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IRS EXAMINATIONS & PROCEDURES

IRS EXAMINATIONS & PROCEDURES. Agenda. Organization of the IRS Penalties IRS examinations Tier Isuses Appeals Section 6011 – Reportable transactions Alternative dispute resolution procedural options. Organization of the IRS. Mission of the IRS.

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IRS EXAMINATIONS & PROCEDURES

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  1. IRS EXAMINATIONS & PROCEDURES

  2. Agenda • Organization of the IRS • Penalties • IRS examinations • Tier Isuses • Appeals • Section 6011 – Reportable transactions • Alternative dispute resolution procedural options

  3. Organization of the IRS

  4. Mission of the IRS • “Provide America’s taxpayers top-quality service by helping them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all.”

  5. Today’s IRS organization • The IRS Restructuring and Reform Act of 1998 prompted the most comprehensive reorganization and modernization of the IRS in nearly half a century. • The IRS is divided into three commissioner-level organizations: • Commissioner • Deputy Commissioner for Services and Enforcement • Deputy Commissioner for Operations Support

  6. IRS organization chart Chief Counsel EEO and Diversity CommissionerChief of Staff Appeals Research, Analysis,and Statistics National Taxpayer Advocate Communications and Liaison Services and Enforcement Operations Support Office of Professional Responsibility Chief InformationOfficer Chief Financial Officer Large and Mid-size Business Small Business / Self Employed Agency-wideShared Services Human Capital Officer Tax Exempt andGov’t Entities Wage and Investment Whistleblower Office Mission Assurance Criminal Investigation

  7. Commissioner • Doug Shulman current IRS Commissioner • Specialized units report directly to the Commissioner’s office: • IRS Chief Counsel • Appeals • Taxpayer Advocate Service • Equal Employment Opportunity and Diversity • Research, Analysis, and Statistics • Communications and Liaison

  8. What constitutes a valid return • Who must sign? • Corporate returns – president, vice president, treasurer, chief accounting officer, or any other officer authorized to act (IRC §6062) • Partnership returns – one of the partners (IRC §6063, Treas. Reg. §1.6062-1) • TEFRA – Tax Matters partner • LLC returns – one of the members • S corporation returns – president, vice president, treasurer, chief accounting officer, or any other officer authorized to act

  9. Who must file – IRC §6012 • Individuals with gross income that equals or exceeds the exemption amount • Special rules for nonresident aliens • Corporations subject to tax under Subtitle A • Special rules for foreign corporations • Estates with gross income of $600 or more • Trusts with any taxable income or with gross income of $600 or more • Estates or trusts with nonresident alien beneficiaries

  10. When returns are due – IRC §6072 • Returns for individuals, estates, and trusts • If calendar year → April 15 • If fiscal year → 15th day of the fourth month after close of fiscal year • Corporations • Fifteenth day of the third month following the close of the corporation’s tax year • Certain nonresident alien individuals and foreign corporations • If calendar year → June 15 • If fiscal year → 15th day of the sixth month after close of fiscal year

  11. Amended returns – superseding vs. amending • Service considers an amended return filed on or before due date to be taxpayer’s return for that period • Really a superseding original return • If a return has been filed and the due date has passed, Service can accept or reject amended return, but original return is the operative return for purposes of the period of limitations on assessment • If original return is fraudulent, taint stays even if amended return is filed

  12. When are returns considered filed? • “Mailbox rule” • Timely mailed, timely filed • Foreign postmarks • Certified private delivery service • Annual Rev. Proc. updates list

  13. Confidentiality and disclosure of returns • IRC §6103 – statutory limitations to IRS disclosure of tax return information • Freedom of Information Act (FOIA) – requires IRS to make public certain information • IRC §7216 – criminal penalty imposed on tax return preparer for unauthorized disclosure of tax return information

  14. Penalties

  15. IRS stated purpose of penalties • I.R.M. 20.1.1.2 (2-22-2008), Purpose of Penalties • Penalties exist to encourage voluntary compliance by supporting the standards of behavior expected by the Internal Revenue Code. • For most taxpayers, voluntary compliance consists of preparing an accurate return, filing it timely, and paying any tax due. Most penalties apply to behavior that fails to meet any or all of these obligations. • Penalties encourage voluntary compliance by: • Defining standards of compliant behavior • Defining remedial consequences for noncompliance • Providing monetary sanctions against taxpayers who do not meet the standard

