January 1999 Issue

Better treatment for the U.S. taxpayer The IRS  Restructuring and Reform  Act of 1998

By Linda Garrett Levy and J. David Mason

In Brief

Responding to Abuses by the IRS

The IRS Restructuring and Reform Act of 1998 is a reaction to the widespread disillusionment with the tax system, as documented during the fall 1997 Senate Finance Committee hearings on abuses by the IRS. The 1998 act contains both IRS reforms and expanded taxpayer rights.

IRS reforms include the following:

* A reorganization into functional, rather than geographic, units.

* Five-year terms for IRS Commissioners.

* A new mission statement to focus on taxpayer services.

* An Oversight Board will be created.

* Enhanced responsibilities for the National Taxpayer Advocate.

* Employee evaluations will stress individual accountability.

Expanded taxpayer rights include:

* Financial status audits will be limited.

* The burden of proof will shift to the IRS in certain situations.

* A confidentiality privilege extended to all practitioners authorized before the IRS for tax advice.

* Expanded innocent spouse relief.

* Interest and penalty provisions made more favorable to taxpayers.

* Easier access to IRS.

* Procedural safeguards for audits and collections.

The authors have a number of suggestions concerning representing clients before the IRS and for the management of the tax practice of CPA firms.

The fall 1997 Senate Finance Committee hearings presenting abuses by the IRS dramatically spotlighted the public's frustrations with the IRS. It was this frustration that led to the passage of the IRS Restructuring and Reform Act of 1998 (the 1998 act). The 1998 act calls for changes in taxpayer rights and IRS operations, with the underlying premise that the IRS must become more service-oriented toward taxpayers.

Although changes created by the 1998 act promise better IRS­taxpayer relations, the reality is that any changes will be implemented to a large extent by current IRS employees. The IRS is a huge agency with over 100,000 employees; a quick attitude overhaul is simply not possible. Determining the best strategies for dealing with the IRS as it implements the mandated changes requires examining how the IRS currently views taxpayers.

The New IRS Perspective: Focus on Taxpayers' Needs

Becoming more service-oriented is not a new idea within the IRS. In remarks made to the New York Chapter of the Tax Executives Institute in 1992, Shirley Peterson, then Commissioner of Internal Revenue, stated that cooperation with taxpayers is central to the IRS' vision for the future. Charles Rossotti, current IRS Commissioner, recently stated that the IRS is taking steps to emphasize the taxpayer's point of view. By prioritizing fair and equitable treatment of the taxpayer, Congress and the IRS hope to reestablish public confidence in the tax system.

IRS Reforms

IRS Reorganization. One of the most basic changes of the 1998 act is the reorganization of the IRS from geographic divisions to operating units serving particular groups of taxpayers with similar needs, consistent with the plan announced by IRS Commissioner Rossotti in January 1998. Congress has provided no guidance on how the structural change will be implemented, and it is unclear what will happen to the current 33 district offices and 10 service centers.

Five-Year Terms for IRS Commissioners. Historically, the IRS Commissioner is appointed by the President and confirmed by the Senate and has served an average term of only three years. To provide needed continuity within the IRS, the IRS Commissioner will now serve a five-year term. Having longer terms should provide more stability, allow needed reforms to be implemented, and provide more accountability within the IRS.

New IRS Mission Statement. The current IRS mission statement emphasizes tax collection, with a focus on enforcement rather than taxpayer service. The 1998 act directs the IRS to restate its mission. Although a new mission statement has not been finalized, the IRS has proposed two alternative revised mission statements and invited public comment by August 21, 1998. However, the old mission statement included pledges to serve taxpayers, so it is not clear that this restatement will serve any substantive purpose other than to improve the IRS's image.

IRS Oversight Board. As part of the attempt to rebuild public confidence in the tax system, the 1998 act creates the IRS Oversight Board to oversee administration and application of internal revenue laws. The board will be composed of nine members serving five-year terms; it will consist of six individuals from the private sector, the Secretary of the Treasury, the IRS Commissioner, and a representative of IRS employees. Unlike purely advisory groups, the IRS oversight board has authority to control actions taken within the IRS.

