Withstanding an IRS Audit
Broadcast Date: August 15, 2012
• Collected: $2.4 trillion
• Collections net of refunds: $2 trillion
• Processed: 234 million tax returns
• More than 143 million individual income tax returns filed, accounting for 61.2% of all returns filed
• Individual income tax withheld and tax payments,
combined, totaled more than $1.3 trillion before refunds.
• Individual taxpayers received almost $337.8 billion in refunds.
• IRS spends 53 cents to collect $100 of tax revenue.
Reasons a Return Is Selected for Audit
• A high DiF score
• Document matching
• Related party examinations
• Specific IRS audit initiatives
• Information from third party sources -- document matching
Types of Audits: Correspondence Audit
• For individuals
• Reserved for people with whom the IRS believes it can communicate effectively
Types of Audits: Office Audit
• IRS wants taxpayer to come and bring records to an IRS office.
• Somewhat more complicated subject matter than correspondence audits.
• Requires a face-to-face explanation of specific items:
• Basis of property
• Itemized deduction that may need explanation, such as casualty loss or employee business expenses
• IRS employee will be following an audit program.
• IRS will not hesitate to open other years if seems appropriate.
Types of Audits: Field Audits
• Most are business tax audits.
• IRS agent will come to office expecting taxpayer to have a tax problem, and that IRS will make money.
• 80% of the audits end up with a tax liability.
• Likelihood of taxpayer ending up with a tax problem as a result of the audit is high.
• Auditor will ask to interview taxpayer/client.
• Tax professionals generally reject this request and ask that the audit be conducted in the tax practitioner’s
office.
Types of Audits: Field Audits
• IRS auditor will assert a right to tour the business location.
• IRS agent may attempt to turn the tour into a conversation with the business owner.
How to Audit-Proof a Return
• Computer-prepared return is always preferable to a hand-prepared return.
• Schedule C a sure prescription for audit if it has a lot of travel, mileage, entertainment, and auto
expenses.
• Don’t round numbers.
• Account for all Form 1099s, W-2s, and K-1s. • Extend/file by the extended due date, but not
before.
• Forego itemizing .
Negligence Penalty: Sec. 6662(b)(1)
• Fail to do what a reasonable and ordinarily prudent person would do.
• IRS cannot assess if taxpayer had a reasonable basis for taking the position.
• “Reasonable basis” is a relatively high standard of tax reporting. It is significantly higher than “not frivolous” or “not patently improper.”
• The reasonable basis standard is not satisfied by a return position that is merely arguable or that is merely a colorable claim.
Substantial Understatement Penalty
• 20% of the portion of the underpayment of tax due to any substantial understatement of income tax • Understatement is substantial if it exceeds 10% of
the correct tax or $5,000.
• Penalty applies to undisclosed positions unless the taxpayer has substantial authority for the position. • Can be avoided if the taxpayer makes adequate
Fast Track Mediation
• Optional: does not replace existing dispute resolution options.
• FTM Appeals Official, serving as a neutral participant, helps the parties understand the nature of the dispute and reach a mutually satisfactory resolution.
• FTM Appeals Official may recommend a resolution on the merits based on the FTM Appeals Official’s analysis of the issues.
• Either party may withdraw from the mediation process at any time.
• FTM Appeals Official also may terminate the mediation process.
• If any issues remain unresolved at the conclusion of FTM, the taxpayer retains all appeal rights.
Fast Track Settlement
• FTS process works best in cases where all
unagreed issues are included in the application.
• Individual unagreed issues or groups of issues will be accepted for FTS in cases where it is determined to be in the best interest of tax administration.
• When FTS is unsuccessful in resolving all issues, the taxpayer will be offered the
opportunity to pursue resolution through traditional Appeals.
Early Referrals to Appeals
• Taxpayer requests early referral to Appeals of
developed unagreed issue in an open audit (prior to 30-day letter).
• Taxpayer and Team Manager agree issue should be referred early.
• Remaining issues are not expected to be complete before Appeals resolve early referral issue.
• Closing agreements executed if agreement is reached.
• If no agreement, taxpayer may request mediation or will be issued a statutory notice of deficiency.
Appeals Mediation
• Available for cases with limited number of issues unresolved following settlement discussions in
Appeals.
• May be used to resolve issues in cases that qualify while they are under consideration by Appeals.
• This procedure may be used only after Appeals settlement discussions are unsuccessful and, generally, when all other issues are resolved.
30-Day Letter
• When examination results in a proposed tax deficiency, taxpayer issued 30-day letter.
• Advises of the right to appeal to Appeals Office.
• If statute of limitations for assessment and
collection of tax is about to expire, extensions of time to file a protest will be granted only if the
taxpayer consents to extend the Statute of Limitations.
90-Day Letter
• Indicates tax, interest, and penalties owed
• Right to go to the U.S. Tax Court
• Within 90 days, taxpayer must submit one of the following:
• Form 1040 completed and signed
• Consent to Assessment and Collection form, signed and dated
• A statement explaining why taxpayer believes he or she is not required to file, or information taxpayer would like IRS to consider
Appeals Small Case Request
• Prepare a small case request instead of a
written protest if the total amount for any one tax period is $25,000 or less.
• Send a letter requesting Appeals consideration.
• Indicate the changes you do not agree with and the reason you don’t agree.
• No protest required.
Preparing a Protest
• Required if total amount > $25,000
• All partnership and S corporation cases
• Include name, address, SS#, and daytime telephone number
• Statement that taxpayer wants to go to Appeals • Tax periods or years
• All changes taxpayer does not agree with, and why • Facts supporting taxpayer’s position
• Legal authorities
Client Tax Practitioner Privilege
• Section 7525 extended the attorney-client
privilege of confidentiality to tax advice in a non-criminal tax proceeding that is furnished to a
client-taxpayer or potential client-taxpayer by any individual who is authorized under Federal law to practice before the IRS.
• Privilege may be waived in the same manner as the attorney-client privilege.
Kovel Rule
• Attorney-client privilege extended to tax
practitioners when a tax practitioners acts at the direction of the lawyer to provide information for the client.
• Tax practitioner should document the circumstances of hiring, obtain engagement letter from lawyer,
label the project's work product "confidential," and properly conduct client meetings.
• Invoice attorney (not client), send reports directly to the lawyer, and make sure engagement report
Voluntary Disclosure
• Will not automatically guarantee immunity
from prosecution, but may result in prosecution not being recommended.
• Occurs when the taxpayer’s communication is truthful, timely, complete, and when:
▫ Taxpayer cooperates with the IRS; and
Rules Applicable to Tax Practitioners
• Circular 230
• AICPA’s Statements on Standards for Tax Services (SSTSs)
• ABA Standing Committee on Ethics and Professional Responsibility
• State bar associations
Schedule C Abuses
• Overstate expenses/understate income
• Fail to pay employment tax or file information returns
• Claim refunds from earned income credits to which the taxpayer was not entitled
Construction Industry
• Non-reporting of cash payments
• Non-reporting of bartering transactions
• Misuse of the completed method of accounting
• Using the cash method of accounting when the taxpayer is not entitled to use it
• Deducting expenses that should be capitalized and depreciated