TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION
Chief Counsel Should Address Questions Related to Proposed Changes in the Automatic Consent Process
June 3, 2008
Reference Number:† 2008-10-123
This report has cleared the Treasury Inspector General for Tax Administration disclosure review process and information determined to be restricted from public release has been redacted from this document.
Phone Number ††|† 202-622-6500
Email Address ††|† email@example.com
Web Site†††††† ††††|† http://www.tigta.gov
June 3, 2008
MEMORANDUM FOR CHIEF COUNSEL
FROM:††††††††††††††††††††††††††† Michael R. Phillips /s/ Michael R. Phillips
†††††††††††††††††††††††††††††††††††††††† Deputy Inspector General for Audit
SUBJECT:††††††††††††††††††† Final Audit Report Ė Chief Counsel Should Address Questions Related to Proposed Changes in the Automatic Consent Process (Audit # 200810030)
This report presents the results of our limited-scope review to evaluate the possible impact of the automatic consent process proposed in Notice 2007-88.† We limited our review to an assessment of the Office of Chief Counselís (Chief Counsel) proposal to change the consent processes used by taxpayers to request changes to another method of accounting.† This audit was conducted as a supplement to the Treasury Inspector General for Tax Administration Office of Audit Fiscal Year 2008 Annual Audit Plan.
Impact on the Taxpayer
The Chief Counsel is responsible for reviewing a taxpayerís
request to change their method of accounting for Federal income tax purposes
through its Change in Accounting Method (CAM) program. †Although Chief Counsel has initiated and
recommended actions to improve the efficiency of the
Year 2007, the Chief Counsel initiated efforts to improve the efficiency of its
We made no recommendations in this report.† However, Chief Counsel management agreed with the observations and conclusions presented.† Managementís complete response to the draft report is included as Appendix IV.
Copies of this report are also being sent to the IRS managers affected by this report.† Please contact me at (202) 622-6510 if you have questions or Nancy A. Nakamura, Assistant Inspector General for Audit (Headquarters Operations and Exempt Organizations Programs), at (202) 622-8500.
Change in Accounting Method
Internal Revenue Code
Internal Revenue Service
Income Tax and Accounting
Each year, individuals and businesses are required to keep records and report income and expenses for a certain period of time called a tax year.† Individuals and businesses must account for income and expenses in a way that clearly shows taxable income. †The methods by which taxpayers assign items of income and expenses to specific taxable years are referred to as methods of accounting.† Most taxpayers use either the cash method or the accrual method for their accounting.† Usually, the determination of which accounting method to choose is made when a taxpayer files his or her first tax return.†
If taxpayers want to change to another method of accounting, they must follow the statutory provisions in Internal Revenue Code (I.R.C.) Section (ß) 446(e) and ß 481.† I.R.C. ß 446(e) requires taxpayers to obtain the consent of the Internal Revenue Service (IRS) Commissioner (the Commissioner) prior to changing a method of accounting for Federal income tax purposes.† This consent requirement permits the IRS the opportunity to review consent requests in advance to determine whether the new methods of accounting are permissible. †Under the automatic consent process, the Commissioner grants eligible taxpayers automatic consent to change to certain methods of accounting that the Office of Chief Counsel (Chief Counsel) has determined to be routine and non-controversial. †I.R.C. ß 481 requires taxpayers to compute and report adjustments to their taxable income for any taxable year when changing accounting methods.
The Associate Chief Counsel, Income Tax and Accounting (ITA)
Division, is primarily responsible for the administration of the Change in
Accounting Method (CAM) program.† The
The March 2007 analysis shows the ITA Division spent approximately 30 percent of its direct time on a low volume of advance consent requests.† According to the study results, in many cases, the ITA Division was unable to respond to the advance consent requests in time for taxpayers to implement the changes on their tax returns.† The inability to respond in a timely manner was caused by several fundamental problems facing the advance consent process.† These problems included delays in assigning requests to an ITA Division professional upon receipt and delays caused by taxpayers providing incomplete information.† Also, advance consent requests often involve novel and complex legal issues, which require a more in-depth review of the request to determine whether it is appropriate.
