In its new form, the IRS will be more responsive to business, promises senior official Larry Langdon. Could there be a reason to cheer the tax man?


When the sweeping Internal Revenue Service Restructuring and Reform Act was signed into law two years ago, many finance executives may have dismissed it as just another bureaucratic reshuffling. But Larry R. Langdon, commissioner of the IRS’s new Large and Mid- Size Business Division (LMSB), believes the legislation may end up dealing Corporate America a much stronger hand in tax matters.

Specifically, the act threw out the agency’s geographically based structure, replacing it with five industry-focused units under the LMSB. In addition, auditors have been instructed to learn more about the operations they cover. And they even have a vision statement to abide by–one that promises to be “responsive to the needs of our customers in a global environment.”

Customers? Clearly, this is not your father’s IRS. And to aid in the transformation, Langdon is stacking the 138-year-old Treasury Department agency with managers who, like Langdon–the recently retired vice president of tax, licensing, and customs for Hewlett- Packard Co.–have private-sector backgrounds and familiarity with the intricacies of corporate tax decisions. Once on board, these managers will help implement the strategic initiatives that Langdon and IRS commissioner Charles Rossotti have developed for the LMSB: to adjust to the global economy, to install issue-based management, to improve employee skills and satisfaction, and, of course, to attack abusive corporate tax shelters.

The tax-shelter enforcement has obviously captured the most press attention. But Langdon believes IRS structural changes will have a resounding impact even after those shelters are rooted out. After all, the 7,300 employees at the LMSB deal with 210,000 corporations and partnerships with assets over $5 million– including 9,300 companies with at least $250 million in assets. And if those “customers” can be convinced to cooperate more fully with the LMSB, says Langdon–in part through a prefiling resolution process now being tested in a pilot program–the time devoted to audits will decrease. Further, companies will realize significant tax savings.

Langdon, who has been selling the changes internally through a series of “town meetings,” recently sat down with CFO senior editor Roy Harris to discuss the overhaul, scheduled to be fully in place this October. Does he really expect taxpayers to buy the customer-service pledge and come willingly to the IRS for filing guidance? Yes indeed, he answers, adding optimistically that “resolving taxpayer burdens administratively eliminates the burden on tax auditors.” A new outlook, indeed, from the federal tax man.

When finance executives discuss the IRS, they frequently complain about long delays during audits, and how government tax auditors simply don’t understand their businesses. Are those criticisms fair?

Audits do take too long. Issues are resolved too slowly. And auditors’ understanding of the true nature of many businesses is limited.

How will your restructuring address such concerns?

The structural reorganization will move all our people into one of five industry groups. The reason for this is to train them more acutely in industry practices, industry accounting, and emerging trends.

To deal with the delays, we are changing the focus of the audits from an historical, time- driven process to an issue-driven process. In the past, we’d spend, say, three years doing an audit. Then, we’d add up the hours, and add 10 percent more in the next audit cycle. In an issue-driven process, we’ll review the prior audit plan, and look at what time is required in the audit to resolve the key issues. Then, we’ll sit down with the taxpayer, with an audit plan that focuses on issues, rather than time spent.

What will it take to implement such a change?

We need to get our people trained to focus on audits under our new techniques, and that will take some time.

But we also need taxpayers to become proactive with the IRS if they want audits to speed up. I’ve just completed 17 town meetings at which we outlined the new practices for the IRS audit teams. Their push back to us was, “Yes, but the taxpayers often aren’t interested in speeding up the audit cycles; they would like to hold things up by not responding to documentation requests and filing claims late in the audit process, to force a last-minute negotiation of the issues.” That’s not fair to us. The taxpayer community must play fair with us if they want us to play fair. But, in effect, both sides can improve the audit process by having transparency. Companies can do it by being fair about the issues, and the IRS can do it by being open about our processes.

Obviously, that hasn’t always been the case. There have been some cases where things have gone very smoothly. On the other hand, there have been cases where it has been a fight.

What can companies do to make the process go more quickly?

