Continuous audit disclosures are not dead

Background

Historically, a major component of the IRS’ compliance and enforcement strategy was to conduct continuous audits of certain large corporations. In May 2019, the IRS announced that the continuous audit program in effect at the time, the Coordinated Industry Case (CIC) program, would be replaced by the Large Corporate Compliance (LCC) program. In a move away from continuous audits, the LCC program uses a risk-based approach to select which large corporations should be audited and which issues on the returns of those corporations should be examined. In October 2021, a similar risk-based examination program, the Large Partnership Compliance (LPC) program, began for large partnerships. Although the goal of the LCC and the LPC programs is to more precisely identify which taxpayers to audit for a particular tax year rather than audit every tax year of the same group of taxpayers, the IRS acknowledged that some large businesses could be in a continuous audit posture under these risk-based programs.

Generally, taxpayers are subject to accuracy-related penalties under IRC Section 6662 for certain conduct, including substantial understatements of income tax and negligence or disregard of rules or regulations. If a position has at least a “reasonable basis,” the negligence penalty does not apply. If a position has a reasonable basis and the position is adequately disclosed (on a Form 8275, “Disclosure Statement,” or Form 8275-R, “Regulation Disclosure Statement,” as appropriate), the substantial understatement and disregard penalties generally do not apply.

Taxpayers also can avoid application of the IRC Section 6662 penalty by showing additional tax due or adequately disclosing a position that otherwise would be subject to penalty on an amended return that meets the requirements for a qualified amended return under Treasury Regulation 1.6664-2(c)(3). One of the requirements for a qualified amended return is that it must be filed before the IRS contacts the taxpayer for examination.

Because corporations under continuous examination were unable to meet the qualified amended return criteria requiring the filing of the amended return before being contacted by the IRS, the IRS provided relief in Revenue Procedure 94-69. Under that revenue procedure, a corporation in the CIC program would be treated as filing a qualified amended return – and therefore be protected from penalty – if it timely provided the IRS with a written statement showing the additional tax due or making an adequate disclosure.

Revenue Procedure 94-69 revisions

In August 2020, the IRS announced that because the Large Business and International Division replaced the CIC continuous examination program with the LCC risk-based audit program, and because of disparate treatment between taxpayers permitted and taxpayers not permitted to use the special rules under Revenue Procedure 94-69, it would be making Revenue Procedure 94-69 obsolete. The IRS received numerous comments recommending against removing the special rules in Revenue Procedure 94-69, with some commenters suggesting expansion of the rules to other taxpayers. As a result of these comments, the IRS has stated that it will instead revise Revenue Procedure 94-69 to apply to large-business taxpayers that are under continuous audit.

Draft disclosure form

As part of its update to Revenue Procedure 94-69, the IRS will issue Form 15307, “Post-Filing Disclosure for Specified Large Business Taxpayers,” to standardize disclosures under the new procedures. The draft form and instructions include examples of disclosures that the IRS will treat as acceptable and unacceptable. Unacceptable disclosures will not be treated as adequate disclosure for penalty protection and will cause the taxpayer to be ineligible to use these disclosure procedures for a period of time that, to date, has not been specified. The instructions provide that mathematical errors within a disclosed item will not constitute an inadequate disclosure unless they are intentional or recurring.

The future of continuous audits

The good news is that the IRS is continuing to provide relief for taxpayers that are denied the opportunity to seek penalty protection using a qualified amended return merely because of the mechanics of the IRS’ latest audit strategy. However, it remains to be seen whether the IRS’ definition of continuous audit will be sufficient to prevent unfair results. It also will be interesting to see the details of requirements for acceptable disclosures and how the rules for suspending taxpayers from eligibility to use the updated procedures will work.

The bad news is that the IRS does not appear inclined to extend this relief to more taxpayers. This limitation is a missed opportunity to incentivize all taxpayers to identify potential issues at the start of an examination, which would increase the overall efficiency of IRS audits. In the meantime, taxpayers currently eligible to use Revenue Procedure 94-69 should review their internal procedures to determine if changes will need to be made if they no longer are eligible to get penalty protection under updated procedures.