Enhanced Responsibilities for National Taxpayer Advocate. To assist taxpayers in identifying and resolving problems with the IRS, the existing taxpayer advocate position has been renamed the National Taxpayer Advocate and includes enhanced responsibilities. The most important expansions are as follows:

* A requirement to advertise and publicize the local offices of the taxpayer advocate;

* The independence of local taxpayer advocates from other IRS offices; and

* Increased authority to issue taxpayer assistance orders.

The intent is for each state to have a local taxpayer advocate. If the provisions are carried out as intended, these changes will benefit many taxpayers by providing another avenue to seek help for problems with the IRS.

IRS Employee Accountability. Evaluating IRS employee performance received extensive attention in the new law. Individual accountability is stressed. For example, records of misconduct relating to individual employees must to be used in evaluating individual employee performance. In addition, the IRS must generally terminate employees who commit perjury, falsify documents, retaliate against or harass a taxpayer or IRS employee, or threaten to audit a taxpayer for personal gain or benefit. Although the 1988 Taxpayer Bill of Rights specifically prohibits production goals or quotas and a 1973 IRS directive says that enforcement statistics may not be used to evaluate employees, an IRS review panel revealed in September 1998 that both provisions were violated in both national policy and field-level collections. The 1998 act reiterates that the IRS may not use records of tax enforcement results or production quotas or goals to evaluate employees. Fair and equitable treatment of taxpayers must be one of the standards used to evaluate employee performance.

Miscellaneous IRS Reforms. The 1998 act made over 30 miscellaneous reforms. Of the remaining changes, some serve to remind the public that the IRS is acting not on its own but on behalf of the Federal government. For example, checks may now be made payable to the United States Treasury to emphasize that the IRS is collecting taxes on behalf of the Federal government. Other changes are designed to provide better relations between the IRS and taxpayers. For example, within 180 days of passage of the 1998 act, the IRS Commissioner must submit a plan to Congress for a program to ensure adequate customer service training.

Expanded Taxpayer Rights

The 1998 act contains over 40 provisions concerning taxpayer rights. Some of the highlights are summarized as follows:

Financial Status Audits Limited. One of the most significant safeguards for taxpayers, championed by the AICPA, concerned financial status audits. Financial status audits could be conducted whenever an IRS agent encountered a gross income on a personal tax return for a taxpayer that did not seem consistent with his or her lifestyle. Financial status questions focused on the taxpayer's lifestyle and standard of living, distinct from information on the tax return, with the goal of discovering unreported income. The AICPA argued that in using this technique the IRS was presuming a fraudulent situation without due process and legal representation. As a result of the 1998 act, financial status or economic reality examination techniques are now limited to situations where the IRS already has indications of unreported income.

Burden of Proof. A controversial change introduced by the 1998 act shifts the burden of proof from the taxpayer to the IRS in certain situations. The burden of proof will shift to the IRS in a court proceeding with respect to a factual issue that is relevant to determine a taxpayer's tax liability if the taxpayer presents credible evidence with respect to that issue and satisfies the following two conditions. The taxpayer must--

* comply with the substantiation and record-keeping requirements of the Internal Revenue Code and the regulations, and

* cooperate with reasonable requests by the IRS for information, documents, meetings, interviews, and witnesses.

Corporations, trusts, and partnerships with a net worth exceeding $7 million are not eligible to use this provision. CPAs should be leery of this provision because it potentially gives the IRS permission to be more intrusive into taxpayers' affairs.

Privilege. The 1998 act extends the existing attorney­client privilege of confidentiality to all practitioners authorized to practice before the IRS when giving tax advice. The privilege may be asserted in any noncriminal tax proceeding before the IRS or Federal courts. However, the privilege does not extend to written communications between a tax practitioner and a corporation in connection with the promotion of a tax shelter. Although increased confidentiality protection is provided to nonlawyer communications, CPAs should proceed with caution in explaining the scope and application of the privilege to both clients and employees because blanket protection is not provided. Many issues remain to be settled, including the following:

* What constitutes tax advice?

* When does a noncriminal proceeding become criminal?

* What happens when both tax advice and nontax advice are provided to a client?

* What constitutes an effective waiver of the privilege?

A more extensive discussion of the client privilege aspects of the 1998 act appears in the October issue of The CPA Journal.

Innocent Spouse Relief. Innocent spouse relief should be easier to obtain under the new law. Understatement thresholds have been eliminated, and relief can be granted for erroneous (rather than only grossly erroneous) items. In addition, spouses who are divorced, legally separated, or have been living apart for at least 12 months may make a separate-liability election to limit their liability.

