Announcement 2004-59

As a result of the success of a pilot program, the IRS established a permanent PFA Program with the issuance of Rev. Proc. 2001-22. Although many of the procedures remained the same, there were some significant changes, including:

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, a mandatory orientation session for the examination team and the taxpayer is conducted. Subsequently, the taxpayer and 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 conforms with guidance provided in Rev. Proc. 68-16 (regarding closing agreements), the Industry Director could 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 table below reflects activity concerning those PFA requests which were received in calendar year 2002 or prior and carried over into calendar year 2003.

The table below reflects the status of PFA requests received in calendar year 2003.

The 42 applications that were received for the PFA program in calendar year 2003 came from taxpayers in each LMSB industry segment and involved a variety of issues as provided in the tables below.

Five of the applications received in 2003 were not considered appropriate for the PFA program.

In accordance with procedures set forth in Section 8 of Rev. Proc. 2001-22, 4 taxpayers withdrew from the PFA process — three after their requests had been accepted and one prior to acceptance. Due to tax legislation enacted in 2003 regarding dividends, one taxpayer withdrew its PFA request regarding a conversion from a C corporation to a partnership. Another case concerning the fair market value of a qualified conservation contribution was withdrawn because the taxpayer could not reach an agreement as to fair market value. In another case, regarding the accounting method to be used for qualified research expenses, the taxpayer could not reach an agreement regarding the appropriate project accounting methodology to be used. In another case, concerning the research and experimental credit, after an initial informal meeting with the examination team, the taxpayer determined that its facts were not appropriate and withdrew its PFA request before the Industry Director made a decision to accept the request.

The Service withdrew from the PFA process in two cases. In one case, the existence of an open regulations project within the Office of Chief Counsel relating to IRC § 4271 indicated that the legal issue to be addressed by the PFA was not well settled. In another case, the taxpayer and the Service could not agree to the facts regarding products held for sale that were subject to excise taxes.

The Service and the taxpayer mutually agreed to terminate the PFA process in 2 cases. In the first instance, the taxpayer and the Service were unable to agree on the methodology for computing the net operating loss carryover relating to stock acquisitions. In the other case, the taxpayer and the Service were unable to reach an agreement regarding the fair market value of contributed patents and intellectual property.

Eighteen PFAs were completed in calendar year 2003, resulting in the execution of closing agreements.

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 executed PFAs involved the following issues:

The taxpayer requested a factual determination regarding the fair market value of the taxpayer’s assets for purposes of computing built-in gain pursuant to IRC § 1374. Prior to the taxpayer’s election to be treated as a small business corporation under IRC § 1362, the taxpayer was taxed as a C corporation. IRC § 1374 imposes a tax on an S corporation that has a net recognized built-in gain during the recognition period. A closing agreement was executed specifying the fair market value of the property identified in the agreement.

In each of these unrelated cases, the taxpayers sought an agreement as to the fair market value of certain patented technology donated to qualified organizations. In each of the cases, a closing agreement was executed specifying the fair market value of the property contributed.

Three taxpayers requested an agreement regarding the proper amount, if any, of qualified research expenses and the research credit under IRC § 41 as well as the amount of experimental expenditures under IRC § 174. Closing agreements were executed with all three taxpayers. The closing agreements did not address the methodology to be used for subsequent years.

The taxpayer requested agreements concerning two separate transactions intended to qualify as tax-free transfers of assets and stock under IRC § 351. A closing agreement was executed for each transaction that specified the taxable status of each transfer and the fair market value of the transferred stock and assets.

The taxpayer requested an agreement regarding the tax treatment of fees and other expenditures incurred in connection with the following transactions: (1) an acquisition of stock in a reverse triangular merger; (2) an acquisition of separately acquired businesses for cash; and (3) a disposition of a portion of the acquired businesses in response to antitrust concerns. A closing agreement was executed specifying the nature and treatment of the fees and expenditures and whether such costs were currently deductible under IRC § 162, amortizable under IRC § 195 or capitalized under IRC § 263.

The taxpayer requested an agreement concerning whether certain advances made to the taxpayer’s wholly owned foreign subsidiary and treated as loans were worthless during the taxable year. A closing agreement was executed specifying the amount of bona fide indebtedness and the amount considered a bad debt and allowable under IRC § 166.

The taxpayer requested an agreement regarding the existence, amount and deductibility under IRC § 165 of abandonment losses incurred. A closing agreement was executed specifying the amount of abandonment loss.

The taxpayer requested an agreement concerning the potential application of IRC § 382 with respect to prior-year net operating loss carryforwards in the case of an ownership change of greater than 50 percent occurring over a three-year period. A closing agreement was executed specifying that an ownership change did not occur and that the taxpayer was not subject to the limitation. In an unrelated request, the taxpayer requested an agreement regarding the number of ownership changes. A closing agreement was executed specifying the number of ownership changes.

The taxpayer requested an agreement concerning the tax consequences of the sale of the taxpayer’s entire interest in a foreign subsidiary for cash along with a discharge of various liabilities. A closing agreement was executed specifying the amount of the capital loss under IRC § 165 and the amount of ordinary and necessary business expense deductible under IRC § 162.

The taxpayer requested an agreement regarding the proper treatment of start-up costs and operating expenses. A closing agreement was executed specifying the amounts amortizable under IRC §§ 195 and 709, the amounts depreciable under IRC § 167 and the amounts deductible under IRC § 162.

The taxpayer, the parent of a consolidated group, requested an agreement regarding amounts deductible as ordinary losses on the worthlessness of stock and notes in its foreign subsidiary. A closing agreement was executed specifying that the stock and notes of the subsidiary were worthless, the amount of loss on the stock deductible under IRC § 165 and the amount of bad debt expense deductible under IRC § 166.

A taxpayer requested an agreement regarding the fair market value and deductibility of stock contributed to pension plans administered by the taxpayer. A closing agreement was executed specifying the value to be used for purposes of IRC §§ 162 and 404.

Phase I is the screening 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. Of the 42 applications received during the calendar year 2003, 34 applications completed the Phase I Application Screening Process. Of these 34 applications, 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 65.8 days. For the 18 cases that resulted in closing agreements in 2003, the average time for completing the Phase I process was 59.1 days.

The second (and final) phase in the PFA program process is the evaluation phase. 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 Phase II Evaluation Process for the 18 cases that resulted in closing agreements in calendar year 2003 was 240.3 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 a 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.

The average total time to conclude the 18 cases that resulted in closing agreements in calendar year 2003 was 299.4 days. The range was from 100 to 808 days. Illustrated below are the average elapsed time (in days) processing statistics for the 11 cases that resulted in closing agreements under the pilot program, the seven cases that resulted in closing agreements in calendar year 2001, the 12 cases that resulted in closing agreements in calendar year 2002 and the 18 cases that resulted in closing agreements in calendar year 2003.

The increased processing time for 2003 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 responses from taxpayers regarding satisfaction with the PFA process in a questionnaire. Responses to the questionnaire were received from 14 of the 18 taxpayers who executed closing agreements for calendar year 2003. These responses were converted to mathematical equivalents based on the level of satisfaction, were arrayed and a mean average to each question was calculated. The responses received are summarized below.