The IRS is ready to make significant changes to the income tax form Schedule E, Supplemental Income and Loss, in an effort to ease the process of matching information from Schedules K-1 to taxpayers' income tax returns. Earlier this summer the IRS launched a massive K-1 matching program in an attempt to match income between taxpayers and pass-through entities.

Pass-through entities include partnerships, S corporations, estates, and trusts. These entities provide their partners, shareholders, and beneficiaries a Form K-1 that summarizes the appropriate share of income and expenses. Information on the K-1 forms is then reported and taxed on the individual's income tax return.

Shortly after beginning the matching process, the IRS halted the program, facing criticism from pundits who argued the program would require taxpayers to spend unnecessary time proving to the IRS that they had indeed reported their income and expenses correctly.

An effective solution seems to have been achieved by changing the Form 1040 Schedule E to require taxpayers to report exact amounts as they appear on each K-1 form received. This type of reporting will enable an electronic matching process to occur rather than the cumbersome manual process that the IRS was attempting to pursue.

The IRS estimates that billions of dollars are lost in tax revenue as a result of somewhere between 6% and 15% of taxpayers not reporting K-1 information on their income tax returns.

Wealthy taxpayers who want to avoid paying exorbitantly high estate taxes of up to 50% have taken solace in recent years with a tax scheme that enabled them to purchase certain life insurance policies which get passed on to heirs tax free. Those days are over.

The way the scheme worked, up until last Saturday's Treasury Department notice (Notice 2002-59), a taxpayer would purchase a life insurance policy for a high price, when the actual value of the policy is significantly lower. The taxpayer would report the lower price on a gift tax return. The difference between the actual cost of the policy and the value of the policy would be invested, tax free, and used to pay the premiums for the remaining life of the taxpayer. Since life insurance proceeds are not taxed, when the taxpayer dies, the entire value of the policy gets passed over to the beneficiary or beneficiaries, tax free.

"The Notice makes clear that using any scheme to understate the value of benefits for income or gift tax purposes won't be respected," said Pamela F. Olson, acting assistant Secretary of the Treasury for Tax Policy.

Some taxpayers have invested as much as $40 million for such policies. The New York Times (U.S. Bans a Scheme to Avoid Estate Tax, August 17, 2002), described a typical policy that might cost $550,000 but be worth $50,000. The taxpayer reports $50,000 as a gift and the $500,000 passes out of tax range. In a second layer of the tax avoidance scheme, the taxpayer can gift the policy to his or her spouse, and since gifts to spouses are not subject to gift tax, the entire transaction becomes tax free.

The technique was devised in 1996 by a New York lawyer, Jonathan G. Blattmachr, and a California-based chemical engineer, Michael Brown. The two received a ruling from the Internal Revenue Service allowing what was at that time called "family reverse split-dollar" life insurance. The Treasury Department now claims that Mr. Blattmachr, who has been advising clients on this technique since 1996, went far beyond the intent of the ruling.

The Institute of Internal Auditors Chairman LeRoy E. Bookal has outlined the key challenges confronting internal auditors after the recent round of accounting scandals and legislative reforms. The challenges focus on ways to create a working environment conducive to creating opportunities for internal auditors to add value.

For maximum value-added, Mr. Bookal urges internal auditors to concentrate on these areas:

1. Working relationships. Internal auditors must do their part to establish and maintain good working relationships. There should be a comfort level that allows any of the four key parties (management, directors, external auditors and internal auditors) to pick up the phone at any time and seek advice, either as a group or in a private session.

2. Awareness and problem-solving. In addition to ensuring that activities on the audit plan are performed each year, internal auditors must also participate actively in planning sessions and meetings. By cultivating a solid understanding of the business and its challenges internal auditors can go beyond just pointing out what is wrong and become part of the solution.

3. Professionalism. Ways to convince management, the board, and the general public of the value that internal auditors can bring to governance processes include: complying with the Code of Ethics and Standards for the Professional Practice of Internal Auditing, obtaining The IIA's Certified Internal Auditor designation and using formal quality assurance review mechanisms.

