* This article is adapted from a presentation made to the 1999 Federal Tax Conference sponsored by the Washington Society of Certified Public Accountants.

I. INTRODUCTION

This article is devoted to an overview of how changes to the Internal Revenue Service (the "IRS") dictated by the Restructuring and Reform Act of 1998 (the "Act") may impact your practice in the new millenium.

The Act created or amended over 50 code sections and requires approximately 1,100 implementing actions and the retraining of approximately 75,000 IRS employees. The Act will cost hundreds of millions of dollars to implement, affects virtually every taxpayer, and dictates the revision or creation of 153 forms and countless publications.

Changes to the Internal Revenue Code and the IRS have come and gone over the years. Most of these changes pale in comparison to the significance of the Act and the metamorphosis the IRS is now experiencing. The current change is not just a matter of purchasing new computers or redrafting of organizational charts. Tax practitioners are witnessing a comprehensive change to the organization of the IRS and the way it will administer the law in the future.

This article discusses some of the important organizational and directional changes to be implemented by the IRS and how these changes will affect the practice of lawyers and accountants in the next few years. It offers comments about potential problems the IRS will encounter meeting the requirements of the law and offers a few suggestions as how to deal with the IRS during this transition period.

II. THE NEW FOCUS ON "SERVICE"

My perspective is from one who has worked as both an IRS lawyer and a private practitioner in the field of tax and tax controversy dealing with audits, collection, appeals, litigation, and criminal defense. I have practiced before the IRS for almost 30 years and I have dealt with most types of agents, collection officers, managers, appeals officers, and government lawyers. Although I must admit that, since the Act was passed, I have not seen many revenue agents or collection officers in the field. They are as scarce as steelhead or a tech stock selling under 100 times earnings.

The absence of enforcement agents in the field has been due in large part to newly emphasized efforts by management to transform the IRS into a "customer focused agency." Many of the IRS’ agents, revenue officers, and technicians are spending their time in training, learning substantive changes of the law (and how to implement those changes with sensitivity), or fielding taxpayer questions on the telephone.

Those implementing the reorganization such as John LaFaver, Deputy Commissioner in charge of Modernization, actually used private industry as the model for the reorganization of the IRS. Mr. LaFaver and his crew hope to rely heavily upon new and sophisticated technology, which will admittedly take years to install, to improve productivity and offset the reduction in employees.

The most fundamental change to the reorganization of the IRS, at least as expressed by those speaking for management, is how the IRS and its agents will deal with the taxpaying public. Service to the taxpayer, with a renewed appreciation for taxpayer rights, is the expressed essence of the IRS’ new approach.

At a recent American Bar Association seminar, a key IRS management official cited the following example as an illustration of the new attitude: In the past, if a conflict existed between the interests of the IRS or an agent and the taxpayer, the interest of the government prevailed. Now the position of IRS management is that the rights of the taxpayer will override the interests of the IRS. As one who has learned over the years to appreciate the benefits of at least a moderate dose of cynicism, but is always hopeful, I say Alleluia! Alleluia!

III. REASONS FOR THE REORGANIZATION

The magnitude of restructuring the IRS and the implications of the change are tremendous and cannot be fully appreciated without considering the IRS’ structure and methods of operation before the Act.

The organization of the IRS prior to the Act dated back to 1952. The former mission statement of the IRS was in essence: "To collect the proper amount of tax at the least cost." The emphasis of the IRS’ efforts in its dealings with taxpayers was upon collection, not service. In the view of Congress, this focus is what caused problems for the IRS.

Since 1952, the number of pages in the Code has increased from 812 to 3,500; the number of returns filed has doubled; and, in the last 12 years, there have been approximately 9,500 modifications to the Code. The IRS collects about $1.7 trillion a year; however, it relies upon an antiquated computer system. Millions of returns filed each year are primarily on paper, which must be processed and stored.

