Announcement 2005-42

The IRS established a permanent PFA program with the issuance of Rev. Proc. 2001-22 and revised it on December 22, 2004, with the issuance of Rev. Proc. 2005-12, 2005-2 I.R.B. 311. Although many of the procedures remained the same, there were some significant changes and clarifications:

The PFA process is managed and conducted by LMSB Industry Directors and field staff, with support from the Office of Pre-Filing and Technical Guidance in LMSB Headquarters. The PFA Program Manager receives all applications and, with the assistance of the Technical Advisors and the Office of Chief Counsel, ensures that the issues presented are appropriate for inclusion in the PFA program.

The Industry Director with jurisdiction over the taxpayer makes the final decision whether to accept a taxpayer’s request for participation in the PFA program. The criteria for selecting a request include:

For the cases selected for participation in the PFA program, a mandatory orientation session for the examination team and the taxpayer is conducted. Subsequently, the taxpayer and the examination team convene a joint planning meeting to reach agreement on a proposed timeframe, to identify and arrange for IRS access to relevant records and testimony, and to define the potential scope and nature of the PFA.

The examination team conducts the factual determination and issue development consistent with IRS auditing standards. Based upon an examination of the issue, the Team Manager prepares a PFA recommendation for the Industry Director. The Industry Director’s decision to execute a PFA closing agreement is based on the Team Manager’s recommendation and discussions with the PFA Program Manager, Chief Counsel attorneys, appropriate Technical Advisors, and the taxpayer. Following Chief Counsel review to ensure that the proposed PFA closing agreement conforms with guidance provided in Rev. Proc. 68-16, 1968-1 C.B. 770 (regarding closing agreements), the Industry Director will execute a PFA if he or she determines that:

A designated PFA Program Manager assigned to the Office of Pre-Filing and Technical Guidance in LMSB Headquarters provides oversight for the PFA program. The PFA Program Manager provides assistance to taxpayers, Industry Directors, and Team Managers throughout the process.

The tables below reflect the status of PFA applications received in calendar year 2004.

The applications received by the PFA program in calendar year 2004 came from taxpayers in each LMSB industry segment and involved a variety of issues as provided in the tables below.

Forty accepted applications (including applications accepted in prior years) were resolved or withdrawn in 2004.

In accordance with procedures set forth in Rev. Proc. 2001-22, four taxpayers withdrew from the PFA process in 2004 after their requests had been accepted (three of these were accepted before 2004). In one case the taxpayer and the Service agreed that the timeline was too burdensome. In the other cases, no explanation for the withdrawal was given by the taxpayer.

In 2004, the Service withdrew from the PFA process in eight cases accepted before 2004. In one case, the taxpayer did not have adequate records to substantiate a deduction for the Research and Experimental Credit. In the other seven cases, the taxpayer and the Service were unable to reach agreement.

The Service and the taxpayer mutually agreed to terminate the PFA process in one case. They agreed that it would be more efficient to roll the issue into the normal examination process rather than continuing with the PFA process.

Twenty seven PFAs were completed in calendar year 2004 that resulted in the execution of closing agreements. Eight of these were for applications received and accepted in 2004.

The Office of Chief Counsel provided advice to the examination teams and assisted in the drafting and review of the PFA closing agreements. No Technical Advice or Chief Counsel Advice Memoranda were issued for issues addressed in the PFA process.

The PFAs executed in 2004 involved the following issues:

In each of these unrelated cases, the taxpayer sought an agreement as to the fair market value of property donated to qualified organizations. Patents and technology were donated in four cases and land was donated in two other cases. In three of the cases, a closing agreement was executed specifying the fair market value of the property contributed. In the other three cases, both fair market value and deductibility were addressed, and in one of these, no deduction was allowed.

The taxpayers requested an agreement regarding the proper amount of qualified research expenses and the research credit under IRC § 41. Closing agreements were executed with all taxpayers. The closing agreements did not address the methodology to be used for subsequent years.

