to engage in a dialogue with their IRS auditor – and for financial executives to encourage their tax leaders to start that process now.
The procedures place a premium on taxpayers and agents engaging in
“robust discussions that include the issue that is the subject matter of an IDR, what information is necessary to evaluate that issue and why, what information the taxpayer has and how long it will take to provide it, and how long it will take the IRS to review the information for completeness to respond to the taxpayer.”
As such, it is incumbent on tax leaders to also engage with management so the issue doesn’t rise to the next level of the organization. If financial executives and their tax leaders have a plan in place that can help them avoid a summons, as the directive states, “it is anticipated that when both the IRS and taxpayers engage in robust, good faith communication in advance of an IDR being issued, enforcement procedures will be needed only infrequently.”
New Procedures in a Nutshell
Under the new procedures issued in February, the agent or specialist issuing an IDR has the authority to issue one 15-business-day extension if a taxpayer is unable to meet an agreed upon IDR deadline. After that, the three-step enforcement process must be triggered. Accordingly, if a taxpayer fails to provide a complete response to an IDR within an agreed-upon timeframe (including any extension), the following procedures apply:
(1) Delinquency Notice: Once an agreed-upon deadline has passed, a delinquency notice will be issued by the IRS team manager within 10 days of the enforcement process being triggered, providing the taxpayer another 10 days to respond. Response dates in excess of 10 days require the approval of the territory manager.
(2) Pre-Summons Letter: Generally within 10 days of the response date in the delinquency notice, a pre-summons letter will be issued to the taxpayer if a complete response is not provided. The pre-summons letter is signed by the territory manager, who is instructed to discuss the letter with the taxpayer. The pre-summons letter will give the taxpayer another 10 days to respond. Response dates in excess of 10 days require the approval of the director of field operations. Significantly, the pre-summons letter is explicitly supposed to be issued to a level of management above the taxpayer employee who received the delinquency notice.
(3) Summons: If a complete response is not provided by the response date in the pre-summons letter, the IRS will follow standard summons procedures.
Preventative Measures
There are four key preventative measures that tax departments should be considering.
- Communication is key. Tax departments must play a proactive role in the IDR process, clearly communicating to the IRS what information is available and how long it might take to collect it. Similarly, calendar constraints, whether driven by the exigencies of the business or by personal matters such as vacations, need to be clearly communicated in advance. Tax teams should be encouraged to ask for sufficient time for privilege review. Once the IDR is in final form, there will be relatively little room for unanticipated delays.
- Be prepared to elevate early. In the event tax departments are unable to negotiate an IDR that they feel has a reasonable scope and/or response date, they should be prepared to go up the chain at the IRS. While many companies resist “rocking the boat” at this early stage in an IRS controversy, the IRS tells us the process cannot work without tax departments keeping the IRS agents accountable and informing management of problems. Moreover, earlier dialogue and intervention can prevent more difficult conversations down the road after the enforcement procedures are triggered.
- Relationships are crucial. Tax leaders need to be encouraged to form positive relationships with the IRS. Never has a tax department’s relationship with its IRS team been more important. Positive relationships are likely to lead to greater leeway in negotiating content and response dates of IDRs, while negative relationships are likely to lead to distrust, more onerous requests, and tighter deadlines. IRS training materials indicate the taxpayer’s “history” is relevant to setting deadlines for IDRs so a history of reasonableness and timeliness by the tax department is likely to be helpful. Moreover, although the agents have limited discretion to grant extensions, they do appear to have significant discretion in deciding when to issue an IDR, as well as when to deem a response complete.
- Keep management informed. In the event things don’t go smoothly, tax departments need to know how critical it is to keep financial executives informed to avoid unpleasant surprises. If financial executives are kept fully in the loop, they should understand that everything possible has been done to prevent a pre-summons letter being issued in the event of an issue arising. Importantly, they will be able to communicate this to counsel in advance of receiving a summons – not afterwards.
Staying on the Front Foot
It should be emphasized that the enforcement procedures described above only apply to IDRs that comply with specific requirements set forth in the directive, chief among them the three requirements outlined in the June directive. It remains to be seen whether the IRS’s prediction that IDRs that meet these requirements will reduce the need for enforcement comes to fruition.
Although summonses may be somewhat more limited in terms of what can be requested, they can also be more onerous to respond to than a typical IDR. Even if more summonses do ensue, the decision whether to seek enforcement of a summons lies with the Department of Justice, which may take a more objective and pragmatic approach to summons enforcement. At the same time, IRS counsel will be involved earlier in the IDR process, with a view toward what might be included in a summons.
All of this means financial executives and tax departments need encouragement to proactively manage the IDR process from the outset, before IDRs are issued. In some cases, a consideration might be to reallocate resources or priorities to ensure timely compliance with IRS information requests. In others, it may mean having the tax department review document retention policies and organizing audit-ready files for major transactions.
In any event, the process of responding to IRS information requests is becoming increasingly complex and merits renewed focus from tax departments as well as financial executives outside of the tax function. Companies should be putting in place preventive measures now, not waiting until the first unexpected pre-summons letter is delivered.
Liz Askey is Principal, Tax Controversy and Regulatory Services, at PwC
[1] The revised directive clarifies that the requirement than an IDR be focused on a single issue does not apply to IDRs typically issued at the beginning of an audit that request basic books and records and general information about a taxpayer’s business.