The IRS enforcement projects seemed to jump from one thing to another. For a time, the IRS focused upon "economic reality audits," or drug cases, where IRS personnel were used to assist other agencies. There was a period when the IRS emphasized the enforcement of penalties, and another period when it placed pressures upon accountants to help police the filing and accuracy of returns.

The perception of the IRS progressively worsened in the eyes of the public. Numerous polls reflected low public satisfaction with the agency. A recent University of Michigan survey of public and private sector organizations ranked the IRS dead last. The most recent American Customer Satisfaction Index listed the IRS significantly below waste disposal.

Real, as well as perceived, problems included inadequate technology; poor service to taxpayers; an attitude problem in light of the tremendous power possessed by a revenue agent or collection officer; violation of taxpayer rights; failure to follow established procedures; lack of adequate training; and inappropriate use of enforcement statistics.

The Roth Senate Committee hearings represented a low point for the IRS. The hearings resulted in a widespread desire to change, which the IRS resisted. The Congressional hearings were the catalyst to the new approach of IRS management.

The current Commissioner recognizes that the IRS resisted change, just as many large corporations have resisted change. He cites IBM’s failure years ago to recognize the significant role of the personal computer as an example. Just as IBM was able to retool and is now competitive, he states that management’s principle goal is to retool the IRS. This "retooling" will be a difficult task, however, and may not be successful. The next year or two will likely determine if the 1998 law precipitated a lasting fundamental change in the IRS and our practice.

IV. OVERVIEW OF THE ACT

The Internal Revenue Service Restructuring and Reform Act was passed in July of 1998. The effective dates of the Act varied. Some provisions were effective immediately and others not until 1999, or in some cases 2000. The Act laid out a new direction for the agency. The bill contained 71 new taxpayer rights. Much has already been published about the taxpayer rights, which attempted to address the problems perceived by the public, but also are an extension of the new approach and role of the IRS.

Your practice in the future will be dictated by a number of factors, most of which emanate from the new IRS emphasis upon service and the practical problems this change in focus will cause. Since the Act’s passage a year and a half ago, the publicly stated emphasis of the Commissioner and the IRS has been upon providing quality service to taxpayers, respecting their rights, and collecting taxes efficiently. Most of the publicity has been centered upon the desire to make the IRS a "service" oriented agency and new taxpayer rights. The "retooling" of the IRS will not be an easy task, however. An inherent obstacle is that the primary purpose of the IRS is to collect taxes. In its effort to become "customer friendly" and "service oriented," the IRS has reduced its efforts to administer the tax laws by enforcement and compliance activities. This phenomenon has not gone unnoticed and already the pendulum may be swinging back to an emphasis on enforcement. The reason is simple: money.

In addition to creating numerous taxpayer rights, Congress dictated that the IRS develop a plan to reorganize and imposed taxpayer protections. How the IRS goes about this change will determine how your practice will evolve in the year 2000 and beyond.

The new Commissioner started his retooling efforts by redefining the IRS mission statement. The new mission statement speaks of "Providing top quality service to taxpayers, helping them to understand and meet responsibilities and applying the tax laws fairly." The word "collection" is conspicuously absent. Customer satisfaction is the theme.

Newly articulated goals for IRS personnel expand upon the mission statement. These goals are: "Service to each taxpayer;" "Service to all taxpayers;" and "Productivity through a quality work environment." The last goal is directed at stabilizing the work force within the agency while the IRS undergoes its enormously ambitious transformation.

As a continuation of this transformation, the IRS is currently undergoing a comprehensive effort to restructure the IRS and retrain employees. Job descriptions for nearly every employee and manager are being rewritten. Management has developed a plan to structure the IRS around taxpayer groups (discussed in Section V, infra) instead of geographic territories. Concentrated efforts are being made to overhaul the outdated technology and to bring in new management from outside the IRS to run the organization. The process will be a long one. The Commissioner estimates that it will take at least ten years. The computer modernization program will take longer, potentially 10 to 15 years. In December of 1998, the IRS entered into a contract with Computer Sciences Corporation to replace the computer system of the agency from the core data system to processing of returns.

