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Joint Audit Planning Process Circular 230 and Conflicts of Interest Post-Craft Federal Tax Liens
Editor:
Editors note: Messrs. Ely and Dougherty are former chairs of the AICPA Tax Divisions Tax Practice and Procedures Committee. Mr. Van Deveer is the current Committee chair. Mr. Davis is a member of the AICPA Tax Divisions Tax Practice Responsibilities Committee.
Individuals from the IRSs Large and Mid-Size Business Division and members of the Tax Executives Institute (TEI) recently teamed up to create a new joint audit planning process. (Although TEI members and staff participated in the project, this is not an official TEI position.) This process combines many of the best practices occurring in audits today. The goals are to provide a consistent approach to audit planning and an issue-focused plan to encourage efficiency and accountability. The process has six parts: (1) preliminary meetings and discussions; (2) involvement of IRS counsel, specialists and technical advisors; (3) audit scope; (4) audit timeline/monitoring progress; (5) information document requests (IDRs); and (6) issue resolution/Notices of Proposed Adjustment (NOPAs). Each part is detailed below.
Preliminary Meetings and Discussions As part of the new process, the examination team will have several preliminary meetings with the taxpayer to learn about the latters business, begin identifying areas of potential risk and establish audit timelines. In the timeline discussion, the taxpayer should address any concerns as to times during the year when it will not be able to dedicate its resources to the examination (e.g., filing season). This will prove to be crucial once the taxpayer and the IRS agree on response times for IDRs and NOPAs.
Involvement of IRS Counsel/ Specialists/Technical Advisers Specialists will be involved earlier in the process; they will be part of audit planning and will be able to offer input as to the audits scope and depth. At the initial meetings, the examination team will alert the taxpayer as to the specialists who will be involved in the audit and their roles and responsibilities. Specialists will meet with the taxpayer before issuing IDRs to ensure that they are clear and the information being requested is appropriate. In some cases, IRS Counsel may need to assist in risk analysis or provide technical advice.
Audit Scope In determining the examinations scope, the audit team will perform a risk analysis to prioritize the issues to be examined; it will establish materiality thresholds to further limit scope. The team and specialist managers, the audit team and the taxpayer will all be involved in determining the examinations scope and depth. The risk analysis should be a continuous process revised based on the examinations findings. As part of the joint audit planning process, the IRS encourages the use of the Limited Issue Focused Examination process (a streamlined, focused examination that uses a risk-based approach to limit an examinations scope). Once the audit scope is established, it will be documented along with other pertinent agreements in the audit plan. The draft audit plan will be shared with the taxpayer for input prior to finalizing. If possible, the IRS should provide the taxpayer the final audit plan for signature on the date of the opening conference. If not available at the opening conference, the audit plan will be provided before any substantial testing. If new issues are added to the scope after the audit plan, the IRS will discuss them with the taxpayer before any extensive audit work is performed. In addition to limiting the audits scope, the joint audit planning process also addresses the audits depth. The examination team will use statistical sampling or alternative methods to limit testing on particular issues, reducing the burden on both the taxpayer and the IRS.
Audit Timeline/Monitoring Progress The audit team and the taxpayer will set timelines throughout the examination (e.g., the completion date and the last date for issuing IDRs, filing claims and issuing NOPAs). The audit team and the IRS should sign agreements for these commitments and include them as part of the audit plans pertinent agreements section. The new process also encourages managements involvement and elevation of issues to the next level (e.g., territory manager) if issues cannot be resolved between the taxpayer and the audit team or team manager. Communication is the key to monitoring the examination.
IDRs IDRs are a main component of an IRS audit; thus, it is beneficial to coordinate agreements with the IRS early in the process. One IRS employee should issue all IDRs to one taxpayer contact; this will allow the IRS and the taxpayer to track IDRs and prevent the taxpayer from being issued numerous requests with similar response deadlines. All IDRs will be discussed before issuance, allowing the taxpayer to understand the IRSs intent as to the request and notify it if other information would be more appropriate. To encourage efficiency, the IRS and the taxpayer should enter into agreements outlining the taxpayers response time to IDRs, as well as the IRSs response to the taxpayers information.