  16. Failure-to-file/failure-to-pay penalties • Failure to file tax return (IRC §6651(a)(1)) • Five% of the amount required to be shown on return as tax per month, with a 25% maximum • 25% maximum interacts with §6651(a)(2) • Reasonable cause exception

  17. Failure-to-file/failure-to-pay penalties (cont.) • Failure to Pay (IRC §6651(a)(2)) • 0.5% of tax shown on return per month with 25% maximum penalty if tax not paid by the due date (without regard to extension) of that return • 25% maximum interacts with §6651(a)(1) • Applies to: • Income, employment, excise, gift, and estate tax returns • Reasonable cause exception

  18. Other penalties • Other penalties apply for failure to file certain returns or make payments: • Information returns (See IRC §§6721 and 6722) • Reasonable cause • Payments of estimated tax (See IRC §6655 below) • No reasonable cause • Partnership returns (See IRC §6698) • Reasonable cause

  19. Penalty for failing to file certain information returns • Sections 6038, 6677 and 6679 • Forms such as 5471, 5472, 926 and 3520 • Penalty assessed for failing to file timely, regardless of tax liability shown on return • Reasonable cause exception applies

  20. Civil penalties – accuracy-related penalties (IRC §6662) • Accuracy-related penalties (IRC §6662) • Negligence or disregard of rules or regulations (IRC §6662(b)(1)) • Substantial understatement of income tax (IRC §6662(b)(2)) • Substantial valuation misstatement (IRC §6662(b)(3)) • Substantial overstatement of pension liabilities (IRC §6662(b)(4)) • Substantial estate or gift tax valuation understatement (IRC §6662(b)(5))

  21. Civil penalties – accuracy-related penalties (IRC §6662) (cont.) • Penalty amount = 20% of portion of underpayment • Increases to 40% for gross valuation misstatements • Imposed only once, even if more than one violation applies • Amount of underpayment not reduced by any carryback or carryover of an NOL, deduction or credit

  22. Civil penalties – accuracy-related penalties (IRC §6662) (cont.) • Negligence = lack of reasonable basis • Reasonably prudent person standard • Burden of proof on taxpayer • Disregard of rules or regulations = failure to follow the appropriate law • Careless, reckless, intentional • Substantial understatement • Individuals: • Greater of 10% of tax required to be shown on return, or $5,000 • Corporations: • Lesser of 10% or $10 million

  23. Penalty relief requirements • Reasonable Cause • Internal Revenue Manual (IRM) provides some examples • Reliance on written advice of IRS • Reliance on qualified advisor • Boyle • Supreme Court case dealing with reasonable cause • Substantial Authority • No IRC §6662(d) penalty if there is substantial authority for the tax treatment of an item or return position (objective standard) • Special rules for tax shelter items

  24. Penalty relief requirements (cont.) • Adequate disclosure • No substantial understatement penalty if there is adequate disclosure and reasonable basis • Disclosure not protective for tax shelter items • Form 8275 or 8275-R

  25. Preparer penalties (IRC §6694) • Section 6694(a) imposes a preparer penalty for an understatement on a taxpayer’s federal tax return or refund claim if the federal tax return preparer knew or reasonably should have known: • that there was not substantial authority for the return position; • if the position was disclosed as provided in §6662(d)(2)(B)(ii), that there was no reasonable basis for the position; OR • if the position related to a tax shelter or a reportable transaction (whether or not disclosed), that it was not reasonable to believe that the position would more likely than not be sustained • Preparer bears burden of proof • Penalty not assessed under §6694(a) if reasonable cause for the understatement and the preparer acted in good faith • This new standard applies for income tax returns due after 31 December 2007

  26. Civil penalties – preparer penalties (IRC §6694) • Preparer: any person (including a partnership or corporation) who prepares for compensation, or who employs one or more persons to prepare for compensation, a substantial portion of any income tax return or claim for refund of income taxes • Signing preparer: one who signs a tax return • Non-signing preparer: one who gives oral or written advice

