The IRS Large Business and International Division (LB&I) has announced (LB&I-04- 0812-010) that it will no longer use its "tiered issue process" to manage audit issues, freeing the research and development (R&D) credit from its designation as a Tier I issue. LB&I is replacing the tiered issue process by creating a knowledge management network with issue practice groups (IPGs) for domestic issues and international practice networks (IPNs) for international issues.
Background
The tiered issue process was established in 2006 to promote greater consistency and accountability in resolving high-risk compliance issues. Under the process, many issues were assigned to one of three tiers and managed by issue management teams. These teams were responsible for developing resolution strategies and tools, and each tier carried specific requirements for coordinating audit issues. Examiners were required to address any Tier I issues on a return, though having a Tier I issue did not mean a taxpayer's return would automatically be selected for audit.
Under the tiered issue process, R&D tax credit claims (i.e., R&D credits not taken on original tax returns) were designated as a Tier I issue — indicating that the R&D credit was one of the IRS's highest strategic priorities. After their designation as Tier I issues, R&D credit claims often generated long and difficult examinations for taxpayers, including a lengthy mandatory information document request (IDR) and mandatory consultation and approval from a very small group of IRS R&D technical advisers. As a result, many R&D credit claims were completely disallowed at the field audit level, leading to a significant backlog of R&D credit issues at the appeals level. Many audits of non-Tier I R&D credits (i.e., credits taken on original returns) were also pulled into this process during IRS examinations.
LB&I Directive
Effective with LB&I's directive issued on Aug. 17, 2012, all Tier I, II and III issues are no longer tiered and should be assessed for risk and examined in the same manner as any other issue in an audit. All prior industry director directives issued under the tiered issue process are withdrawn.
LB&I said the new IPGs and IPNs are designed as a resource for examiners to use in audits and to manage compliance priorities. According to the IRS, the goal is to:
- provide LB&I examiners with clear and timely guidance on how to address issues,
- promote collaboration among LB&I employees,
- increase accountability and transparency in the resolution of issues, and
- enable robust lines of communication with taxpayers.
The LB&I directive acknowledges the "fact that no one LB&I employee has all the answers" and says that IPGs and IPNs will better balance the "need for consistency with the recognition that there is no 'one size fits all' approach to examining and resolving issues."
Potential impact
As a result of the directive, R&D tax credit claims are officially no longer considered a Tier I issue. The end of the tiered issue process should give audit teams more flexibility to settle issues; LB&I is instructing front-line managers, territory managers and directors of field operations, however, to consult IPGs and IPNs when reviewing cases and considering the proper treatment of issues under their supervision. Of particular note, the LB&I directive did not address how the IRS intends to deal with taxpayers currently under audit with tiered issues.
It remains to be seen what impact the end of the Tier I designation will have on R&D tax credits (and other tiered issues) currently being examined by the IRS. Hopefully, the new process will allow taxpayers more meaningful interactions with the examination teams and give field agents more decision-making authority. Taxpayers may have better access to the IPGs than they had to the issue management teams under the tiered issue system.
Even with the end of the tiered issue process, taxpayers should still expect examination teams to consider the R&D tax credit a significant issue and to make similar documentation requests during examinations. Taxpayers should continue to focus heavily on meticulously documenting their R&D tax credit claims.
Questions
Contact a Grant Thornton tax adviser to discuss the impact of these IRS changes and substantiation requirements for R&D credit claims in more detail.
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