The Associate Chief Counsel, ITA Division, discussed the
results of the March 2007 analysis with the Chief Counsel, Deputy Chief Counsel
(Technical), and Deputy Chief Counsel (Operations).† The Associate Chief Counsel, ITA Division, received
approval to proceed with a project to consider whether to modify the process
for requesting accounting method changes.†
On November 13, 2007, Notice 2007-88
was published in Internal Revenue Bulletin 2007-46
and outlined the proposed changes to the
We limited the scope of our review to an assessment of Chief
Counselís proposal to change the consent processes used by taxpayers to request
changes of accounting methods. †This
review was performed at the Associate Chief Counsel, ITA Division, in
Notice 2007-88 describes in detail the existing accounting method change process versus the proposed accounting method change process.† Under the existing process, taxpayers must use the advance consent process unless the accounting method the taxpayer wants to change to is specifically listed as an eligible method for the automatic consent process. †According to Chief Counsel personnel, the IRS has identified more than 100 accounting methods for eligible taxpayers to elect to use under the automatic consent process.† Most of these accounting methods are described in an appendix to Revenue Procedure 2002-9. †Taxpayers who comply with all of the applicable provisions of this revenue procedure are presumed to have obtained the consent of the Commissioner to change their method of accounting under the automatic consent process. †
The notice proposes replacing the existing CAM program with a system under which taxpayers request to change their accounting methods through either the standard consent process (proposed automatic consent) or the specific consent process (proposed advance consent).† The major difference between the existing and proposed consent processes is that taxpayers will be eligible to use the automatic consent process for many types of non-routine and controversial accounting methods, unless the method the taxpayer wants to change to is specifically identified as having to use the advance consent process.† In addition, the scope of the review to be performed on the proposed accounting methods eligible for the automatic consent process is not specified.† This could impact the tax compliance and administration that relate to changes in accounting methods. †As a result, several stakeholders have raised concerns about the proposed consent processes, including whether the proposed consent process would violate I.R.C. ß 446(e).† The Treasury Inspector General for Tax Administration has identified the following questions for Chief Counselís consideration.† Specifically, Chief Counsel should consider the:
The Commissionerís authority to extend the automatic consent process to include non-routine and controversial accounting methods could be questioned
I.R.C. ß 446(e) requires taxpayers to obtain the Commissionerís consent before changing to another method of accounting for Federal income tax purposes.† Under the current rules, all requests are made using the advance consent process specified in Revenue Procedure 97-27, unless the method being sought is specifically exempted from the advance consent requirement.† If a method is exempt, taxpayers are permitted to use the automatic consent process.† Accounting method changes made under the current automatic consent process include methods the IRS has determined to be routine and non-controversial.
Although the automatic consent process is not specifically provided for in I.R.C. ß 446(e), the Commissioner has applied the automatic consent process to the routine and non-controversial accounting methods.† However, the proposed automatic consent process in Notice 2007-88 intends to expand the automatic consent process to all accounting methods, unless the accounting method the taxpayer wants to change to is specifically identified as having to use the advance consent process.† Under the automatic consent process, taxpayers are deemed to have obtained consent to make the change without an extensive IRS review.† However, extending the automatic consent process to non-routine and controversial accounting methods could be viewed as not satisfying the consent requirement in I.R.C. ß 446(e) because the central policy underlying this requirement is to allow the Commissioner the opportunity to review consent requests in advance.
Extending the automatic consent process to these accounting methods could allow the Commissionerís authority to be questioned.† Notice 2007-88 indirectly acknowledges this in the language of the noticeís Reasons for Change section.† This section states, ďThe IRS believes that the proposal contained in this notice fulfills the broad policy aims of I.R.C. ß 446(e).Ē† In our opinion, some uncertainty exists in Chief Counselís position, especially because the notice does not clearly address the legality of how the proposed automatic consent process fulfills the broad policy aims of I.R.C. ß 446(e).