4. Progress through sharing. Every major audit failure or control breakdown brings with it an opportunity to learn from the experience of others. After an event like Enron, auditors in all organizations should analyze what happened and why it happened so that they can apply this knowledge to their own organizations.

Mr. Bookal recognizes that the above may require internal auditors to "step out of their traditional comfort zone." But, he says, the results will be well worth it. By stepping up to these challenges, internal auditors can add value to their own organizations and employers and also help businesses and the public better understand the important roles that internal audits play in the process of corporate governance.

Earlier this summer the Internal Revenue Service announced the launch of a new program to encourage compliance in the area of reporting amounts on partner, shareholder, and beneficiary K-1 forms. New computer software allows the IRS to match K-1 forms filed by partnerships, S corporations, and estates and trusts with the tax returns on which the numbers should be reported.

Under the IRS's matching program, notices are sent to taxpayers requesting an explanation of any discrepancies that are found. The matching program was initiated with tax year 2000 and as of early July, some 65,000 notices had been sent.

The matching program has met with criticism among politicians, practitioners, and members of the Internal Revenue Service Advisory Council (IRSAC), an organization whose purpose is to provide an organized forum for IRS officials and representatives of the public to discuss issues in tax administration. Senator Christopher "Kit" Bond (R-MO), a frequent advocate of improved IRS service, said "The last thing small business owners need is to spin their wheels proving their returns are accurate simply because the IRS and its computers do not have the data to explain a mismatch. That is a heavy burden that amounts to an unnecessary, virtual audit."

Effective August 1, 2002, the IRS has suspended the K-1 matching program with no information provided as to if or when the program might be reinstated. Any notices sent out already under the program will be acted upon until discrepancies are resolved, but no further notices will be sent out.

The Nasdaq Stock Market has made available a pilot test of how Web services and the Extensible Business Reporting Language (XBRL) will transform corporate communications. You are invited to take it for a test drive and see for yourself how real-time reporting will look and feel in the future.

Here's how:

§ Go to Nasdaq's XBRL Web site at http://www.nasdaq.com/xbrl and download the Excel Investor's Assistant.

§ Under the home page, pick one or more of the companies that volunteered for the pilot program. There are 23 technology companies in the pilot, including Microsoft and Intel.

§ Click on "build analysis," then check out the pages for financial measures, ratio analysis, financial statements, notes, and XBRL instance documents.

Not only does this spreadsheet rack and stack traditional financial measures and ratios based on historical accounting data, but it also integrates and graphs up-to-the-minute market data. About the only things missing are a stamp of approval from the Securities and Exchange Commission (SEC) and maybe some explanations of the definitions that underlie the metrics shown on the charts. For example, some users may not know what a SOXX index is or how to interpret it.

The pilot was a joint effort of Nasdaq, PricewaterhouseCoopers (PwC) and Microsoft. Microsoft built the Web service and spreadsheet template, Nasdaq hosts the Web service and pilot content, and PwC tagged exemplary data in XBRL from 23 companies over a five year period of financial statements and selective notes.

Mike Willis, founding chairman of XBRL International, a non-profit industry consortium, and a partner at PricewaterhouseCoopers, explains the new system will benefit companies, as well as individual investors and professional securities analysts. He points out, "This pilot demonstrates the advantages of using technology to transform the corporate reporting supply chain for the benefit of all participants."

It may sound complicated, but the concept is really simple. Mr. Willis thinks of it as transforming the corporate communication process from a 'publishing model' to a 'broadcasting model.' The site demonstrates the advantages of the new model. It uses Web services as a broadcasting channel, pushing company information to investors in XBRL format so it will work efficiently and immediately in their analytical applications and software tools (e.g., browser, worksheet software, and data warehouse). Investors get faster access to accurate, complete information that is easily reusable, and this in turn improves the transparency of the information reported by companies.

Learn more about the pilot program and how it will benefit you. Just go to http://www.nasdaq.com/xbrl/iishome2.htm#relevant1