Because of this restructuring effort, IRS personnel have been significantly affected. Audits and enforced collection actions have already dropped at least 30% to 40% and perhaps as much as 80% over what existed before the Act. Reasons for the reduction in audit and collection activities include: a decline in resources and personnel; additional time spent implementing the Act; a large allocation of experienced staff to answering telephones; large blocks of training; continued inadequate technology; and confusion among employees as to what to do and what is expected of them.

Although compliance efforts have decreased, the trend, however, has been greater receipts from income taxes because the taxable income of taxpayers as a whole is increasing significantly. Income taxes paid increased 11% from 1996 to 1997, due to the strong economy.

Resources will be important to the success of the IRS’ efforts to reform. The number of IRS employees is declining. The IRS has 13,000 fewer employees than it did four years ago. Locally, for example, Appeals Officers are down from 43 to 9. The efforts of several of those Appeals Officers will be directed to the Appeals Division’s expanded responsibilities, i.e., conducting collection, due process, and innocent spouse hearings. The IRS will have difficulty maintaining compliance and appeals hearings without agents to replace those that have quit or retired, although it hopes do so through increased productivity. If the public perceives that compliance efforts are diminishing, it is likely that tax shelters will proliferate and some practitioners will start taking more aggressive positions on returns. This in turn will put more pressure on the need to increase employment of agents and the need for budget increases.

One stated goal of the IRS is to hold the workforce level, while handling the increased workload from the growing economy, implement the changes, and improve its service and performance. The agency’s ability to achieve this goal is questionable. A major focus of investment in the future must be in technology if the IRS is going to accomplish the increased productivity. However, the antiquated technology still in use by the IRS is causing problems. The IRS computers, in fact, cannot accommodate some of the new provisions of the Act.

Historically the IRS has emphasized direct enforcement revenue, i.e., collecting taxes, interest, and penalties through enforced collection actions. The agency’s public relations efforts now focus upon other ways to increase compliance through better taxpayer education, early prevention, communication, and service. For the time being at least, the image projected by the IRS is more "touchy feely" than "hard glove."

In addition to an emphasis on communication, better service, etc., the IRS will attempt to broaden the use of electronic administration, i.e., the filing of electronic returns and the use of its web site to access information. A specific IRS goal is to have 80% of returns electronically filed by 2007. Filers are starting to use electronic communication as a means of dealing with the IRS. The pressure from the IRS, the increased computer literacy of the public, and the speed of communication will force tax preparers, accountants, and attorneys focusing on tax to adapt to the change.

Practitioners should take advantage of the IRS Web site, which is www.irs.gov. Most IRS forms and publications are available through the site and basic installment payment agreements can be processed through the site. The site has a calculator which figures monthly payment amounts, then prints an installment payment agreement for the taxpayer to file. Numerous other web sites are available to practitioners, which permit them to access information and research relating to tax and tax procedures. The Tax Section Newsletter has emphasized publication of these sites to assist its members.

V. ORGANIZATIONAL RESTRUCTURING OF THE IRS

The prior organizational structure was comprised of districts and service centers that administer the entire Internal Revenue Code for every type of taxpayer in a specific geographic area. The districts were overseen by four regional offices, which were in turn overseen by a national office. Approximately eight levels of staff and management exist between the IRS employee dealing with the taxpayer and the Deputy Commissioner in the National Office. The work of these fiefdoms was managed by a computer system designed in the 1960s, which uses magnetic tapes to store data and relies upon a computer code employed nowhere else.