We are concerned that this authority might be questioned if
the automatic consent process is expanded to include non-routine and
controversial accounting methods.† If
this occurs and an adverse ruling is later rendered on the change, Chief
Counsel will probably be involved in the adverse decision.† If this begins to occur regularly, some of Chief
Counselís resources will need to be refocused on the
The proposed changes might impact the IRSí ability to ensure that taxpayers are compliant with tax laws governing accounting methods
Under the existing advance consent process, taxpayers will generally not request a change to an accounting method they know Chief Counsel will not approve.† This is because Chief Counsel conducts a review of the request, including requesting supplemental information or explanations from the taxpayer to help in determining whether the request is permissible.† The effectiveness of this control is shown in Chief Counselís March 2007 analysis, which reported that 87 percent of the advance consent requests reviewed by Chief Counsel were approved with little or no change.†
However, the proposal outlined in Notice 2007-88 would extend the automatic consent process to methods not listed in Rev. Proc. 2002-9 or other automatic consent guidance.† While Notice 2007-88 indicates that the automatic consent requests will be reviewed for completeness and permissibility of the accounting method change sought, it does not contain specific details on the level of review that will be performed.† Further, at the time of our review, Chief Counsel had not developed a plan detailing the review process that will be performed when reviewing these requests to ensure that taxpayers would not change to accounting methods that were not permissible.†
If the specifics of the review process for the newly eligible automatic consent requests are not adequately developed, taxpayers might be more likely to request a change to inappropriate or controversial accounting methods that might not be initially detected by the IRS.† It is feasible that accounting method change requests, once sought using the advance consent process, could now be requested under the proposed automatic consent process and no longer be subject to a detailed review prior to approval. †This might result in reduced compliance with the tax laws if taxpayers request changing to the non-routine and controversial accounting methods using this proposed process. †
The IRSí ability to detect taxpayers who make inappropriate use of the automatic consent process could be adversely impacted
The review process for the proposed automatic consent requests under Notice 2007-88 might be limited and might be indirectly transferred to the Examination functions in the IRS Operating Divisions. †Requests by taxpayers to change to a new method of accounting that is not reviewed in advance would potentially become an issue that is considered during an examination (i.e., post-consent review).†
The March 2007 analysis shows Chief Counselís opinion ďthat a post-consent review process exist.Ē† This was based on Chief Counselís belief that the determination of whether to select a tax return for examination rests with the IRS Operating Divisions, not with the Associate Chief Counsel, ITA Divisionís office.† As a result, Chief Counsel management indicated that an option under consideration might be to shift review responsibilities to the Operating Divisions.† At the end of our field work, no decision had been made as to whether Chief Counsel would continue the review of automatic consent requests or if the Operating Divisions would perform this review.† However, shifting the review from Chief Counsel to the Operating Divisions could adversely affect the IRSí administration over accounting method changes, particularly if the Examination functions do not have the resources or do not want to accept the responsibility for reviewing the proposed automatic consent requests. †
In addition, the post-consent review process by the Examination functions will only occur if the taxpayerís return is selected for examination, and the change of accounting method is one of the issues selected for review.† In this instance, the Examination function would review the taxpayerís books and records and determine whether the taxpayer needs to make adjustments for improper or incorrect methods of accounting.† As a result, the taxpayer might be required to pay interest and penalties to correct the return and might also be required to revert to their original method of accounting.† This process could result in increased burden on taxpayers.
summary, when taxpayer returns are selected for examination, the IRS could face
a significant tax administration burden to identify and review the propriety of
accounting method changes months or years later.† This could reduce the IRSí ability to identify
missing taxable income associated with accounting method changes and impact its
ability to promote the uniform application of accounting methods.† A
The overall objective of this limited-scope review was to evaluate the possible impact of the accounting method change consent processes proposed in Notice 2007-88. †These processes are used by taxpayers to obtain the IRS Commissionerís consent to change their method of accounting for income tax purposes.† We limited the scope of our review to an assessment of the Office of Chief Counselís (Chief Counsel) proposal to change the consent processes used by taxpayers to request changes of accounting methods.† This report is being used to elevate our concerns that should be addressed prior to the issuance of any final guidance. †To accomplish our objective, we:
I. Evaluated whether the change in the accounting method process, proposed under Notice 2007-88, might reduce tax compliance with respect to accounting methods.
A. Evaluated the current and proposed published guidance used by taxpayers to obtain consent to change to another accounting method for income tax purposes.†
B. Interviewed the attorneys who drafted Notice 2007-88 and reviewed the Associate Chief Counsel, ITA Divisionís March 2007 analysis of the CAM program to determine whether additional program measures are planned or were implemented to ensure that the IRSí administration of accounting method changes is not adversely affected and result in reduced compliance with the tax law with respect to accounting methods.
C. Evaluated inside and outside stakeholderís comments and suggestions to assess their position and concerns with the current and proposed changes in accounting method processes, both in complying with the new guidance (external) and in enforcing tax compliance (internal).
