The Internal Revenue Service’s (IRS) Large and Mid-Size Business (LMSB) Division serves approximately 224,000 business taxpayers with over $5 million in assets. These taxpayers make annual cash payments of approximately $712 billion. The LMSB Division annually examines 20,000 returns, including 450 to 575 of the nation’s largest corporations. Part of the Division’s mission is to be a world class organization, responsive to the needs of business taxpayers in a global environment, while applying innovative approaches to customer service and compliance.

One of the LMSB Division’s four strategic initiatives to meet its mission is to implement a comprehensive issue management strategy that emphasizes pre-filing efforts to improve examination currency and resolve high-risk issues earlier in the process. The Pre-filing Agreement Pilot Project is the first of several initiatives underway to implement a new method of operation by applying expert resources to the needs of sophisticated taxpayers in a cooperative environment.

The purpose of the Pre-filing Agreement Initiative is to provide the LMSB Division’s taxpayers a process to request examination and resolution of specific issues relating to tax returns not yet filed. Through the cooperative efforts of taxpayers and the IRS, the process is designed to reduce the costs, burden, and delays encountered in post-filing examinations.

The objective of this review was to determine whether the Pre-filing Agreement Pilot Project was effectively designed and implemented to provide officials with reliable information for deciding whether it should be expanded, modified, or terminated.

The Pre-filing Agreement Pilot Project was effectively designed and executed to provide officials with reliable information. The LMSB Division received 19 applications to participate in the pilot project, and approved 12 of them from 11 different taxpayers. During the pilot’s initial 6-month time frame, the LMSB Division completed Pre-filing Agreements for 7 of the 12 applications accepted. Because the pilot project was effectively designed and executed, the IRS was able to successfully validate the concept of a Pre-filing Agreement. However, significant challenges remain in successfully converting the pilot project into an operational program over the next several years.

The results of the Pre-filing Agreement Pilot Project revealed that agreements could be resolved in a cooperative environment within the required time frame, accomplishing the objectives of the pilot program. The pilot was designed and implemented effectively in accordance with objectives, guidelines and procedures outlined in the IRS’ report "Pre-filing Agreement Process Pilot Program Orientation," issued in April 2000, and Notice 2000-12, "Pre-Filing Agreement Pilot Program." Feedback during the project indicated that taxpayers would be willing to participate in the process again, and that it could be an effective tool in the large corporate examination program, saving significant time and money for both taxpayers and the IRS. As a result, LMSB Division management decided to proceed with full program implementation.

Several significant operational challenges remain in converting the Pre-filing Agreement Pilot Project into an effective and efficient operational program. To successfully pilot Pre-filing Agreements many of the obstacles associated with an operational program were eliminated or not present. Specifically:

• The pilot cases were given priority access to scarce examination specialist resources. When the Pre-filing Program is operational this priority access may not be available to all pre-filing cases.
• Agreements were limited to one tax issue for one tax year, but taxpayers involved in the test recommended that agreements in an operational program cover more than one year.
• The 11 taxpayers involved were part of the 1,700 taxpayers in the Coordinated Examination Program (CEP) that have an ongoing examination relationship with the IRS. In most cases the examination team conducting the Pre-filing Agreement examination was familiar with the issue and the taxpayer’s books and records. However, the same level of familiarity is not likely to be present when the program is expanded to include all 224,000 LMSB Division taxpayers.
• The cases were closely monitored and scrutinized by various levels of the LMSB Division management team, which eliminated the need for a systematic quality review system. Such a quality review system would, however, be needed in an operational program.
• An informal, flexible and effective management information system (MIS) evolved to allow managers to direct and capture project accomplishments. However, this system may not be functional with hundreds of cases.

The LMSB Division management team is taking action to address many of these challenges and is in the process of converting the pilot project to an operational program. Successful transition from the pilot phase to an operational program holds promise for improving taxpayer satisfaction, facilitating voluntary compliance, and reducing post-filing examination cycle time. It could also reduce costs and burdens to both the taxpayer and the IRS.

The Director, Strategy, Research and Program Planning, and Director of Field Specialists should establish criteria to allocate examination specialists resources to returns with the most significant issues in pre-filing and post-filing activities. The Commissioner, LMSB Division, should also expand Pre-filing Agreements to cover multiple years. The Director of Pre-filing and Technical Guidance should study taxpayers without an ongoing examination relationship to determine if the program needs to be adjusted to meet the needs of this specific group. The Director, Performance, Quality and Innovation should establish a method of systematic quality control for pre-filing to maintain consistent case development standards. Finally, the Director, Business Systems Planning needs to have an MIS developed to support the Pre-filing Program that integrates with other LMSB Division information systems.

Management’s Response: The Commissioner, LMSB Division, agreed to implement the recommendation on establishing an MIS for the Pre-filing Agreement Program. However, the Commissioner did not agree to: (1) establish criteria for allocating resources between pre-filing and post-filing activities, (2) expand pre-filing agreements to cover multiple years, (3) adjust the pre-filing program to meet the needs of all LMSB taxpayers, and (4) develop a quality control system for pre-filing agreements.

Office of Audit Comment: The LMSB Division is now expecting a significant decline in the demand for pre-filing agreements compared to what it estimated at the time of our review. Consequently, we recognize that establishing criteria for allocating resources between pre-filing and post-filing activities, adjusting the pre-filing program to meet the needs of all LMSB Division taxpayers, and developing a quality control system for pre-filing agreements can be achieved through existing processes. However, we believe the expected decline in the number of agreements coupled with the decision not to take actions on our recommendations will, in the long term, adversely affect the Pre-filing Agreement Program.

The fact that multiple-year agreements are not offered could be a contributing factor to a lower than projected interest in the program. In deciding no action was necessary to expand pre-filing agreements over multiple years, the Commissioner, LMSB Division, stated that multiple-year agreements are outside the Division’s current authority. We agree with the technical accuracy of the Commissioner’s comment. However, we believe that the Commissioner, LMSB Division, could initiate actions to request the delegated authority from the IRS Commissioner. Implementing multiple- year agreements would be responsive to the taxpayers’ stated needs and would demonstrate a change to a more customer-focused IRS organization.