SECTION 2. BACKGROUND — Internal Revenue Bulletin 2002-35

.01 Comments on Proposed Guidance . The IRS issued proposed audit procedures for external auditors in Notice 2001–66, 2001–44 I.R.B. 396. Because the IRS and Treasury recognize that the audit process must be implemented in a manner that maintains the cooperative nature and effectiveness of the QI system, the IRS engaged in a lengthy dialogue with the financial community following the issuance of Notice 2001–66 to consider ways to implement the audit procedures so as to minimize cost to the QI while preserving the compliance goals of the withholding regulations.

.02 IRS Response to Five Areas of Con- cern . The majority of the comments on Notice 2001–66 reflected concerns about cost in the context of one or more of the following areas: availability of waivers, scope of audit coverage, statistical sampling, projection of underwithholding over the QI’s account population based on the statistical sample, and use of an internal audit. The following is a brief overview of the modifications reflected in the attached Audit Guidance in response to these comments. A more complete discussion is set forth in Section 4 of this Revenue Procedure.

(i) Waivers . The financial community commented that the criteria for obtaining a waiver from an external audit were too stringent. In response, the following changes have been made:

The monetary threshold in Waiver One has been increased in the attached Audit Guidelines from $250,000 to $1,000,000 and is based on reportable amounts.
Waiver Two (which in Notice 2001–66 was based on number of accounts) now is based on whether the QI received between $1,000,000 and $4,000,000 in reportable amounts.
With respect to the reconciliation of Forms 1042–S and 1099 issued to and by the QI, which are required to re

based allocation ratio or a production cost allocation ratio) (§ 1.263A–1(h)), and the simplified production method without the historic absorption ratio election (§ 1.263A– 2(b)), but does not include any other reasonable allocation method within the meaning of § 1.263A–1(f)(4).

“(4) Multiple changes. Taxpayers making both this change and another change in method of accounting in the same year of change must comply with the ordering rules of § 1.263A–7(b)(2).”