In the past, there were long periods between significant changes for the IRS, whether broad revisions to the tax code or changes in the overall operations of the agency itself. Those days are long gone, and change has become the order of the day. Even as taxpayers work to comply with ever-evolving tax laws and reporting requirements, the IRS -- including the Large Business and International Division -- is faced with well-catalogued administrative challenges: decreased budgets, a dwindling workforce, and a technology gap, along with increased complexity and growing administrative responsibilities resulting from the Affordable Care Act, the Foreign Account Tax Compliance Act, and more.
But challenges can also bring opportunity. The big question is whether the IRS, in response to these pressures, can retool its approach to compliance by leveraging the significant changes taking place in the way multinational corporations view tax compliance risk.
Some Background on the Compliance Challenge
When budget levels remain relatively constant year after year, the way organizations go about their business may not change much, especially a government organization in which making a profit is not a factor in driving innovation and change. But when budget shortfalls meet increasing global complexity, there may be an opportunity for significant change. At this juncture, the IRS could rethink its approach to compliance, especially for the world's largest businesses.
Historically, the IRS has addressed large business tax compliance through its large case examination program. In that program, known today as the coordinated industry case program, LB&I places the largest corporations in the United States under continuous audit, with examination teams stationed at the corporate headquarters of the taxpayer. Over the years, the success of this program has been measured in a number of ways: the percentage of taxpayers audited within particular asset groupings (coverage rate); the amount of time it takes to perform the audit (cycle time); and the dollar amount of the adjustment proposed, not sustained, by the examination team (proposed adjustment). Notably, by using metrics like the coverage rate, the IRS is not selecting returns because they necessarily include issues of suspected noncompliance; rather, it is auditing the taxpayers year after year because they are the largest.
When the large case examination program started, business technology was in its infancy. The economy was largely bricks-and-mortar-based, and the concept of virtual storefronts and global commerce through intangible assets was just a twinkle in the eye of some Silicon Valley self-starters. There was no online access to general ledgers and no e-filing of corporate tax returns. In that context, the IRS had limited tools available to identify, much less predict, noncompliance.
The compliance landscape has changed significantly over time, both in the United States and globally. Technology has made corporate financial data much more accessible. More data are available to tax authorities through the electronic filing of tax returns and electronic business records. The reporting of tax positions is more vigorous as a result of disclosure requirements like Financial Accounting Standards Board Interpretation No. 48 (now Accounting Standards Codification Topic 740) and Schedule UTP (uncertain tax position statement).
The tax affairs of multinational corporations are also becoming more transparent, whether as a result of the OECD's base erosion and profit-shifting initiative and similar efforts by individual tax jurisdictions, or the unregulated efforts of journalists and citizen groups. In the United States, whistleblower laws have been strengthened to make it more lucrative for business insiders to provide information to the IRS regarding a company's questionable tax positions. Tax exposure is no longer just a financial risk; it is also being considered a risk that could tarnish the public reputation of a global franchise or brand. Being seen as a good corporate citizen is more important for multinationals today than ever before, particularly when it comes to tax compliance. Whatever their genesis, all these changes have contributed to a significant shift in the way large businesses approach tax compliance.
How the IRS Can Meet Its Challenges
LB&I spends much of its compliance resources on large case examinations, working to ensure compliance one taxpayer at a time. The results of these examinations rarely drive wide-scale change in the future filing positions of the largest taxpayers. Moreover, determining and defending filing positions on issues that are uncertain under the law is inefficient, risky, and resource-intensive for both taxpayers and the government. At the same time, with increased global transparency and reputational risk, many large taxpayers in the United States crave tax certainty.
In a time of limited resources, actions taken by the tax administrator should be designed to have a multiplier effect -- to change the behavior of as many taxpayers as possible. The best way to achieve that effect is to resolve most if not all of the uncertainty in the law before a taxpayer files a return. Shifting resources away from large examinations and toward activities designed to provide more certainty would be a significant change to the way the IRS allocates its resources. However, that shift would lead to more efficient and effective tax administration, generating what could be thought of as a compliance annuity -- dollars collected each year through the filing of compliant returns well into the future.
The IRS already uses several innovative programs that have embraced the concept of providing certainty. Among them are the compliance assurance process, which resolves material issues with a real-time audit conducted before the filing of a return; the industry issue resolution program, which issues guidance designed to resolve frequently disputed or burdensome tax issues that affect a significant number of business taxpayers; and the prefiling agreement program, which enables taxpayers and the IRS to resolve, before the filing of a return, the treatment of issues otherwise likely to be disputed in post-filing audits. The question now is what the next generation of those and other innovative programs will look like.
To free up resources, the IRS could consider moving away from performing audits that tie a taxpayer's general ledger to its tax return, or that look for large, unusual, or questionable items or for mistakes that taxpayers with complex business structures inevitably make. Instead, the IRS could focus its resources on confirming which multinationals have strong internal controls and tax compliance practices in order to be comfortable that those large businesses no longer need to be under continuous audit. The IRS could then reallocate those resources to auditing only anomalies. This approach to compliance would be similar to the approach used in financial statement assurance audits. Although it may not find every possible adjustment, this change could address a large portion of material filing issues and be the next generation of the CAP program.
This potential new CAP program, coupled with significant efforts to devote resources to making the law more certain, could lead to increases in efficiency and compliance. None of the current audit measures determines success on the basis of change in long-term compliance behavior by individual taxpayers or groups of taxpayers. Admittedly, it is much more difficult to measure the impact of activities designed to increase future filing compliance, and adopting metrics designed to gauge success could be a challenge in making these changes. Changes in filing behavior before and after guidance is issued are one potential gauge. External indications of tax compliance, such as changes in UTP reporting, could also be a gauge of success.
Given the environment of increased transparency and reputational risk for multinationals, more certainty should bring more compliance. Determining a taxpayer's compliance risk profile through factors other than continuous audit should allow the IRS to shift its examination resources to areas where the greatest compliance risk exists.
A Few Final Words
These are challenging times for the IRS. A great deal has changed over time, including the stable predictability of "business as usual." The key to future success may well be in changing the long-standing approach, culture, and metrics that have defined the IRS for decades. Can the IRS take advantage of all the changes to forge a new way to address and ensure compliance? That remains to be seen. But both sides of the taxpaying equation should remain hopeful.