Interest and Penalties. The 1998 act contains an assortment of changes regarding interest and penalties. Accrual of interest and penalties will be suspended after 18 months unless the IRS sends the taxpayer a notice within 18 months following the later of the original due date of the return (without regard to extensions) or the date on which the return was timely filed. For noncorporate taxpayers, there will no longer be a difference between the interest rates paid on underpayments and overpayments. Also, overpayments and underpayments may be netted for interest calculations.

Easier Access to the IRS. To make the IRS more accessible, it is required to--

* include the name, telephone number, and ID number of the IRS employee that the taxpayer may contact in all manually-generated correspondence,

* include a telephone number a taxpayer may call in other correspondence, and

* provide a taxpayer with the employee's name and ID number during personal contact or phone calls.

The 1998 act also provides that the IRS must assign one employee to handle a taxpayer's matter until it is resolved. Finally, the IRS is required to list a local number and address in telephone books. The taxpayer will now be able to find and contact that office directly to solve problems, rather than having to rely upon a toll-free number. These provisions should assist taxpayers and their representatives considerably in responding to contacts from the IRS.

Procedural Safeguards. Many procedural safeguards for audits and collections were added by the 1998 act, including the following:

* The IRS is now required to notify taxpayers before contacting third parties with respect to examination or collection activities regarding the taxpayer.

* Supervisory approval is required of all notices of lien and levy and of actual levy or seizure of a taxpayer's property.

* The amounts exempt from levy as personal effects have been increased.

* Fair debt collection practices apply to the IRS.

* Substantial restraints have been added to seizures of residences and business assets.

* Due process in collection activities has been established to assure that all taxpayers are given the same protections.

* It is now unlawful for the president, vice president, employees of their executive offices, or members of the cabinet, to request or interfere in an audit or other matter concerning the tax liability of a taxpayer.

Implications and
Planning Opportunities

Understand how the new law affects you, your clients, or your employer. This discussion is only meant as a summary. If provisions of the 1998 act affect you, your clients, or your employer, get more detailed information to make sure you fully understand the changes. Knowing how things are supposed to work and the rights of the taxpayer is the first step to successful representation.

Be prepared. Unknown to many outside the IRS is the fact that each individual IRS agent is subject to a professional code of ethical conduct similar in many respects to that of the CPA. The Internal Revenue Manual of the IRS is the single official document of the policies, procedures, guidelines, and instructions for IRS personnel. The manual is available to any subscriber of an online tax service and is a great resource to prepare for an IRS examination. With the manual available, it is possible to know in advance the specific procedures and policies that will be followed in the examination of a return. The CPA can anticipate and provide the information the agent will request. In addition, being able to anticipate the specific procedures and guidelines the agent will follow in the examination will allow the CPA to present the issues under examination most favorably for the taxpayer.

Make your expectations of fair and equitable treatment known. It is clear that the IRS's expectation of its agents is that they treat taxpayers in a fair and equitable manner. In fact, the agent will now be evaluated on this dimension. Informing the agent at the beginning of the engagement that you are aware of the emphasis the IRS is now placing on fair and equitable treatment of the taxpayer should improve the outcome of the examination in at least two ways. First, it will be a reminder to the agent of this responsibility. Second, it puts the agent on notice that you are knowledgeable of the expectations. Having increased accountability as part of the examination process should result in a more equitable result for the taxpayer.

Request a different agent if you are not being treated fairly. There is a wide spectrum of attitudes toward taxpayers within the IRS: There are even agents with very pro-taxpayer sentiments. It may be in the best interests of the taxpayer to request a different agent if the one originally assigned does not appear to be reasonable.

Know your own staff. Not all tax professionals have the same attitude toward the taxpayer. Some are much stronger advocates than others. This issue becomes important when assigning responsibilities with respect to IRS examinations. It is also important when recruiting and educating your staff. Training and recruiting staff to exhibit the desired level of advocacy and having these strong advocates represent the taxpayer before the IRS should result in the most favorable outcomes. *

Linda Garrett Levy, PhD, CPA, is an assistant professor at the University of Colorado at Denver. J. David Mason, PhD, CPA, is an assistant professor at East Carolina University.

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