OIC Program Changes • New IRS Audit Initiative

Editor:
Mark H. Ely, J.D., CPA
Partner
Washington National Tax
KPMG LLP
Washington, DC

Editor’s note: Mr. Ely is the former chair of the AICPA Tax Division’s IRS Practice and Procedures Committee. Ms. Michnay and Mr. Dougherty are members of that Committee.

IRS and AICPA Collaborate on OIC Program

Since implementation of 1992 IRS Policy Statement P-5-100, describing the Service’s commitment to the Offer in Compromise (OIC) program, the AICPA has been a strong supporter. When the program was expanded by the Internal Revenue Service Restructuring and Reform Act of 1998, the AICPA again showed support. To obtain feedback on the program, it distributed a survey in June 2003 to state CPA societies, and received 80 responses. The results were summarized in a letter to Dale Hart, Commissioner, IRS Small Business/Self-Employed Division; see AICPA Letter to Commissioner Hart (10/14/03), available at www.cpa2biz.com/ResourceCenters/Tax/Tax+Practice/AICPA+Urges+
Changes+to+the+Offer+in+Compromise+Program.htm. The letter discussed several concerns, made suggestions and contained a plea for the IRS “to make the Offer program a legitimate opportunity to bring a segment of taxpayers back into compliance.” It also noted, “a well functioning Offer in Compromise program has the potential of increasing the actual amount of tax collections while at the same time reinforcing taxpayers’ obligations to maintain future compliance.”

This item discusses some of the IRS’s OIC reforms.

Form 656

November 2003 saw the beginning of the $150 user fee for filing Form 656, Offer in Compromise. However, at the same time, the IRS reached out to stakeholders, by requesting suggestions for its revision of Form 656. The AICPA Tax Division’s IRS Practice and Procedures Committee submitted ideas, responded to a draft of Form 656 in January 2004 and conducted a telephone conference with IRS Director of OIC, Michael McDermitt, in February 2004. In July 2004, it revised Form 656 in a number of ways; some of the changes are as follows (items 12, 13 and 14 below are new):

• Item 8: By submitting this offer, I/we have read, understand and agree to the following conditions:

1. If the IRS rejects or returns the offer, the application fee will be kept by the IRS (8(c));

2. The statute of limitations for collection will be suspended during the period an offer is considered pending by the IRS (“pending” is defined in 8(m));

3. The IRS may file a Notice of Federal Tax Lien during the offer investigation (8(o)); and

4. The IRS is authorized to amend Item 5, “tax type and periods,” to include any assessed liabilities failed to be listed (8(q)).

• Item 11: Although a signature(s) is still required, Form 656 now reads “Mandatory Signature(s),” instead of the note at the bottom of each page of the form stating, “Signature(s) of taxpayer required on last page of Form 656.”

• Item 12: If an OIC was prepared by someone other than the taxpayer, that person’s name and address must be supplied.

• Item 13: The information requested includes the preparer’s signature, date, centralized authorization file number or preparer tax identification number, firm name, address, employer identification number and phone number.

• Item 14: The taxpayer may list another person and a phone number that the IRS may call to discuss the offer.

Form 656-A (New)

The $150 user fee must be attached to Form 656; if no fee is required, Form 656-A, Income Certification of Offer in Compromise, must be attached. The application fee does not apply to individuals with limited income. The income exception levels are recapped on the application fee worksheet, which must also be submitted with Form 656 to verify limited income. They do not apply to other entities, such as corporations or partnerships.

Form 656 Instruction Packet

The Form 656 instruction booklet contains information needed to prepare a complete and accurate OIC. Its table of contents is set up as a series of eight steps, including an OIC summary checklist; see the exhibit below. The booklet has had several major changes. For example, to calculate an offer, the personal assets and business assets exemptions have increased by 7.3%. The packet also includes information on how an OIC affects (among other things):

• The taxpayer’s refund;

• Installment agreements and levies;

• Public inspection files;

• Taxpayer Advocate Services; and

• Low income taxpayer clinics.

IRM

The Internal Revenue Manual (IRM), Part 5, Collection Process, Chapter 8, Offer in Compromise, also addresses OIC issues. For example, the overview defines a protracted installment agreement (5.8.1.1.3). The timeliness of OIC investigations is to provide structure for the overall process; they are not guidelines for absolute measures of employee performance. Unwarranted inactivity gaps in an offer investigation should be avoided (5.8.1.1.6). Tax cases controlled by the Department of Justice will not be considered (5.8.1.2.1). The expedited services of the Taxpayer Advocate Service are defined. A five-step process is listed for collection managers to follow when they receive Form 12412, Operations Assistance Request, requesting expedited handling of an OIC (5.8.1.6).