The new organizational structure of the IRS is modeled after business organizations such as financial institutions, which serve different types of customers through divisions. Four business units are to serve a specific group with similar needs: wage and income; large and midsize business; small business; and tax exempt organizations. Three-agency wide organizations including legal and technical assistance will serve these divisions. The Appeals Division and the Taxpayer Advocate Division will be independent and serve nationwide. The National Office will set policy and review plans for each division. An oversight board will review the actions of the IRS.

A more detailed explanation of the Modernization of the IRS is available on the IRS web site. This issue of the Newsletter contains a report on the Western Region Liaison committee meeting held in Hawaii, which discussed some of these changes.

VI. EXPANDED TAXPAYER RIGHTS

Expansion of taxpayer rights was a central theme to the Act. Recognition of these rights reflects the new approach to the administration of the tax laws dictated by Congress. Much has already been written about some of the key provisions, i.e., the shifting of the burden of proof in litigation; the creation of a tax advisor’s privilege; expanded relief for innocent spouses; the creation of due process hearings when levies are to be issued or liens have been filed; and the increased role of the U.S. Tax Court in collection and innocent spouse matters. How will these expanded rights affect the tax practice of a lawyer in the next few years?

Shifting of the burden of proof was perhaps the most publicized provision of the Act. For years, the Commissioner enjoyed the rebuttable presumption that his or her determination in a notice of deficiency was correct. Taxpayer litigants possessed the burden of production and persuasion if they wished to overcome the presumption of correctness in court. Under the current law, if certain criteria apply, the burden shifts to the IRS and it loses its presumption of correctness.

The criteria are: the taxpayer must introduce credible evidence as to the factual issue; the taxpayer must maintain records required by the Code; he or she must comply with all substantiation requirements; he or she must cooperate with reasonable requests for information, interviews, and documents; and the taxpayer’s net worth may not exceed a certain amount.

Being able to argue that the Commissioner has the burden of proof certainly has some benefits. Tax controversy advocates usually will take any advantage available to them. The concept may cause revenue agents, their managers, or Appeals Officers to be more cautious when asserting tax deficiencies. An argument can be made, however, that the presumed inherent benefits of the right are illusory in practice.

Fewer than 4% of all tax disputes are submitted to a court of law. An overwhelming majority of those controversies are petitioned to the U.S. Tax Court. Relatively few of those cases are tried and those that are tried are infrequently decided on the burden of proof issue because rarely is the evidence equal. Many cases submitted to a court, particularly smaller cases, turn upon issues of substantiation. If the taxpayer has not met substantiation requirements, the rule does not apply. Perhaps more troubling, to protect their right, taxpayers must provide the IRS with access to witnesses and information if requested. Because of this, agents may be more intrusive with information requests.

The tax advisor’s privilege relating to taxpayer communications with federally authorized practitioners was another well publicized, but somewhat controversial provision. The Act extends the present attorney-client privilege of communication to communications between taxpayers and individuals authorized to practice before the IRS.

The privilege cannot be asserted in any criminal tax matter before the IRS. Therefore, if disclosures about potential fraud are made by a client to an accountant or enrolled agent relying upon the tax advisor’s privilege, the content of the disclosures may actually be discovered by the government in a criminal tax investigation. This exception is potential trap for those tax advisors who discuss fraudulent or possible fraudulent activity with their client relying upon the tax advisor’s privilege.

Many attorneys opposed the extension of the privilege and viewed this provision of the Act as a further intrusion by large accounting firms and commercial enterprises into the practice of law. Litigation by bar associations will likely result at some point, since a central question seemingly ignored by Congress is whether the "tax advice" is actually legal advice and to what extent are the "tax advisors" engaging in the unauthorized practice of law, which is regulated by states.

The recognition of due process in connection with IRS collection actions represents one of the most significant procedural changes of the law. The Act established formal procedures for insuring due process when the IRS resorts to administrative collection procedures.