Issue Resolution/NOPAs The joint audit planning process encourages the examination team to discuss all issues before issuing a NOPA. The IRS should issue NOPAs throughout the examination as testing is completed. Timeframes will be established for the issuance and response to NOPAs. Because the examination team should be discussing the issues all along, the IRS does not predict that taxpayers will need a long response time to reply. The program also encourages the use of alternative dispute resolution techniques (e.g., pre-filing agreements, fast-track settlement and mediation) to resolve issues at the earliest stage possible. The IRS has recently focused on pre-filing initiatives; however, in the future, there will probably be an increased focus on resolution tools that resolve issues for multiple taxpayers and extend beyond one year.
Conclusion The joint audit planning process is a culmination of the best practices occurring in audits today. It encourages greater taxpayer involvement and teamwork to achieve earlier issue resolution and greater consistency in all audits. This process should benefit both sides, by reducing audit time and costs. From James Dougherty, Director, and Rona Hummel, Manager, Tax Controversy, Deloitte & Touche LLP, Washington DC
Circular 230 and Conflicts of Interest Treasury issued Circular 230 final regulations in July 2002, governing practice before the IRS. Treasury Circular 230, Regulations Governing the Practice of Attorneys, Certified Public Accountants, Enrolled Agents and Appraisers Before the Internal Revenue Service, imposes duties and restrictions on practitioners, including in Section 10.29 a ban on representing conflicting interests before the IRS.
Overview Section 10.29(a) bars practitioners from representing a client before the IRS if this involves an actual (not merely potential) conflict of interest. A conflict of interest exists if: (1) The representation of one client will be directly adverse to another client; or (2) There is a significant risk that the representation of one or more clients will be materially limited by the practitioners responsibilities to another client, a former client or a third person or by a personal interest of the practitioner. Under Section 10.29(b), such representation can nevertheless occur if (1) it is not prohibited by law, (2) the practitioner reasonably believes that he or she can diligently and competently represent each affected client and (3) each affected client gives informed written consent. Under Section 10.29(c), a practitioner must retain copies of the clients informed consent for a minimum of 36 months from the date the representation is concluded, and furnish it to the IRS on request. There have been no authoritative pronouncements on this issue since the final regulations were published.
Practice Before the IRS IRS Pub. 947, Practice Before the IRS and Power of Attorney, defines practice before the IRS as all matters relating to any of the following: communicating with the IRS for a taxpayer regarding the taxpayers rights, privileges or liabilities under IRS-administered laws and regulations; representing a taxpayer at conferences, hearings or meetings with the IRS; and preparing and filing necessary IRS documents for a taxpayer. Because this definition is broad, it may, for example, include a variety of engagements, such as estate planning, resolving marital disputes and representing passthrough entities. Just preparing a tax return, furnishing information at the IRSs request or appearing as a witness for the taxpayer, is not practice before the IRS. These acts can be performed by anyone to the extent provided by the regulations governing practice before the IRS.
Conflicts Section 10.29(a) prohibits a practitioner from representing a client before the IRS if the representation involves a conflict of interest, except with the express consent of all directly interested parties after full disclosure. In discussions with the AICPA, IRS representatives have stated that practitioners need not maintain a central file for all conflict-of-interest waivers; rather, these records may be retained with the engagement file. They also indicated that Section 10.29 is not intended to be an audit trap; they will not conduct audits for the sole purpose of testing compliance. Although consent for potential conflicts was removed from the final regulations, practitioners should still monitor potential conflicts to avoid being caught unprepared during a representation engagement. This may be a more significant issue (1) for passthrough entities, in which the conflicts may not be obvious or (2) between a practitioner and client. For example, a conflict could occur between a practitioner and a client on advice given as to disclosure requirements to avoid preparer and taxpayer penalties.
Consent Section 10.29 does not address the form and substance of consent. The only requirements are that consent be obtained in writing and retained for at least 36 months from the date representation ends. In the absence of IRS guidance, tax advisers are left to seek guidance from other professional standards. However, consent should at least adequately describe the nature of the conflict and the parties the practitioner represents.
Recommendations The practitioners staff may need additional training to identify conflicts of interest before being engaged on a project. Firms with multiple service lines or offices may need to implement additional procedures and systems to determine whether conflicts may exist. Relationships with pass-through entities should be evaluated for potential conflicts. The practitioner should also evaluate the potential litigation risk related to performing services for parties with actual conflicts, and review the conflict with his or her insurance carrier.