They need to work with the audit team at the beginning of the audit to develop an audit plan. When requests for information are developed, the companies need to point out: 1) information that may not be available, and 2) any request that is inappropriate because the information won’t deal with the issue at hand. Corporate tax people need to be candid and straightforward about all that information. IRS people need to be clear about what the issues are, and how to resolve them. It really requires a good working partnership.

One of your priorities is to resolve corporate taxpayer issues through pre-filing conferences. What do you hope to accomplish with these conferences?

The prefiling conference plan resembles the advance ruling process that has been in place for years for many transactions resolved by our national office through private rulings. These new initiatives, though, really go beyond the private letter rulings, which typically take six months to get in place. We’re hoping to shorten that period–maybe by half. These prefiling agreements will be done by IRS people in the field, and signed off by LMSB industry directors. So, it’s consistent with our policy of moving decision-making into the field, closer to the taxpayer, and speeding up the decision process.

Companies are fearful of providing too much information, and drawing attention to questionable practices. What can be done to encourage them to come to the IRS in advance? If there is a feeling of distrust between corporate tax departments and the IRS–caused by one side or, most likely, by both–our prefiling and other initiatives won’t work. However, I think most CFOs want certainty in how issues are resolved between them and the IRS. If you’re in the gray area, or you don’t know what’s going to happen in an audit, you’re basically required, under the accounting rules, to fully provide for that matter in your financials. That means you really can’t drive down your effective tax rate. CFOs want the lowest possible tax rate they can report. And this can be achieved by developing the right kind of relationship with the IRS.

This presents a marketing issue for you, doesn’t it?

Yes. It’s a marketing issue on both sides. In the meetings I’ve had with the people in Corporate America, they’re as excited about these new techniques as the management team in LMSB. The IRS people are split. In fact, at my last town meeting a majority said, “Yeah, this makes sense, we should go that way.” Of the remaining IRS auditors, maybe half were neutral and half said, “You don’t understand my taxpayers. They don’t trust us, we don’t trust them. These things won’t work.”

With this divided group of field personnel in mind, what can be done to entice agents to wrap up their assignments efficiently and respectfully?

We need to change the measures by which we evaluate not only our efficiency in audits, but also how we evaluate our people. We need the right drivers to make sure that our people are spending enough time on an audit. But when the issues are resolved, quite frankly, they need to move on to the next taxpayer.

For what kinds of things might the auditors be rewarded?

If you look at the prior audit cycles and you find that one particular issue, say, intercompany pricing, or the R&D tax credit keeps recurring, and the agent or the team is then able to resolve that issue with a prefiling initiative, that team should get major credit for eliminating a contentious issue that’s been a problem for both sides.

The high-profile campaign against abusive tax shelters has aggravated a lot of corporate executives.

I can understand that.

How prevalent do you believe these so- called abusive tax shelters really are?

I’m not all-seeing and all-knowing, but I do know that the amount of potential assessments involving taxpayers doing these things on a real-time basis is to the tune of billions of dollars. Plus, based on my experience at Hewlett-Packard, there are just too many firms out there marketing these devices. So, based on anecdotal and real IRS data, I’d say it is a real problem. I can’t peg a number, though; it’s beyond my bandwidth.

Executives fear that the widespread discussion of abuses might imply that the problem is bigger than it really is.

At all levels of the IRS and Treasury, we’ve tried to be very cautious. We’ve created our Office of Tax Shelter Analysis, which will improve coordination in the field, identify emerging issues, improve communication within the IRS, and improve technical training for examiners on tax-shelter issues. We’ve also instructed the field to go after only the abusive tax-shelter devices we’ve published. In addition, we’ve instructed the field that they should resolve matters involving legitimate corporate tax planning, and even gray-area cases, as if they were part of normal operating procedure and not abusive corporate tax shelters.

Our position is: If you see something that’s either a taxpayer claim or position, you should treat it as tax planning and deal with it as a routine audit matter. Under no circumstance should you characterize as abusive a provision of the Internal Revenue Code that Congress enacted, such as R&D tax credits or accrued vacation pay. As tax administrators, we have an obligation to administer the law as we find it.

In dispute resolution, some executives note a lack of consistency in penalties–waivers being granted on an arbitrary basis, and changing definitions of “reasonable cause,” for example. What is the correct role of penalties?

