Caplin & Drysdale's Diara M. Holmes and Marcus S. Owens were recently joined by Paul Streckfus, Editor of the EO Tax Journal, for a lively interview on matters relevant to the EO community. The interview covered a variety of topics, including automatic revocations, the proposed equivalency determination regulations, IRS enforcement, and the EO Division's move to new quarters. Below are select excerpts from the interview. Please go to www.eotaxjournal.com for more information, and click the above link for a transcript of the complete interview.
EO Audit Function
Streckfus: I wanted to ask the two of you since you're ABA subcommittee chairs of Audits and Appeals about the EO Examination function under Nan Downing. I think Nan is a wonderful person but I've been disappointed because it seems like she has disappeared. I blame that partly on her being in Dallas -- out of sight, out of mind -- and maybe a lack of IRS travel money, although it doesn't seem to stop the Washington folks.
What is your sense of the effectiveness of the Examination function?
Owens: There are a number of factors at play here, I think. One is that if you look at the IRS Workplan for the last few years, there has been a significant component of programs that have been imposed on the function from outside. By that, I mean not outside the agency but, for example, there has been an employment tax study which assigned 1500 cases, 1500 organizations, to EO to be examined, 500 a year.
Normally the IRS, if you look at their statistics, will assert that there is something like 12,000 audits but if you look at the footnotes to the statistics in the IRS Data Book, you will see that it's not organizations being counted, it's returns. So, for example, if a charity is under audit and it had a Form 990 and a Form 990-T and a couple of employment tax returns, you could easily be up to maybe four or five or half a dozen returns just in one year with one organization.
Years ago, when I was at the IRS, I asked my staff the question of how many organizations were reviewed in a given year and that actually required a special search on the management information system. Somebody, I think it was Ron Williams, had to go in and query the system for returns closed after examination by EIN and every time he found the same EIN, he backed it out. So he basically whittled it down by EIN and it looked like, at that time, if I recall correctly, the IRS was reviewing something like 2500 organizations a year and my guess is it's still probably about the same.
So when you look at things like the employment tax audit project, which had 500 organizations, that could have been a quarter of the audits for each year for three years in a row. The number of audits of tax exempts could be down, but it was likely due to circumstances beyond Nan's control, and may be a temporary phase. It will be interesting to see what the FY 2013 workplan looks like.
Streckfus: And then of course you had the university audits that took up a lot of time.
Owens: Right, those take time because they're complex by definition and they can afford to hire lawyers to argue points. So they're not going to go quickly.
Holmes: When you combine the low audit rate with the lack of guidance on some important issues, it's challenging to plan, especially for risk-averse organizations. All we can do is advise reasonable, good faith compliance in the absence of guidance, and documentation of the steps they've taken to demonstrate that good faith compliance. When our clients do get audited, we do our best to prepare them to explain the measures they've taken to comply and, where applicable, the steps they've taken to self-correct when they discover issues on their own.
Owens: I think there's another factor as well and that is for reasons, I have no idea what the internal reasons are, but it seems as if the TE/GE function hasn't been able to find a way to communicate enforcement information. Back in the seventies and eighties and nineties, you had the Workplan. You also had the CPE textbooks and if you look at the language used in the CPE textbooks, it really was a training document designed to tell revenue agents about the issues they were going to be auditing in the coming year.
The idea was the topics were selected to mesh with the topics in the Workplan. And so you had this megaphone coming from the Workplan of IRS concerns. Coupled with that, the IRS also would release memoranda to the field and you can still find a few old ones on the website. But there used to be directives to the field about discrete audit projects. The IRS would issue audit guidelines on a regular basis, some of which were even proposed for comment. We're not seeing that sort of communication device. We're not seeing much in the way of explicit numbers and data that, even though the numbers might not be high, they reflect the fact that the IRS is looking at certain kinds of cases or certain issues.
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Holmes: One really positive development in the audit function is the creation of the Financial Investigation Unit. There are only two teams right now, but I got the sense from Peter Lorenzetti's remarks at the ABA that they may expand in this area. The Service has invested in training these multi-disciplinary, specialized teams to handle the complex cases, whether it's in the international anti-terrorist financing context or in the 170 deduction or alleged sham transaction context, where the audit requires looking at 1040s as well as 990s. We have certainly had good experiences engaging with FIU teams. When I say good, I mean constructive.
Streckfus: They should be yelling that from the rooftops that these teams are out there. To me, fraud in the sector is one of the biggest concerns and the IRS should be shouting we're after it, we're determined to get the bad guys, that we're going after people who walk out with wheelbarrows of cash out as they leave in the evening.