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Presenting a live 110‐minute webinar with interactive Q&A

State Corporate Income Tax Audits: Preparing the CaseAnticipating Critical Planning and Documentation Needs for State Examinations

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

THURSDAY, JANUARY 20, 2011

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

Jeff Blum National Leader Multistate Tax Controversy Practice Deloitte Tax MiamiJeff Blum, National Leader, Multistate Tax Controversy Practice, Deloitte Tax, Miami

Nicole Crighton, Principal, KPMG, New York

Walter Nagel, Partner, Reed Smith, Washington, D.C.

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St t C t I T A dit State Corporate Income Tax Audits: Preparing the Case Webinar

Jan. 20, 2011

Nicole Crighton, [email protected]

Jeff Blum, Deloitte [email protected]

Walter Nagel, Reed Smith [email protected]

Today’s Program

Pre-Audit Best Practices[Jeff Blum]

Slide 6 – Slide 16

Best Practices During The Audit[Nicole Crighton]


Best Practices After The Audit[Walter Nagel]


PRE AUDIT BEST PRACTICESJeff Blum, Deloitte Tax

PRE‐AUDIT BEST PRACTICES

Transfer Pricing Audits

• Several separate reporting company states have retained outside contractors to identify taxpayers that may be appropriate targets for transfer pricing adjustments. One contractor has applied for a state transfer pricing audit patent.

Copyright © 2011 Deloitte Development LLC. All rights reserved.7

Transfer Pricing Audit Methodology Patent

A system and method are provided for analyzing tax avoidance of a taxpaying entity. A taxpaying entity’s financial information may be analyzed and used to compute a set of one or more financial ratios based at least in part on the entity’s return on assets, capital, sales, and/or operating expenses. Those ratios may be compared to corresponding ratios for related firms operating in a pre definedcompared to corresponding ratios for related firms operating in a pre-defined industry to identify whether the taxpaying entity engages in tax avoidance. The level of the taxpaying entity’s tax avoidance may be calculated from analysis of the taxpaying entity’s controlled transactions An adjusted tax liability may bethe taxpaying entity s controlled transactions. An adjusted tax liability may be produced after redistribution, re-apportioning or re-allocation of income, deductions, credits or allowances.


Transfer Pricing AuditsThe transfer pricing firm lists the following jurisdictions as its clients:

- Alabama

- Minnesota

- CaliforniaCa o a

- Connecticut

- Los Angeles

- New Jersey

- Rhode Island

- District of Columbia


Forced Combination

States are increasingly asserting forced combinations.

Wal-Mart Stores East Inc v Hinton: Forced combination between retail storeWal-Mart Stores East, Inc. v. Hinton: Forced combination between retail store company and captive REIT

Court also upheld 25% under-reporting penalty.p p g p y


Economic Substance And Business Purpose

- Wisconsin

- Connecticut

- California- California

- New York

- Texas


Uncertain Tax Positions And Tax Accrual Workpapers

IRS Announcement 2010-98• Taxpayers required to report uncertain tax position

IRS form• Statement for the rationale behind uncertain tax position• Statement of reasons why a tax position is uncertainStatement of reasons why a tax position is uncertain• Quantification of maximum adjustment associated with the position

Announcement 2010-76 expands and clarifies policy of restraint with p p yrespect to tax accrual workpapers

What will states do?


Pre-Audit Planning

Know your filing position• How is your system sourcing receipts?• How is this documented?How is this documented?

Review prior audit history• Reliance on previous results, correspondence or agreement with theReliance on previous results, correspondence or agreement with the

state• Unresolved issues still under protest?

Gather intelligence and data• What are state hot button issues?• Is your documentation sufficient?


Is your documentation sufficient?

Pre-Audit Planning (Cont.)

Refunds and other offsetting claims• Are there open federal periods?• Will an extension help? • Interest is usually a factorInterest is usually a factor

Know the rules• Will the state “net” the refund against assessment, or is a separate claim g , p

required?• Whose refund is it? Unitary group vs. individual entity


Pre-Audit Planning (Cont.)

Inconsistent positions

• Are the positions truly inconsistent?

I h diff i h d i h ?• Is there a difference in the tax statutes and taxing schemes?

• Can a state require you to produce copies of other state returns?

• Does the inconsistency create nowhere income or multiple deductions?

• Potential to reduce assessed amount


Contacts

Jeffrey S. BlumNational Leader Multistate Controversy Tax Services305-808-2360 [email protected]

This presentation contains general information only and the respective speakers and their firms are not, by means p g y p p , yof this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. The respective speakers and their firms shall not be responsible for any loss sustained by any person who relies on this presentation.


BEST PRACTICES DURING THE Nicole Crighton, KPMG

BEST PRACTICES DURING THE AUDIT

NOTICE

ANY TAX ADVICE IN THIS COMMUNICATION IS NOTANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND

CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDINGPERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER

OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREINANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions,

memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser

© 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International (“KPMG International”), a Swiss entity. Printed in the U.S.A. FOR INTERNAL USE ONLY.

Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.18

determined through consultation with your tax adviser.

DATED MATERIALDATED MATERIAL

THE MATERIAL CONTAINED IN THESE COURSE MATERIALS IS CURRENT AS OF THE DATE PRODUCED. THE MATERIALS

HAVE NOT BEEN AND WILL NOT BE UPDATED TO INCORPORATE ANY TECHNICAL CHANGES TO THE CONTENT

OR T0 REFLECT ANY MODIFICATIONS TO A TAX SERVICE OFFERED SINCE THE PRODUCTION DATE. YOU ARE

RESPONSIBLE FOR VERIFYING WHETHER OR NOT THERE HAVE BEEN ANY TECHNICAL CHANGES SINCE THE

PRODUCTION DATE AND WHETHER OR NOT THE FIRM STILL APPROVES ANY TAX SERVICES OFFERED FORAPPROVES ANY TAX SERVICES OFFERED FOR

PRESENTATION TO CLIENTS. YOU SHOULD CONSULT WITH WASHINGTON NATIONAL TAX AND RISK MANAGEMENT-TAX

AS PART OF YOUR DUE DILIGENCE



AS PART OF YOUR DUE DILIGENCE.

Preparing For The Audit

Review previous audit fileDetermine what issues aroseReview how if at all those issues were resolvedReview how, if at all, those issues were resolvedIdentify whether the taxpayer agreed to any filing positions that would apply in the current audit cycleId tif th d ti th dit d h th th t i di id lIdentify the person conducting the audit and whether that individual is different in this audit cycle



Preparing For The Audit (Cont.)

Review returns under auditUsing prior audit file identify potential exposuresUsing prior audit file, identify potential exposuresIdentify potential refund opportunities and discuss refund strategy with the client

Does taxpayer prefer to identify refund issues when the auditorDoes taxpayer prefer to identify refund issues when the auditor walks into the door, or …Wait to the end when the audit is nearly complete?



Preparing For The Audit (Cont.)

Review return preparation fileReview notes“Pull before audit”Pull before audit Identify issues raised by the reviewer and determine whether they are exposure itemsConsider gathering documents related to those issuesConsider gathering documents related to those issues



During The Audit

Managing the auditConduct a “pre-audit” conference with the taxpayer

Identify taxpayer’s refund strategyIdentify taxpayer’s waiver strategyIdentify taxpayer s waiver strategyIdentify location where audit will occurIdentify issues likely to arise during the auditU f l t i filUse of electronic filesUse of electronic audit roomsUse of plant tours or similar excursionsIdentify taxpayer’s policy on entertaining auditor (you should already be aware of state statutory limitations)



During The Audit (Cont.)

Managing the audit (Cont.)Conduct a “pre-audit” conference with the auditor

Get to know your auditorGet to know your auditorIdentify what years under auditDetermine how much time will be neededD t i h t d t b i dDetermine what records are to be reviewedDiscuss use of electronic audit roomsIdentify auditor’s policy on accepting lunch or dinner (you should already be aware of state statutory limitations)




Managing the auditIdentify an audit spokesperson

Auditor’s point of contact during auditResponds to information requestsResponds to information requestsGathers documentsEnsures a positive relationship between taxpayer and auditorN ti t i th iNegotiates issues as they ariseAssists in controlling auditor’s access to information




Information document requests (IDRs)Request for audit usually comes with a list of initial informationAuditor may present additional IDRs after reviewing this informationBe mindful of response timesBe mindful of response times

“As a general rule, response times shall be determined on an IDR-by-IDR basis with a maximum response time of 30 days from the date the IDR was hand-delivered to the taxpayer or thefrom the date the IDR was hand delivered to the taxpayer, or the taxpayer’s representative by the auditor or the date mailed by the auditor …” Cal. Code Regs. tit. 18, 19032(b)(5)(C)g , ( )( )( )




What must the taxpayer provide to the auditor?Request for 50-state apportionment spreadsheet

Dial Bank v. Ala. Dep’t of Revenue (Ala. Admin. Law Div. 1998)Alabama DOR requested a 50-state apportionmentAlabama DOR requested a 50 state apportionment spreadsheet from Dial during the audit. Dial refused to provide the spreadsheet. Alabama assessed Dial using a 50% apportionment factor. ALJ concluded that assessments ppwere arbitrary and could not be upheld. However, the ALJ did state that the department is authorized to require corporations to provide a 50-state apportionment worksheet,for income tax purposes.




What must the taxpayer provide to the auditor?Request for tax accrual workpapers

U.S. v. Textron (1st Cir., en banc, 2009)Court held that taxpayer’s tax accrual workpapers were not protected under the work product doctrine and thus had to be turned over to the IRS in its tax shelter investigation.

Opinion on sale-structuringC ’ f R C t C (M 2009)Comm’r of Revenue v. Comcast Corp. (Mass. 2009)

Certain memoranda prepared by an accounting firm were protected from disclosure to taxing authorities under the work product doctrinedoctrine.» Taxpayer had the prospect of litigation in mind when it

requested advice, and the memoranda would not have been prepared irrespective of the prospect of litigation.




