In March 2007, the Large and Mid-Size Business Division (“LMSB”) of the Internal Revenue Service (“IRS”) implemented new procedures for the “Industry Issue Focus Program” (the “Program”). LMSB has since begun reorganizing into the Large Business and International Division (“LB&I”), and the IRS now also refers to the Industry Issue Focus Program as “Issue Tiering,” but the principles underlying the Program remain the same. The Issue Tiering approach is a very significant change in the IRS’s approach to recurring issues and can present unique audit challenges, particularly for taxpayers who are unfamiliar with the Program’s procedures. Nonetheless, it also presents opportunities for taxpayers that use the information available under the Program to position themselves better for audit.

The Program is the latest effort to consolidate the IRS approach to certain common issues presented by multiple taxpayers. Such issues are now considered with an unprecedented level of coordination across taxpayers and industries. Taxpayers and their advisors have frequently expressed the concern that the Program causes inflexibility and results in an inappropriate one-size-fits-all approach to issues that fails to consider distinguishing facts. It removes discretion from the line agents who work with individual taxpayers as well. The IRS has stated its goals for the Program are: (i) consistency in resolution across industry lines; (ii) improved currency; (iii) increased coverage of non-compliant taxpayers by maximizing limited resources; and (iv) greater oversight on and accountability for important issues. As recently as June of this year, LMSB area counsel Nancy Vozar Knapp attempted to reassure taxpayers by stating that the Program was under review and will “evolve with the times.”

This article explains some basic facts about the Program and offers a list of guidelines for taxpayers facing audit issues that have been designated for participation in the Program. Understanding the rationales and goals of the Program and how the Program actually works is key to handling a case involving an issue that has been designated as a “tiered issue.” Although the Program presents challenges, its procedures also provide opportunities to understand the IRS’s approach to an issue in advance in order to develop your strategy and defense.

The basic concept of the Program is that the IRS identifies compliance issues and then prioritizes those issues based on their prevalence and level of compliance risk. This prioritization is implemented by designating issues using a series of “tiers.” Issues that have been so designated are generally referred to as “tiered issues.”

Tier I issues are identified by the IRS as issues of high strategic importance that have a significant impact on one or more industries. There are two categories of issues within Tier I: (i) compliance issues and (ii) shelter issues. According to the IRS, Tier I identification does not necessarily mean a transaction or issue is “bad,” but rather indicates that the transaction or issue presents considerations that are of high importance. Unfortunately, anecdotal evidence suggests that agents in the field do associate a negative, “shelter-like” connotation with any Tier I issue. Tier II issues are identified by the IRS as issues where there is potentially high non-compliance and/or a significant compliance risk. Tier III issues are generally industry-related and designated because of their prevalence, not necessarily because of their importance or risk level.

Issues are classified by the Industry Directors. Potential Tier I or Tier II issues are presented to a group called the Compliance Strategy Council for approval. If approved, an issue is assigned to the primary affected industry executive or another issue executive to develop a compliance strategy. Once an issue has been fully developed and a resolution strategy prepared, it will move from “active” status in its tier to a “monitoring” status in the same tier. The IRS does not typically “demote” issues from higher-priority to lower-priority tiers. According to the IRS, an issue is considered eligible for “monitoring” status when the Issue Management Team (“IMT”) responsible for the issue has: (i) identified the universe of returns that are likely to contain the issue; (ii) provided the necessary direction to the Field; (iii) issued appropriate procedural guidance and legal position; (iv) developed a resolution strategy; and (v) determined that there is no need to continue the heightened level of oversight.

If you have an issue that is designated as a tiered issue, that issue will likely be more difficult to resolve, given the IRS’s coordinated approach. You will face a very strong, pre-conceived notion on the part of the IRS as to how the issue should come out. However, following a few guidelines can give you the best chance to use the Program to your advantage and achieve the best possible resolution under the circumstances.

Guidelines for Handling a Tiered Issue Under the Program

1. Be Proactive Before and During Your Audit.

You need to know whether you may have a tiered issue before your audit. Accordingly, it is important to research the different issues that have been designated as tiered issues and have a general understanding of the types of issues the IRS considers for the Program.

For most tiered issues, the IRS has published guidelines, which include an analysis of the issue and the pertinent facts, directions to agents on how to develop the issue, and Model Information Document Requests (“IDRs”). If an issue has been designated, you must use this guidance to your advantage. These published materials tell you what the IRS will ask to see and what facts it views as problematic. Try to structure your transactions not to share those difficult facts. Be sure you develop and maintain the specific types of information that you know the agent will demand. Where the materials describe the scope of the issue, use that information to position your transaction outside of the definition or to make sure your transaction is as strongly defensible as possible.

