Recently announced changes to the Internal Revenue Service (IRS) Large Business and International (LB&I) Division’s examination process include a requirement that the audit team issue an Information Document Request (IDR) asking for the taxpayer’s acknowledgement of the facts for any unagreed issue before closing the case to Appeals. Pub. 5125, Large Business & International (LB&I) Examination Process. See LB&I’s announcement about the new examination process. The IRS has not yet provided details about the new acknowledgement of the facts (AOF) IDR process but has indicated that the Internal Revenue Manual will be updated before May 1, 2016, to reflect the new procedures.

The new AOF IDR process replaces the long-standing existing process whereby LB&I revenue agents typically (but not always) were supposed to issue a draft Form 5701, Notice of Proposed Adjustment, when an adjustment was being considered. The previous LB&I Quality Examination Process procedures specified that: “Generally, prior to the issuance of a Form 5701 *** the taxpayer and exam team will discuss the issue associated with the proposed adjustment. The taxpayer will, at a minimum, confirm the facts of the issue in question and clarify its position.” See Pub. 4837, Achieving Quality Examinations through Effective Planning, Execution and Resolution. See also LB&I Quality Examination Process Reference Guide.

Under the new procedures, the AOF IDR will be sent to the taxpayer before a Notice of Proposed Adjustment is issued “so that [the exam team] can accurately apply the law.” Pub. 5125. It is unclear whether exam teams will continue to issue draft Forms 5701 or whether proposed adjustments will be made in final form after completion of the AOF IDR process. Also, under the new procedures, while the case manager for the exam team has the overall responsibility for a case, an issue manager is assigned to each issue. The issue manager “has oversight of the planning, execution and resolution of the issue.” In conjunction with the AOF IDR process, “[t]he issue manager should ensure that all relevant facts, including additional and/or disputed facts, are appropriately considered before a Notice of Proposed Adjustment is issued.” The issue manager concept is part of the new IRS issue team approach wherein LB&I personnel who are knowledgeable about a particular issue will work with exam teams on developing and managing the issue during the course of the audit.

The AOF IDR process appears to have been designed, in part, with recent IRS Appeals policy changes in mind. Under procedures implemented in 2014 to promote a quasi-judicial approach, Appeals generally will not consider new facts that are presented during the settlement process, and consistent with that rule, the new LB&I examination process provides that “[i]f a case is closed to Appeals and the taxpayer provides relevant new information that requires investigation or additional analysis, the case will be returned to exam’s jurisdiction for consideration.” See an overview of the new Appeals procedures.

Sutherland Observations

The new AOF IDR process potentially represents a significant shift in LB&I examination policy. Historically, the facts were not always fully developed or agreed to before a case was protested to Appeals, and taxpayers often presented new evidence during the settlement process. Under the new Appeals rules, which emphasize the quasi-judicial nature of Appeals, unless additional evidence is cumulative or does not require any analysis, taxpayers should anticipate that Appeals will return the matter to the examination team for further consideration. The AOF IDR process appears to be aimed squarely at compliance with the new Appeals policy and, therefore, LB&I taxpayers should focus on the desirability of producing all relevant evidence to the examination team before the case is closed. Indeed, because of the new emphasis on the quasi-judicial nature of Appeals, taxpayers should consider developing most or all of the essential favorable facts before (rather than after) a case is protested, similar to preparing a case for trial.

What if a taxpayer declines to respond to the AOF IDR? It is doubtful that the IRS could enforce an AOF summons which asks the taxpayer to confirm the IRS’s version of the facts, and there is no indication in the new procedures that LB&I would seek enforcement if a taxpayer declined to respond. (Generally, a summons may only require production of existing documents or testimony, and a witness cannot be compelled to create or analyze documents, although a witness could be asked questions about the facts. See IRM 25.5.4.2.) But if a taxpayer refuses to dispute or accept the exam team’s statement of facts in the AOF IDR, could the exam team determine that the case is not eligible for Appeals consideration?

Recently implemented procedures for Small Business/Self Employed (SB/SE) cases provide that “if information requested on Form 4564, Information Document Request, is not provided, the taxpayer may not be eligible for an Appeals conference.” See Memorandum for Appeals Employees – Appeals Judicial Approach and Culture (AJAC). (In a recent report to Congress, the National Taxpayer Advocate criticized SB/SE’s policy, arguing that Appeals alone should make the determination on whether or not to consider a case. See National Taxpayer Advocate 2015 Annual Report to Congress, p. 82.) LB&I has not suggested that failure to respond to the AOF IDR would preclude Appeals settlement consideration, but taxpayers certainly should evaluate that possibility in situations where the facts are unclear, unusually complex or in dispute. Moreover, if a taxpayer does not respond to the AOF IDR, could that refusal adversely affect the settlement process – e.g., the Appeals Officer may conclude that the examination team’s version of the facts is correct?

Finally, because the new LB&I examination process requires an issue manager/team to be assigned for each issue, a well-crafted, thorough response to the AOF IDR may facilitate resolution of an issue at the exam level. Indeed, taxpayers may want to confirm that the response to the IDR has been provided to the appropriate issue team members. Moreover, in many cases, while the essential facts may appear to be undisputed, taxpayers should resist the temptation to respond by acknowledging that the facts are correct. More often than not, when applying the law to the facts, the interpretation of the facts by the IRS and the taxpayer may be quite different – and the taxpayer should always consider submitting its own statement of the facts in response to an AOF IDR.