Chapter 13

1. Chapter 13 Working with the IRS William A. Raabe Gerald E. Whittenburg Debra L. Sanders © 2009, South-Western, a part of Cengage Learning, Mason, Ohio

2. Chapter 13 - Overview • This chapter addresses the following topics related to working with the IRS: • Organization of the IRS • Taxpayer rights • The audit process • Examinations • Appeals process

3. Organization of the IRS • Department of the Treasury • Commissioner of Internal Revenue • Commissioner is the CEO of the IRS • IRS was established in 1862 • Then called the Bureau of Internal Revenue • Named changed to “IRS” in 1953 • Currently organized along functional lines • IRS Oversight Board • Allows for private sector input

4. IRS National Office • The IRS is the second largest agency of the Federal government with 100,000 employees • Located in Washington, D.C. • Commissioner of is appointed by President • Chief Counsel is the agency’s top legal advisor • National Taxpayer Advocate • Administers a taxpayer intervention system

5. IRS National Office

6. IRS Service Centers • Primary function • Tax return processing and mathematical verification • Service Centers located in: • MA, GA, CA, MO, TN, PA

7. IRS Service Centers • 3 Computing Centers • Manipulate data collected from processing centers • 4 Processing Centers • Return processing verification • 25 Customer Service Sites • Electronic filing, answer telephone and e-mail inquiries

8. Taxpayer Assistance Orders (TOA) • Taxpayer Advocate • Reports directly to Commissioner • Issues TAO to suspend, delay, or stop actions that would cause undue hardship on taxpayers • Taxpayer files Form 911 for a TAO to relieve hardship

9. Local Taxpayer Advocates • Resolve taxpayer complaints • Access to IRS officials in district and regional offices, and service centers • Notify taxpayer within 5 days of case status • Usually resolve billing, procedural, computer-generated, and other problems

10. Taxpayer Rights • Taxpayer Bill of Rights guarantees: • Representation before the IRS • A recording of any proceeding • An IRS explanation of its tax position

11. Taxpayer Rights • Right to know: • Why IRS is requesting information • How IRS will use the information • Repercussions of not providing information • Pertinent aspects of audit procedures

12. Taxpayer Rights • Taxpayer representation • Taxpayer may be represented by an attorney, CPA, or other with power of attorney • Taxpayer may suspend IRS interview if he/she wishes to include a representative • Taxpayer need not appear personally (unless summoned) • Taxpayer may record interview

13. Taxpayer Rights • Attorney-client type of confidentiality • Confidentiality exists between taxpayer and representative in non-criminal tax matters • Does not apply to dealings with tax shelters • Innocent spouse rights • IRS must inform (ex)spouses of joint and several liability for tax deficiencies

14. The Audit Process • Tax system promotes voluntary compliance • Based on self-assessment • Examinations are used as enforcement tool • The threat of an IRS audit encourages accurate filings • A small number of returns are audited each year • IRS attempts to select returns for audit that will generate additional tax liability

15. Preliminary Review of Returns • All business and individual returns • Reviewed for simple/obvious errors (e.g., SSN, signatures) • Automatic Data Processing • Information Document Matching Program • Mathematical/Clerical Error Program • Unallowable Items Program

16. Information Document Matching Program • Matches information on tax return with third party information returns (e.g., W-2, 1099) • Millions of discrepancies per year • Approximately 2 million failure-to-file inquiries per year

17. Mathematical/Clerical Error Program • Conducted at IRS service centers • Checks returns for math errors and recomputes tax due • Not considered an examination (called a summary assessment) • Around 5% of returns contain these errors • Interest accrues on untimely payments • 60 days to request abatement of tax • Not entitled to remedies available to taxpayers subject to formal exams

18. Unallowable Items Program • Conducted at IRS service centers • Question items that appear to be unallowable • Identified manually and by computer • Tax recomputed based on adjustments • Not considered an examination

19. Selection of Returns for Examination • Audit those likely to increase tax liability • Selection methods • Manual and computerized methods • Informants • Economic reality factors • Other selection methods

20. Computer Selection • Discriminant Function System • Returns with high DIF score examined manually • TCMP • Furnishes IRS with tax return statistics • Used to update the DIF formulas • Around 50,000 individual returns selected randomly • Extremely thorough audit