The taxpayer requested an agreement concerning the value of preferred stock in transactions intended to qualify as transfers to a controlled corporation under IRC § 351. A closing agreement was executed that specified the fair market value of the transferred stock and provided that the IRS would not challenge the value under IRC § 482 or other Code sections.

The taxpayer requested an agreement concerning the proper class lives and recovery periods of property placed in service during the tax year. The taxpayer and Service agreed to use statistical sampling techniques and came to agreement on the depreciation deduction amount. A closing agreement was executed specifying the amount allowed.

The taxpayer requested an agreement regarding the treatment of periodic fee income from software licenses. A closing agreement was executed specifying that the licenses shall be treated as leases rather than sales of software and that the fees shall be included in income in the year due and payable.

The taxpayer requested an agreement regarding the deductibility of periodic interest and other costs on debt. Some of the proceeds of this debt were temporarily invested in tax exempt securities. A closing agreement was executed specifying that the interest and costs are not to be disallowed under IRC § 265.

The taxpayer requested an agreement concerning the sale of the stock in its subsidiary for cash. A closing agreement was executed specifying the amount of the IRC § 338 aggregate deemed sales price.

The taxpayers requested an agreement regarding amounts deductible as ordinary losses on the worthlessness of stock in its subsidiary. A closing agreement was executed for each of the PFAs specifying that the stock was worthless and the amount to be deducted.

The taxpayer requested an agreement regarding its fuel credits through consideration of the “placed in service” question and other issues bearing on the credits. A closing agreement was executed specifying the amount of the fuel credit to be allowed and how that amount was to be allocated to the partners.

The taxpayer requested an agreement concerning the tax consequences of the sale of two parcels of property. A closing agreement was executed specifying the amount of the losses and that they are to be characterized as ordinary losses under IRC § 1231.

The taxpayer requested an agreement regarding the proper treatment of inventory write-downs. A closing agreement was executed specifying the amount allowable as a deduction reflected in the determination of the cost of good sold.

The taxpayer requested an agreement regarding the proper treatment of amounts paid to the U.S. government in restitution, civil damages, and fines. A closing agreement was executed specifying the amount allowable as restitution under IRC § 162 and the amount determined to be a fine or penalty and therefore not allowable as a deduction.

The application screening process is the process to determine if an application is appropriate for inclusion in the PFA program. This screening process includes obtaining comments from various LMSB functions and Chief Counsel, the review of these comments, and the acceptance or rejection of an application by the Industry Director. The average time from the date an application was received by the IRS until the Industry Director rendered a decision to accept or reject an application was 76 days.

The PFA evaluation process is the second (and final) phase in the PFA program. This phase begins when the Industry Director accepts an application into the PFA program and ends when a PFA closing agreement is executed or the process terminates as a result of a withdrawal. The average elapsed time during the PFA evaluation process for the 27 cases that resulted in closing agreements in calendar year 2004 was 285 days.

The PFA Program Manager ensures that an evaluation of all of the PFA program cases, based on feedback from LMSB employees and taxpayer participants, is solicited. As part of this program evaluation, LMSB and taxpayer participants were asked to provide the direct examination time expended to complete the PFA and an estimate of the direct examination time it would have taken to resolve the issue in a post-filing context. The table below indicates the results for those that provided a response since the program’s inception.

The average total time to conclude the 27 cases that resulted in closing agreements in calendar year 2004 was 360 days. Illustrated below are the processing statistics for the cases that resulted in closing agreements since the inception of the program.

The increased processing time can be attributed to the greater degree of complexity of the issues and the time necessary to develop the factual background. Generally, the more complex and fact intensive the issue is, the greater the time necessary to complete the process.

An additional aspect of the evaluation process is soliciting feedback from taxpayers regarding satisfaction with the PFA process through a questionnaire. Responses to the questionnaire were received from 11 of the 27 taxpayers who executed closing agreements for calendar year 2004. Taxpayers were asked to rate the PFA process on a scale of 1 to 5. The responses are summarized below.