Taxpayers now have the right to request a hearing before the Appeals Division after a Notice of Federal Tax Lien has been filed or a Notice of Levy has been sent to the taxpayer. If a taxpayer makes a timely request, a levy may not be made until the Appeals Division makes a determination on the propriety of the taxpayer’s challenge. If the Appeals Division issues an adverse ruling, the taxpayer may challenge the administrative finding in the U.S. Tax Court. The IRS is prohibited from making a levy during this appeal process and the taxpayer can request that collection alternatives to seizure, such as an installment agreement, be considered. At the due process hearing, the IRS must demonstrate that relevant requirements of the law and administrative procedures have been met; that the liability assessed by the government is owed; and that no reasonable alternative to the enforced collection of the debt exists. Although the criteria to guide the U.S. Tax Court is not set out in the Act, the Court will likely adopt the same criteria when reviewing appeals in collection matters.

Another extremely important change is the expansion of the innocent spouse provisions of the Code. Appeals by those claiming innocent spouse status in opposition to collection efforts by the IRS is now permitted.

VII. WAYS IN WHICH THE IRS RESTRUCTURING WILL
AFFECT YOUR PRACTICE IN THE NEAR FUTURE

Clearly, fewer audits will occur over the next several years. The frequency of audits is significantly down. The Commissioner has publicly admitted that audits have been reduced by 40% since the passage of the Act. The actual percentage reduction is probably significantly greater.

Audits will probably be processed differently than in the past. Audits should be closed more quickly because of time constraints. Experienced agents are being used to assist taxpayers during the tax season instead of working or opening audits. Managers will be more concerned than ever with moving the case along and bringing the case to a prompt resolution.

Fewer summonses for information will occur. If a summons is issued, taxpayers can challenge the breadth of the request, and, in light of the emphasis upon recognition of taxpayer rights, may attempt to use any ensuing summons enforcement proceeding as a means to challenge the reasonableness of the agent’s actions. The managers will not want audits to bog down in enforcement proceedings, which can take months.

The robust economy has lessened the pressure on the IRS to generate revenue through compliance enforcement. As long as tax receipts more than offset revenue lost from fewer audits and collection efforts, the IRS will continue to emphasize its restructuring plan and compliance efforts will be less than before the Act’s passage.

At some point, however, the loss of revenue from fewer audits and collection actions will take its toll on both revenue and the perception that the IRS is allowing some taxpayers to avoid paying their fair share. In the last few weeks, the Commissioner and the IRS have begun shifting public relations statements from an emphasis on service to the need for a more aggressive approach to compliance efforts. The magnitude of the restructuring effort will make increased compliance efforts difficult, unless Congress significantly increases funding for the IRS to meet its commitments to restructuring, technological improvements, and compliance. Without a major reversal in the mandate by Congress, it should be some time before audit and collection efforts exceed or even reach pre-Act levels.

Circular 230 says that the chance of audit should not be a consideration of tax advisors when giving advice on questionable tax reporting positions. If taxpayers are aware of the reduced audit risk, however, one would expect that this awareness would invite more aggressive positions on returns. Until the Service can increase its compliance efforts, many corporations will continue participating in corporate tax shelters.

The new tax advisor privilege raises several questions concerning the scope of duties of accountants in firms that have audit and tax branches. If a client discloses potentially harmful information in consultations with the tax department, what are the duties of the tax partner to protect the privilege from audit partners of the firm or from disclosures on returns? Is this not an inherent conflict of interest? How do accountants square the privilege with their roles as accounting advisors and their duty of disclosure? Can the accounting firms really protect the privilege by building a wall around the tax advisors as some have suggested? Accounting firms, particularly the larger firms, will have to address these difficult issues.

Some accountants may find themselves at odds with their clients because they did not appreciate the limits of the new privilege. Part of the resolution of these issues will depend upon how the IRS recognizes the privilege and how accounting firms or nonprofessional tax preparation services market this new privilege.

