On September 16, 2008, the IRS identified ten Tier III issues under its
“Industry Issue Focus” (“IIF”) program. The IRS established the IIF program in
March of 2007 to improve consistency in issue resolution across industry lines,
allow the IRS to focus on high risk areas, increase coverage of non-compliant
taxpayers by maximizing limited resources, and provide greater oversight on and
accountability for important issues.
In the IIF program, the IRS Large and Mid-Size Business Division (“LMSB”)
identifies compliance issues through field examinations and prioritizes the
issues into one of three categories (i.e., Tier I, Tier II, and Tier III) based
on how prevalent they are across industry lines and the level of compliance risk
they present. The IRS anticipated that Tier III issues would likely contain
issues affecting fewer taxpayers than issues in Tiers I and II. Tier I and II
issues address listed transactions and other issues of high potential
non-compliance or significant non-compliance risk, with varying levels of
discretion available to field examination agents. For additional information on
the IIF program, please see our
March 14, 2007
The ten Tier III issues identified by the IRS span each of the LMSB five
industry focus groups. The ten issues include:
Launch Fees Paid to Cable Operators
(Communication, Technology, and Media Industries). The IRS is examining
whether cable television operators who receive cash incentives (launch fees)
in connection with the execution of long-term affiliation agreements may
defer the launch fees and take them into income over the agreement period.
- Amortization of Intangibles (Communication, Technology, and Media
Industries). The IRS is examining whether broadcasters and cable channel
providers accrue liabilities for license fees for the rights to broadcast
sporting events upon the execution of the broadcast rights contracts and
amortize the fees over the term of the contract when they should, according
to the IRS, accrued the liability as the games are played.
- Real Estate Mortgage Investment Conduits (“REMIC”) (Financial Services
Industry). The IRS is examining REMIC sponsors' potential understatement
of reportable gain on the retention and the sale of regular interests. The
IRS is reviewing the sponsors' economic models and assumptions used to value
the residual interests in order to determine if the fair market value and
basis allocations are appropriate for the retained regular interests.
- Premium Deficiency Reserves (Financial Services Industry). This issue
concerns a reserve required by health, life and property casualty companies
to book additional liabilities and expenses associated with any contract
that will produce a loss during the subsequent year.
- Uniform Capitalization for Automobile Dealerships (Heavy Manufacturing
and Transportation Industries). The IRS is examining whether retailers
(including motor vehicle retailers) are properly applying the limitations
imposed in 2007 on a variation of the simplified retail method allowed by
the Uniform Capitalization (UNICAP) rules under Section 263A to calculate
capitalized costs. The IRS is concerned with how it should apply a 2007
technical advice, inconsistent treatment by examiners, and its belief that
the industry is “virtually completely non-compliant” with the 2007 technical
- Service Loyalty Programs (Heavy Manufacturing and Transportation
Industries). The IRS is concerned about the appropriate tax treatment of
loyalty programs such as frequent flyer programs in the air transportation
industry and frequent stay programs in the hospitality industry,
specifically whether revenues received as payment for these points are
subject to deferral under either a 1971 or 2004 revenue procedure.
- Delay Rental Payments (Natural Resources and Construction Industries).
The IRS is examining whether delay rental payments are subject to
capitalization under Section 263A as costs of producing property.
- Environmental Remediation Costs Under Section 198 (Natural Resources and
Construction Industries). The IRS is examining whether taxpayers are
complying with the requirements of Section 198 and related guidance, as well
as the relationship between capitalization requirements of environmental
remediation costs and the expensing of those costs.
- Cost Segregation Studies (Retail Food, Pharmaceuticals, and Healthcare
Industries). The IRS is examining whether assets are Section 1250 property
(generally subject to depreciation over 39 years) or Section 1245 property
(generally subject to depreciation over 5-7 years).
- Vendor Allowances (Retail, Food, Pharmaceuticals, and Healthcare
Industries). The IRS is examining whether vendor allowances are properly
characterized as gross income, trade or other discounts reducing the invoice
price of merchandise, or the reimbursement of an expense, as may be
appropriate. Vendor allowances include, but are not limited to, asset-based
allowances, merchandise-based allowances, sales-based allowances, post
acquisition-based allowances and can also include upfront payments.
Although many of these issues address accounting issues, the IRS has
indicated that it is not specifically targeting accounting issues. However, due
to the recent prevalence of accounting issues in examinations and the IRS’
historic difficulty of handling accounting issues, the focus on these issues is
The identification of an issue as a Tier III issue does not necessarily mean
that audits on these issues are automatic. Instead, the IRS sees these issues as
issues in need of national coordination, development, and potential guidance.
Even so, taxpayers, and their advisors, with these issues should prepare
themselves for potential examination by the IRS.
McGuireWoods LLP routinely handles tax controversies and litigation against
the Internal Revenue Service and has broad experience representing clients in
LMSB audits. If you have any questions, please do not hesitate to contact us at