What must the taxpayer provide to the auditor?Request for tax accrual workpapers

IRS Policy for requesting audit workpapers, tax accrual work papers and tax reconciliation workpapersp p p p

1) Single disclosed listed transaction: IRS will routinely seek tax accrual workpapers only relating to listed transaction/

2) Non-disclosed listed transaction or multiple-listed2) Non disclosed listed transaction or multiple listed transaction: IRS will routinely seek ALL tax accrual workpapers.

3) Unusual circumstances standard for non-listed transactions3) Unusual circumstances standard for non listed transactions4) Reported financial irregularities: IRS will ask for all tax

accrual workpapers.




What must the taxpayer provide to the auditor?Request for tax accrual workpapersRequest for tax accrual workpapers

Documentation created to comply with FASB Interpretation No. 48 (FIN48) (FASB ASC 740-10-25) is considered part of tax accrual workpapers IRS Chief Counsel Memo AM 2007-0012accrual workpapers. IRS Chief Counsel Memo AM 2007 0012 (Mar. 22, 2007)

State audit request for tax accrual and FIN 48 (FASB ASC 740-10-25) workpapers?25) workpapers?



Best Practices During Audit

Procedures for providing documents to auditorUse of Bates numbers

Keeping management informed of issues as they arise

N ti t i th iNegotiate issues as they arise

Know when your taxpayer will agree to disagree with auditor



After The Audit

Whether state will issue a proposed assessment

Process for addressing proposed assessmentWhat are penalties for failure to respond to a proposed assessment?Can the taxpayer get an extension of time?

Will the state issue a final assessment, and if so, what is an appropriate response?

Whether state employs a tax court, and if so, what type of assessment will allow you to get there

If the taxpayer has an opportunity to go to the tax court, is that move advisable?



move advisable?

BEST PRACTICES AFTER THE Walter Nagel, Reed Smith

AUDIT

B P i Af Th A diBest Practices After The Audit

I. General post-audit considerations

II. Administrative review and appeal

III. Judicial appeal

34

G l P A di C id iGeneral Post Audit Considerations

I. Resolving auditor error and areas of disagreement

II P i f th t dit fII. Preparing for the post-audit conference

III Protecting privilege and confidential documentsIII. Protecting privilege and confidential documents

IV. Understanding settlement authorityIV. Understanding settlement authority

V. Evaluating alternative tracks

35

Preparing For The Post‐Audit Conference

I. Decide whether to get counsel involved

II U d i l tII. Use a non-adversarial tone

III Understand the auditor’s position and all documents and III. Understand the auditor s position and all documents and workpapers used to develop audit assessment

IV. Understand administrative protest and appeal procedures

A. Especially penalty waiver requirements

36

Resolving Auditor Error And Areas of Disagreement

I. Most auditors are willing to correct factual or technical (e.g., mathematical) errors.

II. However, disagreements involving substantive issues (e.g., whether the auditor correctly applied the relevant legal standard) may be beyond the auditor’s ability to resolve.

III Best practicesIII. Best practices

A. Understand the scope of the auditor’s discretion

B Know all future opportunities for resolutionB. Know all future opportunities for resolution

37

Protecting Privilege And Confidential Documents

I If you wait until you’re in court then it’s too late!I. If you wait until you re in court, then it s too late!

II. Attorney–client privilege

A. Generally, an attorney’s communications with his or her client are protected against disclosureprotected against disclosure.

III. Accountant–client privilege

A. In some states, an accountant’s communications with his or her client are protected against disclos reare protected against disclosure.

IV. Work product doctrine

A. Generally, documents and other materials containing the mental f h f f impressions of an attorney or other representatives of a part are, if

prepared in anticipation of litigation, “work product” and not discoverable.

38

U d di S l A h iUnderstanding Settlement Authority

I. Ability to settle at:

A. Audit level

B Ad i i t ti t t/ l l lB. Administrative protest/appeal level

C. Judicial review level

II. Alternative dispute resolution

III. Quasi-settlement programs

A. State amnesties

B. Voluntary disclosure programs

39

E l i Al i T kEvaluating Alternative Tracks

I. Understand the pros/cons in the particular jurisdiction

A M t ll l i t kA. Mutually exclusive tracks

B. Independent tribunal

C Final determinationC. Final determination

D. Public record

40

Ad i i i R i A d A lAdministrative Review And Appeal

I. Filing the audit protest

II I f l f /h iII. Informal conference/hearing

III Filing the administrative appealIII. Filing the administrative appeal

IV. General considerationsIV. General considerations

A. Protest and appeal deadlines

B. Know who may represent the taxpayer

41

J di i l A lJudicial Appeal

I J di i l l d dliI. Judicial appeal deadlines

II. State pre-payment requirements

A. Prepayment of assessmentp y

1. Full “pay-to-play”

2. Partial “pay-to-play”

3. No “pay-to-play”

B. Bond posting

III Establishing the record/standard of reviewIII. Establishing the record/standard of review

IV. Another chance to settle

42