21. Other Selection Methods • Informants • Link to another return under review • Income exceeds materiality level • Taxable income, gross receipts, or total positive income > $50K • Partnerships with >$500K receipts

22. Other Selection Methods • Economic reality factors • Significant increases or decreases in certain items: • Interest, dividend, and investment income • Mortgage and other reportable interest paid • Self-employment or farm income relative to industry norm • Business and other expenses not justified by income levels

23. Chances of Audit • Less than 1 percent chance of audit • “Red flags” that increase audit chances: • Tax shelter losses • Cash-oriented businesses • Excessive business or itemized deductions for income level • Errors found in prior year audits

24. Examinations • Types of Audit • Correspondence Examinations • Office Examinations • Field Examinations

25. Audit Statistics: Types of Audits

26. Correspondence Examinations • One or two items on a return questioned • Usually itemized deductions • Conducted by phone or mail • Informal examination, but same rights as office or field audits • Service Center usually handles these audits, may be referred to District Office • Simple documentation issues • Verify item by mailing copies of receipts, canceled checks, etc.

27. Office Examinations • Requires IRS analysis and judgment • Conducted at IRS district office • Auditor given little time to prepare • Scope limited to items on notification letter • Taxpayer and/or representative bring records to office • Individual returns with no business income • Difficulty may lead to field exam

28. Field Examinations • Complex issues • Revenue agents have more knowledge and experience • Conducted on taxpayers premises • Sometimes conducted in representative’s office • Open-ended • Agent free to pursue any unusual items in tax returns or taxpayer records • Reviews entire financial operations

29. Audit Statistics: Chances of Audit

30. More Audit Statistics

31. Dealing with an Auditor • Professional courtesy • While maintaining an adversarial role • Be well-prepared for the audit • Issues should be identified and addressed throughout process

32. Dealing with an Auditor • Auditor should not be allowed free access to records or facilities • May resolve to agree to disagree on major issues

33. Conclusion of Examination • Revenue agent’s report (RAR) prepared by the IRS agent for taxpayer • Explanation of proposed adjustments and lists balance due • Actions if taxpayer agrees with RAR: • Sign waiver of the restrictions on assessment • May make advance payment to avoid additional interest and penalties

34. Thirty-Day Letter • If taxpayer disagrees with RAR: • Taxpayer receives 30-day letter • Notifies taxpayer of proposed adjustments and appeals rights • Taxpayer has 30 days from receipt to request conference with appeals officer • Oral request if office audit or if tax and penalties total < $2,500 • Written request if tax and penalties > $2,500 • Formal protest if tax and penalties >$10,000

35. File a Protest or Go to Court? • Reasons to appeal • Appeals officers can consider the hazards of litigation • The litigation path still remains • Possible settlement without litigation costs • Delays payment of disputed tax • Discover more details of government’s position and appeal required to recover some court costs and attorney’s fees • Possibly recover future court costs

36. File a Protest or Go to Court? • Reasons to bypass appeal • New issues could be raised upon appeal • Taxpayer wishes to send message that he/she is firmly convinced of position • Expedite conclusion of the issue

37. Appeals Process • Appeals Office • IRS encourages use of the appeals process • Appeals Office has exclusive authority to settle cases within its jurisdiction • Supervised by Commissioner of IRS with input from Chief Counsel

38. Appeals Conference • Informal proceeding • Appeals officer • Maintains impartiality • Authority to settle all factual and legal questions in the examiner’s report • Can settle based on the hazards of litigation • Can split or trade issues

39. Ninety-Day Letter • Statutory notice of deficiency • Taxpayer and IRS cannot agree on proposed adjustments after appeals conference or if the taxpayer does not appeal • Must be sent before assessing additional (proposed) taxes • Taxpayer has 90 days to pay tax and sue for a refund or file petition in Tax Court

40. Entering the Judicial System • Tax Court • File within the 90-day letter period • Pretrial settlement conference with appeals officer • Available if not previously appealed • Any pretrial agreement is filed with Tax Court • District or Claims Court • Must pay tax first and then sue for a refund

41. Income Tax Appeal Procedure

42. Tax Litigation - Victories

43. Chapter 13 - Key Words

44. End of Chapter 13 If you have any comments or suggestions concerning this PowerPoint Presentation for Federal Tax Research, 8th Edition, please contact: Kristina Zvinakis, PhD kristina.zvinakis@mccombs.utexas.edu University of Texas at Austin