  27. Criminal penalties • Section 7201 – attempt to evade or defeat tax • Section 7203 – willful failure to file • Section 7206 – fraud and false statements • Section 7207 – fraudulent returns, statements, or other documents • Section 7215 – offenses with respect to collected taxes (e.g. employment) • Section 7216 – disclosure or use of information by preparers of returns • 18 USC 1001 – false statements to a government official

  28. Hot interest • IRC §6621(c) provides for an increased interest rate charged on certain large corporate underpayments in excess of $100,000 • Trigger date: • A balance due notice for more than $100,000 tax due may create trigger date. • Issuance of a 30-day or 90-day letter for greater than $100,000 in tax may set a trigger date. • Trigger date not set if amount shown as due is paid within 30 days of issuance of notice or letter.

  29. Restricted interest • Interest computed where start and/or stop dates are other than due date of return to payment/refund date • In general, term applies in situations where interest might be statutorily prohibited or limited to specific time frames: • 45-day rule on overpayments • Signing of Form 870 or 870AD • Carrybacks

  30. Interest netting • The application of a zero-rate of interest to the extent that there are overlapping tax underpayments and overpayments • Interest rate differential for corporations ranging from one to four and a half percent

  31. Statute of limitations • Taxpayer has six years from allowance of a refund to receive correct amount of overpayment interest • If not received prior to expiration of six years, suit must be filed to protect right to such refund • Statute of limitations for requesting a refund of overpaid underpayment interest is the same as for requesting refund of overpaid tax • Generally, three years from date the return is filed or two years from date interest was paid

  32. IRS examination • Enforcement program to promote voluntary compliance with tax laws • Statutory authority • IRC §7602 – Authorizes IRS to examine any books, papers, records, or other data and to take such testimony, under oath, as may be relevant or material to such inquiry and to issues summoned • IRC §§7604(a) and 7402(b) – US district courts have jurisdiction to enforce summons

  33. Types of exams • Service center • Correspondence • Office • Field

  34. Field exams • Complex issues • Open-ended • Revenue agent goes to taxpayer’s residence or place of business to examine records • Agent asks for items to inspect on Form 4564, Information Document Request • May interview taxpayers

  35. Types of exams – field exam • Coordinated industry case (CIC) • Large corporate taxpayers (assets greater than $250 million) • Primary corporation and controlled entities treated as single unit • Support by national office (directives) • Exam conducted by team • Industry case (IC) • Corporate taxpayers with assets between $10 million and $250 million • Generally, exam conducted by single agent with specialist involvement as needed

  36. LMSB industry issue focus/tier strategy • Tiered classification designed to require greater national oversight and ensure consistency in issue resolution • Potential compliance issues are identified by the field through examinations, Schedule M-3 reviews, etc. • Issues prioritized and tiered based on prevalence across industry lines and level of compliance risk • Issue management team (composed of Compliance, Counsel, Appeals) develops guidance/instructions on how to handle issue • IOE with nationwide jurisdiction ensures appropriate examination coverage and consistent approach to the development, handling, and ultimate disposition of the issue.

  37. LMSB industry issue focus/tier strategy (cont.) • Tier I issues are issues of high strategic importance • Large number of taxpayers, significant dollar risk, substantial compliance risk, and/or high visibility • Well established legal positions and/or LMSB direction • Tier II issues involve areas of potential high-noncompliance and/or significant compliance risk • Law is fairly well established, but there is a need for further development, clarification, direction and guidance on LMSB’s position • Tier III issues represent the highest compliance risk for a particular industry segment • Require consistent treatment for taxpayers within the industry

  38. LMSB industry issue focus/tier strategy – tier 1 issues • Domestic Production Deduction • Research Credit Claims • Transfer of Intangibles Offshore/Cost Sharing • Foreign Tax Credit Generators • Foreign Earnings Repatriation • Mixed Service Costs* • Section 118 Abuse* • Section 936 Exit Strategies • Section 162(f) - Government Settlements* • International Hybrid Instrument Transactions* • U.S. Withholding Agents - §1441: Reporting and Withholding • All “Listed Transactions” • Two other “Tax Shelters” • Distressed Asset/Debt • Redemption Bogus Optional Basis * Issue or sub-issue moved to “monitoring status”

