LMSB has announced its Industry Issue Focus ("IIF") program as part of its effort to coordinate its approach to developing strategic issues for enforcement and potential litigation. LMSB plans to focus its management effort and resource deployment on those issues that it believes have the greatest compliance risk. The IRS sees the program as consistent with its efforts to examine more taxpayers by focusing on industry issues. Under the program, LMSB will identify potential IIF issues through examinations, Schedule M-3 reviews, and other sources. LMSB will prioritize IIF issues into "tiers" based on how prevalent they are across industry lines and the level of compliance risk. For each issue, LMSB will appoint an Issue Owner Executive (or "IOE") who is responsible for overseeing the identification of the issue, developing an IRS position, and coordinating on disposition or resolution. Exam, Counsel, and Appeals will coordinate in identifying and prioritizing issues as well as developing the IRS positions on IIF issues.

The initiative appears to be the next step in the IRS’s establishment of issue management teams ("IMTs") to develop generic issues for application to multiple taxpayers. See Miller & Chevalier Tax Alert of July 6, 2006. The IMTs evolved from the cross-functional teams that the IRS used to identify corporate tax shelters, develop the IRS’s positions, and coordinate with the field. See Blair & Mersereau, "Chief Counsel Revamps Case-Specific Advice Procedures to Match LMSB’s New Enforcement Paradigms," 58 The Tax Executive, 300, 302 (July-August 2006).

One troubling carryover from this history has been the involvement of Appeals personnel in developing the IRS position on a "generic" issue. In the tax shelter context, Appeals involvement at the issue-development stage made it difficult for taxpayers with that issue to get a fresh look from Appeals. If the same problem arises in more mainstream issues, it could undermine Appeals’ ability to settle these issues. Notwithstanding these concerns, recent press reports indicate that LMSB plans to involve Appeals in shaping how LMSB manages and handles IIF issues. Taxpayers and their advisors will be interested to watch how this role develops for Appeals.

Tier I -High Dollar/High Visibility Issues

Tier I issues are those issues that LMSB has determined to have high strategic importance, a significant impact on one or more industries, high dollar risk, substantial compliance risk, or high visibility. LMSB includes issues in Tier I where it believes the law (or at least the IRS’s position) to be well established. LMSB requires that the IOE have oversight and control over Tier I issues. The disposition or resolution of Tier I issues must be in accordance with the IOE’s guidance. Accordingly, taxpayers can expect that their audit team will have little control over the disposition of these issues. The Tier I issues and IOEs assigned to these issues are as follows:

1 .§ 118 Abuse - Jo Ann Bank, Director, Field Operations West, Communications, Technology, and Media

2. § 162(f) -DOJ Settlements - John Risacher, Industry Director, Retailers, Food, Pharmaceuticals, and Healthcare

3. § 936 Exit Strategies - John Risacher, Industry Director, Retailers, Food, Pharmaceuticals, and Healthcare

4. Foreign Tax Credit Generators - Barry Shott, Industry Director, Financial Services

5. Backdated Stock Options -Laura M. Prendergast, Deputy Director, Field Specialists

6. Domestic Production Deduction IRC § 199 - John Risacher, Acting Industry Director, Heavy Manufacturing and Transportation

7. Foreign Earnings Repatriation - Frank Ng, Deputy Commissioner, International

8. International Hybrid Instrument Transactions - Walter Harris, Director, Field Specialists

9. Mixed Service Costs - Keith Jones, Industry Director, Natural Resources and Construction

10. Nonqualified Deferred Executive Compensation (§ 409A) - Walter Harris, Director, Field Specialists

11. Research & Experimentation (R&E) Credit Claims - Cheryl Claybough, Director, Field Operations East, Communications, Technology, and Media

12. Transfer of Intangibles Offshore/Cost Sharing - Patricia Chaback, Industry Director, Communications, Technology, and Media

13. Tax Shelter - Distressed Asset/Debt - Larry Barnes, Director, Field Operations East, Heavy Manufacturing and Transportation

14. Tax Shelter - Redemption Bogus Optional Basis - Patricia Chaback, Industry Director, Communications, Technology, and Media

15. Listed Abusive Tax Shelters and Transactions - various IOEs

Tier II - Potential IRS Litigation Vehicles

Tier II issues are issues with potential high non-compliance or significant compliance risk to LMSB or an industry. Tier II includes emerging issues for which LMSB believes that the law requires development, clarification, direction, or guidance. Tier II issues require coordination with the IOE, who is responsible for ensuring that the disposition or resolution of the issues will not undermine LMSB’s efforts to develop the law and guidance in the area. Taxpayers that find themselves with Tier II issues may very well find that their cases are litigation vehicles for the IRS’s effort to clarify the law in a particular area.