Outlook

The IRS reached out to the AICPA for input on the new OIC information packet and forms. The IRM gives additional insight into the process. Tax practitioners and taxpayers should proceed through all the steps of the Form 656 instruction packet to complete an accurate and, hopefully, a successful offer. The program can bring taxpayers back into compliance and increase tax collections. Practitioners and taxpayers should continue to alert the AICPA’s IRS Practice and Procedures Committee of concerns and successes.

From Ruth Ann Michnay, CPA, MBT, EA, Ruth Ann Michnay, P.A., St. Paul, MN

New IRS Initiative—Compliance Assurance Process (Real-Time Audit)

Over the past year, the IRS’s Large and Mid-Size Business Division (LMSB) has been working on improving the traditional audit process by reducing examination cycle time—the time from the return filing to the close of the examination. The average cycle time for LMSB taxpayers is 60 months. This long period potentially presents the IRS with significant problems, including a delay in identifying emerging issues.

In mid-2004, the LMSB unveiled a new approach to compliance audits, which, ideally, will shorten cycle time. Known as the compliance assurance process (CAP), a pilot is scheduled for 2005 returns. It will encompass approximately 20–25 corporate volunteers and center initially on publicly traded companies.

While many details still need to be worked out, CAP’s objective is to assist taxpayers in settling issues before filing a return, by conducting “real time” audits. That will essentially eliminate the need for post-filing examinations. These audits are expected to (1) address issues throughout the year, (2) potentially reduce prolonged litigation and (3) increase audit currency.

How CAP Works

The IRS will assign an account coordinator to the taxpayer, to be the single point of contact for all tax matters. Throughout the tax year, the coordinator will work with the taxpayer to understand the taxpayer’s business and identify and resolve compliance issues arising from transactions that materially affect income tax liability. Once the taxpayer determines how it will report a transaction for tax purposes, the IRS will review the proposed treatment and determine whether it is appropriate. All audit issues will require completion of Form 5701, Notice of Proposed Adjustments. If the IRS and the taxpayer reach an agreement, both will execute Form 906, Closing Agreement. If they cannot agree, Fast Track Settlement will be available to the taxpayer; see IR 2003-44.

Under CAP, the taxpayer’s and the Service’s roles and responsibilities are documented using a memorandum of understanding (MOU). The MOU discusses why open and honest communication is important to the program’s success. The two parties will jointly plan the scope of the CAP review and consider materiality thresholds, to determine the issues to be reviewed, including, but not limited to, permanent, short-term and long-term adjustments. However, the IRS will ultimately decide which items to audit.

Notwithstanding the materiality thresholds and issue identification procedures, it will also conduct a compliance review of tax shelters, listed transactions, fraudulent items and any other issues identified by its directives. Further, the MOU discusses taxpayer disclosures, the Service’s method of requesting information and alternative dispute resolution options for unagreed issues.

A CAP audit will be concluded one of three ways:

1. “Acceptance Letter,” issued prior to filing a return. This letter indicates that the IRS will accept the return as filed, the parties have executed Form 906 for all agreed issues and the parties expect to have limited future contact regarding the return.

2. “Qualified Acceptance Letter,” issued prior to filing the return. This letter indicates that the Service will conduct a limited post-filing examination of unresolved CAP issues, and that all agreed issues have an executed Form 906.

3. An “Adverse Acceptance Letter,” issued at any time. This letter results in the case being withdrawn from CAP and transferred to a regular audit program. This can happen for several reasons, including (1) not adhering to Information Document Request (IDR) response times, not responding to IDRs or providing incomplete IDR responses; (2) not engaging in meaningful or good-faith issue resolution discussions; (3) failing to thoroughly disclose prior, concurrent and on-going transactions; (4) failing to disclose a tax shelter or listed transaction; and (5) not adhering to any other MOU commitment(s).

The IRS does not expect CAP to compromise current audit standards. Taxpayers will not forfeit any rights under the program and can appeal unagreed issues.

Conclusion

The IRS does not plan to extend the volunteer offer to additional taxpayers for the 2005 pilot year. If the CAP pilot is successful, the program has the potential to change the audit process dramatically, by reducing taxpayers’ and the Service’s time and cost, while delivering tax certainty earlier.

From James A. Dougherty, Director, and Sharlene M. Sylvia, Manager, Tax Controversy Services, Deloitte Tax LLP, Washington DC