Conclusion A few issues remain unresolvedshould Section 10.29 be expanded to more clearly define conflict of interest and informed consent? For now, practitioners must rely on professional judgment and other similar standards for professional conduct. The preamble to the Circular 230 final regulations stated that they were modified from the proposed regulations to conform more closely to the approach of the recently revised Model Rule 1.7 of the American Bar Association (ABAs) Rules of Professional Conduct. The AICPA Code of Professional Conduct also addresses conflicts of interest. CPAs should be careful about reliance on Rule 102-2, because ABA Model Rule 1.7 is more comprehensive than AICPA Rule 102-2. Practitioners should also evaluate any state, local and foreign independence rules that may apply. Legal counsel should be consulted to resolve differences. For an analysis of all the Circular 230 final regulations, see Gardner, Eide and Willey, Circular 230 Final Regs. (Parts I and II), 34 The Tax Adviser 26 (January 2003) and 34 The Tax Adviser 96 (February 2003). From Conrad Davis, CPA, Director of Tax and Accounting Services, Ueltzen & Company, LLP, Sacramento, CA
IRS Guidance on Federal Tax Liens on Entireties Property after Craft The Supreme Courts decision in Sandra L. Craft, 535 US 274 (2002), held that a Federal tax lien arising under Sec. 6321 on all property and rights to property of a delinquent taxpayer attaches to the taxpayers rights in property held as a tenancy by the entirety (TE), even though Michigan law insulates such property from the claims of creditors of only one spouse. The Court stated that while state law determines what rights a taxpayer has in property, Federal law determines whether the state-defined rights are property or rights to property for Sec. 6321 purposes. The decision has consequences in approximately 26 jurisdictions that recognize TE as a form of property ownership. Notice 2003-60 explains how the IRS will apply Craft.
Definition TE is a form of property ownership available only to a husband and wife as a marital unit; a key feature is the right of survivorship (i.e., the surviving spouse becomes the propertys fee-simple owner on the other spouses death). A TE also terminates on the propertys transfer or the spouses divorce. While TE property is subject to the claims of the spouses joint creditors, jurisdictions that recognize TE follow different rules for claims against only one of the spouses. In the majority of these jurisdictions, TE property is completely free of the reach of one spouses creditors. Other jurisdictions permit one spouses creditors to attach the other spouses interest in TE property, subject to the nonliable spouses rights.
Scope Notice 2003-60 addresses collection issues raised by the Courts ruling, including enforcing collection administratively and judicially, valuing the IRSs secured claim in bankruptcy, applications for discharge and subordination and evaluating offers in compromise (OICs) and proposed installment agreements. The notice states that the IRS will rely on a number of general principles in addressing issues raised by Craft. First, the Courts decision confirms that, for Sec. 6321 purposes, a taxpayers property and rights to property have always included any rights that he or she may have in TE property under state law. Craft does not change any limit on the IRSs ability to rescind an accepted OIC or terminate an accepted installment agreement. Further, the Courts decision does not represent new law and does not affect other law applicable to Federal tax liens and tax collection. Second, under certain circumstances, as a matter of administrative policy, the IRS will not apply Craft to certain interests created before Craft, to the detriment of third parties who may have reasonably relied on the belief that state law prevents attachment of a Federal lien. Third, the administrative sale of TE property subject to a Federal tax lien presents practical problems that limit the usefulness of the IRSs seizure and sale procedures. However, levying on cash and cash equivalents held by TE property is considerably less problematic and will be used in appropriate cases. Fourth, because of the potential adverse consequences to a nonliable spouse, the use of lien foreclosure for TE property subject to a Federal tax lien will be determined on a case-by-case basis. Fifth, generally, the value of the taxpayers interest in TE property will be deemed to be one-half. Finally, when TE property subject to a Federal tax lien is transferred without any provision for the liens discharge, the lien thereafter encumbers a one-half interest in the property held by the transferee. The remainder of the notice contains questions and answers as to how the IRS will apply Craft to TE property acquired before and after the decision date. From Mark A. Van Deveer, CPA, Thatcher & Benson, P.C., Virginia Beach, VA |