With respect to Tier II issues, Chief Counsel has acknowledged that that facts and circumstances in each particular case will impact the merits. LMSB Division Counsel explained that the IRS intends to allow the field more discretion in applying Tier II guidance based on facts and circumstances.

The Tier II issues and IOEs assigned to these issues are as follows:

1. Casualty Loss: Single Identifiable Property/Capital vs. Repairs - Sergio Arellano, Director, Field Operations East, Natural Resources and Construction

2. Cost-Sharing-Stock Based Compensation - JoAnn Bank, Director, Field Operations West, Communications, Technology, and Media

3. Enhanced Oil Recovery Credit IRC 43 - Sergio Arellano, Director, Field Operations East, Natural Resources and Construction

4. Extraterritorial Income Exclusion Effective Date and Transition Rules - Larry Barnes, Director, Field Operations East, Heavy Manufacturing and Transportation

5. Gift Cards: Deferral of Income - Lori Nichols, Director, Field Operations East, Retailers, Food, Pharmaceuticals, and Healthcare

6. Healthcare Accounting Issues: Contractual Allowance - Lori Nichols, Director, Field Operations East, Retailers, Food, Pharmaceuticals, and Healthcare

7. Interchange Merchant Discount Fees - Barry Shott, Industry Director, Financial Services

8. Non-Performing Loans - Barry Shott, Industry Director, Financial Services

9. Specific Liability Loss, IRC 172(f) - Paul Cordova

10. Deferred Home Construction Contracts - Paul Cordova, Director, Field Operations West, Natural Resources and Construction

11. Super Completed Contract Method - Paul Cordova, Director, Field Operations West, Natural Resources and Construction

12. Upfront Fees, Milestone Payments & Royalties in the Biotech & Pharmaceutical Industries - Kurt Meier, Director, Field Operations West, Retailers, Food, Pharmaceuticals, and Healthcare

Tier III - Industry Specific Issues

LMSB also plans a Tier III for issues that are of importance to a particular industry. LMSB directs its examiners to consider Tier III issues in when conducting their risk analysis. The LMSB field examiners should use existing resources and guidance in developing and disposing of these issues. There is no specific coordination requirement. The recent IIF announcement did not designate any Tier III issues, and it is not clear that LMSB will create a list of Tier III issues similar to the Tier I and Tier II lists.

Developments to Watch

Taxpayers should keep track of the issues that LMSB designates under the IIF program because their Exam teams are likely to focus on these issues. Indeed, one potential benefit of the IIF program may be that IRS examiners spend less time examining returns that have no IIF issues. Taxpayers should also be aware that their Exam team may lose all or some of its discretion over IIF issues. With respect to Tier II issues, it will be important to emphasize any facts and circumstances that distinguish your case from the generic IIF issue or that make your case a poor litigation vehicle. Finally, taxpayers should monitor developments regarding the independence of the Office of Appeals as IIF issues reach that level. While IRS officials have publicly stated that taxpayers retain their administrative appeal rights, those rights may be illusory if Appeals has already weighed in on the development of the LMSB position.

For further information, please contact any of the following lawyers:

George Hani, ghani@milchev.com, 202-626-5953

Laura Ferguson, lferguson@milchev.com, 202-626-5567

David Blair

The information contained in this communication is not intended as legal advice or as an opinion on specific facts. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. For more information, please contact one of the senders or your existing Miller & Chevalier lawyer contact. The invitation to contact the firm and its lawyers is not to be construed as a solicitation for legal work. Any new lawyer-client relationship will be confirmed in writing.

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