You also need to understand the facts in IRS guidance and work proactively to distinguish your facts from those described in the guidance even before the inevitable audit commences and as you present those facts to the examination agent. Being prepared to address the issues that you know will be raised will put you in the best position possible. Recognize that your response to IDRs may be critical in defining the direction the examiners take. Proceed cautiously during the initial stages of an audit and be careful not to let an agent mistakenly label an issue or transaction as tiered because it has some similarity to a tiered issue.

2. Develop a Good Relationship with the Agent.

An agent’s general impressions of a taxpayer may influence his or her interpretation of transactions. This is purely common sense. Where you develop a relationship of mutual respect and work to keep the audit current, the agent will more readily accept your representations and consider your arguments. If the agent perceives you as unduly hostile or obstructionist, he will be more skeptical of your representations and less receptive to your arguments.

As it relates to tiered issues, if you take steps to cooperate with the agent by providing information as requested and generally make efforts to keep the audit moving, the agent may be more willing to consider your arguments that a transaction falls outside of the tiered issues, or at least go to bat for you in presenting his or her report to the IRS issue specialist or issue owner executive. The tone the agent takes may have a significant impact on the issue specialist or issue owner’s involvement with the issue. Do not wait until the last second to provide information or to establish a working relationship with the agent—establish a good relationship from the beginning so you can work to “manage” the examination as much as possible. The agent is the gatekeeper, and it is better he trusts you. Understand that a good relationship will not cause an agent not to do his job, but it can help your arguments against an issue’s being a tiered issue gain a foothold.

3. Distinguish Your Facts.

One of the most critical tasks in handling a tiered issue is to distinguish your facts from those described in negative IRS guidance and from those of other taxpayers. You should take steps to be prepared early in your audit to present your specific facts to the examining agent and highlight the differences. Sometimes this may be difficult if the guidance is vague and the facts described are generic. However, the more specific facts that you can develop with respect to your own case, the better chance you will have to identify distinctions and convince the IRS your case is different. Doing so is the best opportunity to avoid having your transaction mistakenly labeled as a tiered issue. Once that label is assigned, it will be much more difficult to resolve the issue on audit.

4. Don’t Rely Too Heavily on Arguing the Law With the Examining Agent.

There is a tendency among practitioners to believe that they can fashion a compelling legal argument that will change the IRS’s mind. However, the IRS has very bright, capable tax specialists who analyze these issues extensively, and believe they have fully considered all sides, so the chances of getting them to change their view of the law are remote. The IRS legal position on an issue that has been designated as a tiered issue is developed with consideration by multiple parties. Any one person responsible for handling your issue will not have authority to reverse or modify that position himself or herself. In almost all cases, the examining agent will understand that the Service’s issue experts have fully vetted the law, and will take a very pro-IRS view of the law. Thus, neither agents nor the IMTs will be particularly receptive to your view of legal arguments that others at the IRS have considered as a group. Unless you have an argument that you feel confident that the IRS has never considered, you are better off focusing on ways to distinguish your facts.

5. Understand How the IRS Approaches Your Issue.

As noted above, if you have an issue that has been designated, read the guidance published by the IRS on that issue. IRS guidance may include directives, settlement guidelines, audit guidelines, notices, rulings, coordinated issue papers, regulations, and other published materials. This not only helps you in planning and implementing transactions, but also aids during the audit. Compare your facts to those described in the guidance and answer the following questions: Do your facts appear to be better or worse than the facts in the guidance? How has the IRS approached this issue in this past? What is the IRS record on this issue with respect to other taxpayers? The answers to these questions will influence your strategy in pursuing a resolution to the issue.

6. Understand the IRS’s General Litigation Strategy on Tiered Issues.

Anecdotal evidence has generally led practitioners to believe that the IRS’s strategy with respect to tiered issues is to identify the cases with the worst facts for the taxpayer and get those cases into court. The IRS is therefore likely to try to delay or settle cases with better facts early on in an issue’s development so it can develop law favorable to the IRS by trying cases with facts unfavorable to the taxpayer. Understanding this dynamic, you should work to position your case as a case that the IRS does not want to try in court and would rather settle. Pushing your case forward quickly when it is strong may force the IRS’s hand, so that your case does not become the test case for an issue. If your case has good facts, allowing it to languish is a mistake. That means that you need to double your efforts to stick to deadlines and provide quick responses to all reasonable IDRs on all issues under examination so as not to provide the tools of delay. It may even mean not agreeing to statute extensions that will keep your case from court. In the most extreme cases, you may have to pay the tax, and file a refund claim, to move your case more quickly if being the test case for an issue is your chosen route.