The possibility of obtaining attorney’s fees for unjustified positions by the IRS has been increased under the Act. Attorney’s fees should become a much more frequent concern among tax practitioners when attempting to negotiate settlements. IRS exposure to the payment of attorney’s fees, if raised by practitioners, may cause revenue agents to back off on aggressive or poorly thought-out audit positions. One should consider raising the possibility of obtaining attorney’s fees if an agent is not justified in his or her position or is "jobbing the issue" without doing sufficient work to justify the position taken.

The concept of "qualified offers" has been introduced by the Act. If a taxpayer makes a timely qualified offer to resolve a case before the U.S. Tax Court, which is rejected by an Appeals Officer or IRS lawyer assigned to the case, the taxpayer will be considered the "prevailing party," and may be awarded attorney’s fees and costs, if the determination of the Court is not more favorable to the government. If used by taxpayers, qualified offers will help force the government representatives to bear the consequences of their settlement positions and place more pressure upon government lawyers to settle cases.

Many of the changes will be in the way enforced collection is handled. As with audits, enforced collection activity is down tremendously. Historically, the IRS issues about 3.7 million levies each year. Now each levy may trigger an appeal because of the availability of the due process appeals process. The kinder, gentler IRS will issue fewer levies. There will be more paper work because of the issuance of the Notice of Appeal Rights and the system could overload with the number of appeals. There are no timetables for the Appeals Division or the U.S. Tax Court to resolve collection hearings.

In the past, few obstacles lay in the way of aggressive collection tactics. Now enormous obstacles exist. Taxpayers will undoubtedly take advantage of the appeals process in collection matters. Although the Act does not provide for appeals by third party creditors who are adversely affected by levies or liens, creditors might also consider seeking appeals hearings.

Installment agreements will be easier to obtain and granted more quickly with less documentation, and a significant number of these will be processed electronically. In the future, more offers in compromise will be accepted. In 1998, only 25,000 offers in compromise were accepted, although over 105,000 were submitted. The Act called for an expansion of the offer in compromise program. As a result, the IRS has changed its policy to make offers in compromise easier to process and more likely to be accepted. New guidelines give the IRS authority to look beyond traditional formulas and permit offers that might not otherwise meet acceptance criteria in hardship situations. The basic concept is to create greater flexibility and "instead of collecting nothing, collecting something."

Innocent spouse disputes will be more prevalent than in the past. The IRS has already received significantly greater appeals on innocent spouse questions than it probably ever anticipated.

A large number of employees have left the IRS over the last few years and have not been replaced. Many of them have been older, more experienced agents. The Service could have a difficult time replacing the experienced agents.

The role of the Appeals Division will be significant because of its expanded role and additional procedural burdens. The Appeals Division is to be independent from audit or collection. Ex parte contacts with agents are prohibited, and cases may not be as factually developed as they have been in the past when they are sent to the Appeals Division. The Appeals Division will not be use to this phenomenon. As a result, the objectivity of the Appeals Division will be important.

The Tax Court will probably be used more by the public because of the increased monetary limits in small case litigation and the Court’s expanded role in collection matters.

The push to use electronic filing will be successful. Accountants and tax lawyers will have to adjust to this type of filing and become familiar with the abbreviated forms.

VIII. CONCLUSION

The reorganization of the IRS into four specialized divisions or units should result in much greater efficiency and eliminate layers of administrative "fat." The inclusion of leaders from the private sector to help lead these divisions hopefully will breathe new life into the IRS and make it more responsive to the concerns of the taxpaying public. An oversight board and the expanded role of an independent tax advocate office should create more accountability for the IRS. All of these changes will benefit your practice.

Much seems to be riding on the ability of the IRS to transform its outdated technology. This process will take over a decade to complete and has failed once already. If technology is not improved, the productivity advances needed by the IRS for the change to succeed are probably not achievable. More than a few professionals are skeptical about the IRS’s ability to achieve all of the goals which it has set for itself. Time will tell.