Senior financial executives and tax directors say they lack formal policies and procedures to manage the IRS exam process effectively, despite reporting a noticeable increase in Internal Revenue Service corporate audit activity over 2008 levels, according to a recent survey by KPMG LLP.

In the survey, 40 percent of the nearly 300 senior executives and tax directors polled said that their companies did not have a formal policy or procedure in place to manage the IRS exam process, yet 40 percent said their companies were involved with more IRS corporate audit activity, such as exams and appeals, than two years ago. Almost half — 49 percent — said the level of their audit involvement was unchanged from 2008.

“As jurisdictions face budget deficits and seek new sources of revenue, companies will find that being unprepared can make the audit process extremely time-consuming and strain resources,” said Sharon Katz-Pearlman, principal-in-charge of KPMG’s Tax Controversy Services practice.

At least partly due to looming budget deficits, there is currently a more focused tone around audits, she indicated. “And that is driving more deficiency determinations, and more adjustments,” she said. “We’re seeing more adjustments being made at the exam level, and as the Service coordinates its efforts around specific issues, it becomes more difficult to resolve those issues at that level.”

The Issue Tiering strategy, adopted by the IRS in 2006, is a factor in the number of cases that are not agreed to at the examination level, observed Katz-Pearlman. “It helps the LMSB [Large and Mid-Size Business Division] treat certain issues consistently across the division for all taxpayers involved in the same issue,” she said. “But it takes more discretion away from the agents, so they aren’t always able to reach a resolution at the examination level.”

The survey respondents were a mix of all corporate entities. “It represents a full range of corporate size from smaller corporations to very large CIC [coordinated industry case] corporations,” she said.

“Even though there is clearly more IRS audit activity, companies internally are not always as prepared to respond as they should be,” said Katz-Pearlman. “As jurisdictions face budget deficits and seek new sources of revenue, companies will find that being unprepared can make the audit process extremely time-consuming and strain resources,” she observed.

“The increased likelihood of an audit by taxing authorities can be a significant tax risk that should be high on the priority list of tax directors, CFOs and corporate boards,” said Katz-Pearlman. “Companies of every size should regularly review their accounting methods, tax returns, risk assessments, and the like, and develop or review policies and procedures so they are ready if they receive an audit notification.”

Although many reported that they did not have formal procedures or processes in place to manage the IRS exam process, many do conduct the necessary due diligence related to tax-filing reviews. For example, the majority — 72 percent — of respondents said they proactively review their tax filings to help identify potential issues that might arise during an IRS examination.

“As Schedule UTP [Uncertain Tax Position Statement] becomes imminent, tax departments are starting to look at where they may have uncertainty, and where they can take steps to reduce the uncertainty,” said Katz-Pearlman.

As currently proposed, businesses with a $10 million asset threshold will be required to disclose uncertain tax positions on the new schedule. 

“If all issues are not resolved during the examination, there are many options available to resolve the case at a higher level of review,” she added. “Therefore, it is critical that companies understand their choices — appeals, mediation, and early referral to name a few — and the necessary procedural steps for each of the options.”