We need to be very judicious and circumspect in the use of penalties. We should not presume that every disagreement is a penalty situation- -either penalties in interest, or certainly the more harsh criminal penalties. I would distinguish, though, a case in which there has been material misrepresentation of the facts without reasonable cause. Legitimate differences of opinion, especially if there’s disclosure, should never lead to a penalty. If the Service is going to be transparent about the issues and the process, there’s an obligation that Corporate America treat tax auditors the same way it treats the SEC compliance people. I think that’s the appropriate standard. And that’s where I think some of our difficulties arise.

If you were to compare the skill levels of IRS auditors to those at the Securities and Exchange Commission, would you say they’re on a par?

That’s a difficult comparison for me to make, since I only know about SEC people indirectly. We do have at the IRS a skilled workforce. Where I think we may be lagging the SEC is in our knowledge of our industry groups. We also lag the SEC’s ability to have electronic data exchanges with its clients. Perhaps the SEC has kept up with the direction American business is going, from a practice standpoint, better than the IRS.

How good is the IRS in dealing with such global complexities as transfer pricing and foreign tax credits?

In general, I think the IRS has excellent expertise in the Code’s current international provisions. But because we deal in prior years, we do not fully understand the issues that are a key part of the emerging industries and the information-age economy. We need to frankly advise our colleagues in Treasury and in the Chief Counsel’s Office [about] those global trends, because I think we may need to revise some of the tax rules to expedite and ensure proper tax compliance.

What areas are ripe for possible new rulemaking?

Intangibles, generally: R&D intangibles, marketing intangibles, and manufacturing intangibles. That’s because, in effect, those intangibles can be transmitted via satellites anywhere in the world, which represents transfer of value.

The problem with the tax code is that it was primarily drafted in an era when most international transactions involved the shipment of goods. If you really analyze the services sector and the intangibles being transferred internationally, those values are substantially more important today. The rules on what must be captured as expenses needs clarification.

I see the prospect of longer audits rather than shorter audits then.

Not necessarily. If we could, in the case of these emerging businesses, give them guidance as they’re putting their business plans together, that would be very helpful. Putting some guiding principals in place could lead to certainty and predictability for the future. And the audits would also be shorter because everybody would be apprised of what’s going on.

When will companies see the IRS restructuring result in improved audits?

Hopefully, many will see a material difference anywhere from six months to three years from now. Obviously, it isn’t going to happen immediately for everybody. But I would hope that in a lot of key cases, we will see some immediate changes in how audits are planned and implemented, and how the relationship can be improved.

Is it becoming more common for people with your business background to take high-level positions with the IRS?

Yes. The Alcoa tax director who just retired, Linda Burke, has been selected as LMSB’s operating counsel. She was the first woman president of the Tax Executives Institute. And we’ve already announced that Carol Dunahoo, who came from PricewaterhouseCoopers, is going to be in charge of international. Soon we will announce probably all five of our senior technical advisers, who are assigned to the industry groups. They’re coming from Corporate America. And by August, we will be able to announce several senior technical adviser positions. We’ll have seven people at a senior level in our division from the private sector. This really is a material change from how the IRS was run in the past.

You have said that you “failed” in retirement at HP. How did you decide to jump to the IRS after leaving private industry?

It was a long process. It took about six months. Commissioner Rossotti was very persistent, and my wife and I talked about it for three months. The most important reason why I accepted this job is that this is the most interesting time in the history of the IRS. It’s the time when some material changes can and will occur, and I want to [help the IRS move] in the right direction. I think some of the principles we’re learning will apply to the rest of the government and apply to tax administration worldwide. If I can be part of that, it’s going to be a heck of a retirement.

The IRS vision statement, adopted in October 1999

We will be a world-class organization, responsive to the needs of our customers in a global environment, while applying innovative approaches to customer service and compliance.

We will apply the tax laws with integrity and fairness through a highly skilled and satisfied workforce, in an environment of inclusion where each employee can make a contribution to the mission of the team.

How the new Large and Mid-Size Business Division groupings stack up.

(Chart omitted)

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