II. Evaluated the published guidance program controls used to initiate, develop, and issue Notice 2007-88.
A. Determined why the published guidance project was initiated, developed, and approved.
B. Evaluated the March 2007, Associate Chief Counsel, ITA Divisionís analysis and determined the reasons for the program change and the challenges facing the CAM program that supports the need to change the process for taxpayers to request consent to change their accounting methods.
Internal Controls Methodology
Internal controls relate to managementís plans, methods, and procedures used to meet its mission, goals, and objectives.† Internal controls include the processes and procedures for planning, organizing, directing, and controlling program operations.† In performing this review, we limited our analysis of internal controls to a review of the procedures used to process changes in accounting method requests.† Our review did not identify any material weaknesses.
Nancy A. Nakamura, Assistant Inspector General for Audit (Headquarters Operations and Exempt Organizations Programs)
Jeffrey M. Jones, Director
Diana M. Tengesdal, Acting Director
Joseph F. Cooney, Audit Manager
John W. Baxter, Lead Auditor
Tim A. Chriest, Senior Auditor
Michael J. Hillenbrand, Senior Auditor
Office of the Commissioner Ė Attn:† Chief of Staff† C
Deputy Chief Counsel (Operations)† CC
Deputy Chief Counsel (Technical)† CC
Associate Chief Counsel (Income Tax and Accounting)† CC:IT&A
National Taxpayer Advocate† TA
Director, Office of Legislative Affairs† CL:LA
Director, Office of Program Evaluation and Risk Analysis† RAS:O
Office of Internal Control† OS:CFO:CPIC:IC
Audit Liaison:† Chief Counsel CC
The response was removed due to its size.† To see the response, please go to the Adobe PDF version of the report on the TIGTA Public Web Page.
 Proposed Changes to the Process for Obtaining the Commissionerís Consent to Change a Method of Accounting (Notice 2007-88), page 993 of Internal Revenue Bulletin 2007-46 (November 13, 2007).
 Under the automatic consent process, the Commissioner grants eligible taxpayers automatic consent to change to certain methods of accounting that Chief Counsel has determined to be routine and non-controversial.† If the accounting method is not eligible for the automatic consent process, taxpayers must use the advance consent process.
 The four IRS operating divisions are the Wage and Investment, Small Business/Self-Employed, Large and Mid-Size Business, and Tax Exempt and Government Entities Divisions.
 Under the cash receipts and disbursements method (cash method), taxpayers report income when received and expenses when paid.
 Under the accrual method, taxpayers report income when earned and expenses when incurred.
 Published guidance is Chief Counselís primary means of providing interpretation of the internal revenue laws.†
 The Accounting Method Change Program: Analysis of the Problems and Recommendations for Improvement (March 16, 2007).
 Advance consent is required for all changes in accounting methods other than changes specifically permitted to be made under the automatic consent program.††
 Notices are public pronouncements that may contain guidance that involves substantive interpretations of the I.R.C. or other provisions of the law.† Proposed Changes to the Process for Obtaining the Commissionerís Consent to Change a Method of Accounting (Notice 2007-88), page 993 of Internal Revenue Bulletin 2007-46 (November 13, 2007).
 The Internal Revenue Bulletin is the authoritative instrument of the IRS used to announce all substantive rulings necessary to promote a uniform application of the tax law.
 Methods of Accounting: Automatic Consent (Revenue Procedure 2002-9), page 327 of Internal Revenue Bulletin 2002-03 (January 22, 2002).
 The standard consent process is expected to operate similar to the existing automatic consent process.† The IRS anticipates the majority of accounting method changes would be made through this process.
 The proposed specific consent process is to be available for two categories of accounting method changes: 1) accounting methods specifically identified in published guidance as required to be made under the specific consent process and 2) changes that otherwise qualify under the standard consent process, but specific consent is requested.
 Changes in Accounting Periods and Methods of Accounting (Revenue Procedure 97-27), page 10 of Internal Revenue Bulletin 1997-21 (May 27, 1997).
 The four IRS operating divisions are the Wage and Investment, Small Business/Self Employed, Large and Mid-Size Business, and Tax Exempt and Government Entities Divisions.
 Proposed Changes to the Process for Obtaining the Commissionerís Consent to Change a Method of Accounting (Notice 2007-88), page 993 of Internal Revenue Bulletin 2007-46 (November 13, 2007).