7. Consider How Your Case Fits in With the IRS General Litigation Strategy.

You should learn as much as you can about the cases on the IRS docket with respect to your issue. Is the IRS litigating these cases? What are the facts in these cases? What are the strengths and weaknesses of the cases that are further along in the IRS administrative process or in the courts than yours? Identifying the range of cases that exist and where your case falls in the spectrum between the most-IRS favorable and the most-taxpayer favorable cases can help you select the best strategy. Do not fall into the common trap of convincing yourself your case is the best, without developing more information.

8. Coordinate With Other Taxpayers With Similar Issues.

If possible, make an effort to identify other taxpayers with similar issues and learn their facts. Learn how the IRS is approaching your issue with other taxpayers. You may be able to exchange information with other taxpayers and work collectively to accelerate the strongest taxpayer’s case and delay the weaker ones. If the issue is new and the IRS is still formulating its approach, getting cases with favorable facts to the forefront may influence the pattern IDRs issued by the IRS, alter the IRS’s legal position, and present the IRS with reasons to give examining agents more flexibility to settle cases.

For example, if you believe that you have a strong case and your issue has not been tested in the courts, put pressure on the audit team to move quickly to make your case one of the first. As noted above, if you can convince the IRS that you have strong facts, there is a good chance the IRS will not want your case to be the test case and therefore will be more willing to engage in meaningful settlement discussions.

9. Consider Elevating the Case.

If you are having difficulty resolving your case administratively, consider elevating the case within the IRS to get a new, more senior person involved. The IRS has said that its goal is to resolve cases at the lowest possible level. Thus, a lower level person at the IRS may be reluctant to seek guidance from more senior personnel unless you push for that. Under the normal IRS Rules of Engagement, the seniority progresses as follows: (i) Team manager; (ii) Territory manager; and (iii) Director of Field Operations. The Director of Field Operations has a direct line of communication with the “issue owner executive” responsible for the IRS’s coordinated approach to the issue. The issue owner executive is usually not involved in specific cases, but at least one IRS official has said informally that a taxpayer may want to contact the issue owner executive if he/she has tried to elevate the case under normal channels without success. Sometimes, only a high level official will have the authority or experience necessary to make the decision that a set of facts that looks like a tiered issue is not one.

10. Understand Settlement Procedures.

There are special procedures that apply to the settlement of tiered issues. Make sure that you understand these procedures before you start negotiations towards a resolution. The exam team must present any proposed settlements of tiered, listed issues (i.e., Tier I shelter issues) to the Technical Advisor, Issue Specialist, and/or Counsel before going forward with any resolution other than full concession by the taxpayer unless there are settlement guidelines. Otherwise, whether the proposed settlement of a tiered, non-listed issue needs to be presented to the Issue Management Team may depend on the following circumstances: (i) issue “maturity” (i.e., how well-developed the IRS position is, whether other cases have been settled, etc.); (ii) whether Counsel has provided published guidance; (iii) whether the issue has been designated for litigation; and (iv) whether the issue is being considered for litigation in a different case.

Note that the settlement of other, non-tiered issues you may have during your audit may also be more difficult when you also have a tiered issue. The presence of the tiered issue may cause your examining agent or appeals officer to view such issue as already decided in favor of the IRS. Thus, you as the taxpayer may lose the opportunity to trade a concession on that issue for the IRS’s concession on another issue. While no one likes to think of an audit as a “horse trading” exercise, as a practical matter an audit is a series of negotiations that involves “gives” and “takes” by both taxpayers and the IRS.

Note that the special Fast Track settlement procedures may be available to resolve tiered issues. Under Fast Track, the parties agree to seek a resolution within 120 days. This accelerated time frame may conserve taxpayer resources and allow a case to be resolved before other unfavorable cases either cause the IRS to impose inflexible settlement guidelines or result in unfavorable court decisions. Moreover, it may also help convince the IRS team that you do not have a tiered issue if a more independent third party thinks the distinctions you are making are legitimate.

The taxpayer, exam team, IMT coordinator, and Fast Track coordinator all must agree to use Fast Track. It is better to get support from the exam team first because the exam team manager can contact the other constituencies and be helpful in obtaining the necessary approvals. If Fast Track appears to be an attractive option, be prepared to address the views and concerns of all constituencies. For example, IRS Appeals may look for settlements that can be used in other cases. Remember that Fast Track is a mediation process, so the taxpayer should be prepared to compromise. Do not use Fast Track and expect to receive a full, or near-full concession from the IRS parties involved.


The Industry Issue Focus Program presents unique challenges because the IRS may be more inflexible as a result of the coordinated approach to issues established through the Program. However, taxpayers that are proactive and aware of these challenges can still achieve favorable resolutions.


This article first appeared in the National Law Review