  39. LMSB industry issue focus/tier strategy – tier 2 issues • Backdated stock options* • Casualty loss: single identifiable property/capital vs. repairs • Cost-sharing-stock based compensation • Enhanced oil recovery credit (§43) • Extraterritorial income exclusion effective date and transition rules • Gift cards: deferral of income • Health care accounting issues: contractual allowance • Interchange merchant discount fees • Non-performing loans • Specific liability loss, IRC §172(f) • Super completed contract method • Upfront fees, milestone payments and royalties in the biotech and pharmaceutical industries * Issue or sub-issue moved to “monitoring status”

  40. LMSB industry issue focus/tier strategy – tier 3 issues Communication, Technology, and Media • Carriage/Launch Fees Paid to Cable/Satellite/Television Operators by Programmers/Content Providers • Amortization of Intangibles - Licensed Program Contract Right Financial Services • Real Estate Mortgage Investment Conduits (REMICs) • Premium Deficiency Reserves Heavy Manufacturing and Transportation • Motor Vehicle Dealerships and IRC 263A (Uniform Capitalization/UNICAP) • Loyalty Programs in Service Industries

  41. LMSB industry issue focus/tier strategy – tier 3 issues (cont.) Natural Resources and Construction • Delay Rentals • Section 198 Expensing Of Environmental Remediation Costs (Federal Brownfield Tax Incentives) Retailers, Food, Pharmaceuticals, and Healthcare • Cost Segregation Studies • Vendor Allowances

  42. How the IRS collects information (cont.) • Information Document Requests (IDRs) (Form 4564) – for specific information on an issue under Exam (voluntary) • Interviews of taxpayers/officers/employees or other persons (IRC §7602(a)(2)) • Summons • To taxpayer for records (IRC §7602(a)(1)) • Third-party record-keepers (IRC §§7602(a)(2) and 7609) • John Doe (IRC §§7602(a)(3) and 7609)

  43. How the IRS collects information (cont.) • Summons enforcement (IRC §7604) • Department of Justice must file summons enforcement petition. • Appropriate district court has jurisdiction to compel production of documents and/or witnesses. • Failure to comply can result in legal sanctions.

  44. Audit management • Request copy of audit plan early in process • Participate in joint audit planning process (LMSB taxpayers) • Protocol should be established for working with the agent such as: • Who he/she can deal with • Who can bind company • All discussions should be in writing • Maintain a paper trail of all questions and answers • Establish internal processes to control flow of information to IRS • Example: Log of IDRs and responses

  45. Making adjustments • Revenue agent applies law to facts • If appropriate, revenue agent sends Notice of Proposed Adjustment (NOPA), Form 5701, to taxpayer • If taxpayer agrees – signs, dates copy of NOPA and sends back to IRS • If taxpayer disagrees, can: • Mail additional information for IRS to consider • Discuss position with examiner or examiner’s supervisor • Request Fast Track (Rev. Proc. 2003-40) • Await Issuance of 30-day letter • Request conference with Appeals (Pub. 3498) • Do nothing and get 90-day letter

  46. Making adjustments (Cont.) • If taxpayer disagrees with NOPA, receives a 30-day letter: • Advises taxpayer of right to appeal • If taxpayer agrees, signs Form 870, Waiver of Restrictions on Assessment • Immediate assessment of deficiency • Waive right to go to Tax Court • If taxpayer disagrees, can file a protest and go to Appeals • Form 4549: Computations • Issued with the revenue agent’s report reflecting a deficiency or over assessment as a result of the exam

  47. Appeals

  48. Role and mission of appeals • Appeals’ stated mission is to resolve tax controversies: • Without litigation • On a basis that is fair and impartial to both the government and the taxpayer • In a manner that will enhance voluntary compliance and public confidence in the integrity and efficiency of the IRS

  49. Assessment

  50. Statute of limitations (§6501) • General rule: assessment must be made within three years from date return was filed • Must be a valid return to start SOL • Contains all data necessary to compute and assess tax • Items of gross income, deductions, credits, etc. • Proper accounting period and accounting methods • Properly executed • Amended returns have no effect • Taxpayer has burden of proof

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