LMSB’s Quality Examination Process – Ensuring its Application is “Fair and Balanced”

By David L. Bernard

TaxBlawg’s Guest Commentator, David L. Bernard, is the recently retired Vice President of Taxes for Kimberly-Clark Corporation, a past president of the Tax Executives Institute, and a periodic contributor to TaxBlawg.

In case you missed it, the IRS recently introduced a new approach to its audit management process, called the Quality Examination Process (“QEP”), and is effective for all LMSB corporate tax audits initiated on or after June 1, 2010. This replaces the Joint Audit Planning Process which was developed in partnership with the Tax Executives Institute in 2003. QEP has many of the same features of the 2003 process, but is much more comprehensive and in that respect is an improvement. However, the Joint Audit Planning Process was good in many respects, it was simply never used consistently throughout LMSB.

Surveys of LMSB taxpayers reflected the inconsistent application of the former process, with some reporting that they had never heard of it and others reporting little or no involvement in the development of the audit plan (a primary requirement of the process). This frustrated the leaders within LMSB because they had continuously stressed the importance of the process in their communications to the field. After obtaining input from several constituencies, LMSB decided it was time to come to market with a new and improved process. The question is whether taxpayers will feel that the results are an improvement over their past experiences.

The Quality Examination procedures can be found in IRM 4.46 – LMSB Guide to Quality Examinations. To emphasize the importance of the new process and highlight the major elements LMSB released a brochure “Achieving Quality Examinations through Effective Planning, Execution and Resolution”, (Publication 4837). Also, apparently to make it easier for agents who wanted a Cliff Notes version of the manual, LMSB published a Reference Guide, summarizing the procedures in IRM 4.46. Through these publications LMSB has clearly made an attempt to promote the new process across the organization and ensure its consistent application, but that was also the case with the Joint Audit Planning Process in 2003.

The referenced materials focus on the importance of effective communication between exam teams and taxpayers to make the entire examination process smooth and efficient, and discuss key actions that should take place in each of three phases of an examination, including planning, execution and resolution. Overall, while the QEP is a fairly exhaustive list of early and on-going actions and communications required to keep the examination on track, it also seems to be pro-LMSB. The writer’s views notwithstanding, taxpayers should read the materials and develop their own opinions of the process and strategies for dealing with it.

All three publications reflect the IRS’ emphasis on taxpayer transparency. For example the Reference Guide, in outlining actions that should occur in the planning stage, indicates that taxpayers should provide the exam team with “key information”, including e.g. “A list of significant transactions for the current examination and any other information that is new and/or different from previous examinations (e.g. acquisitions, dispositions, tax shelters, accounting method changes-Forms 3115, etc.)”.

One has to question how much of this would not be apparent from the tax return or at least the tax return work papers, but such a taxpayer initiated communication certainly provides the IRS an idea of the major areas deserving review without any effort on behalf of the IRS. Together with the currently required tax return disclosures, the M-3, and the possible required disclosure of uncertain tax positions, the IRS clearly desires taxpayers to be as transparent as cellophane clothing.

In contrast it is interesting to note that LMSB’s contributions  at the planning stage, and really throughout the three stages of the audit, are largely process related, not substantive. The materials do require transparency by the LMSB where , within the planning section, they state that a taxpayer should be notified if involvement of Office of Chief Counsel or technical advisors is anticipated, and where the exam team is instructed to endeavor to reach agreement with the taxpayer on the facts before a technical advisor is involved.

Taxpayers would be wise to clarify the intent of the above language in the “kick-off” meeting with the IRS at the beginning of the next audit cycle. Taxpayers should insist on this level of transparency from the IRS throughout the three phases of the audit, not just in the planning stage. Absent such insistence the exam team can circumvent transparency with literal interpretations of the materials. Focus on the highlighted words above. As indicated these requirements are in the planning section, not the execution section. After the planning meetings the exam team appears free to wash their hands of any further transparency. Nowhere in the execution section is the exam team told to advise taxpayers of Office of Chief Counsel involvement. Moreover, the planning section only refers to endeavoring to reach agreement on the facts of an issue where referring to the possible involvement of technical advisors. It does not reference this requirement before Office of Chief Counsel involvement.

Perhaps these are mere drafting oversights, perhaps not. In the end, new LMSB processes are carried out by examining agents. Agents, being agents, will prefer to apply those aspects of the policy that require taxpayer transparency while continuing to “hold their cards close to the vest”. Far too many issues are unagreed because the taxpayer is not asked to review and agree with a statement of relevant facts before the exam team sends an issue on to a technical advisor or counsel. Hence it is incumbent on the taxpayer to insist the audit plan require a level of transparency by examining agents heretofore not experienced by most taxpayers. Only the taxpayer can prevent a one-sided application of the QEP. Be an active participant in the process.

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