Practice & Procedures
Tax Examinations
Spring Is Here And So Are The Exams. Watch Out!
May 10, 2013
Larry J. Wolfe
Larry J. Wolfe, Ltd
Larry@larryjwolfe.com
I have been writing letters for years to the Office of the Taxpayer Advocate and Commissioner regarding Office Exam procedures and the lack thereof. The following are issues that I find are ongoing and would like to share with you (misery loves company):
1. Taxpayer’s are receiving an initial letter of contact (Letter 3572), allowing the taxpayer 10 days to respond and call for an appointment for the privilege of an Office Examination. (It’s like calling the executioner and asking to be beheaded in 10 days). When there is no response after 10 days, usually on the 12th and sometimes on the 15th (and believe it or not, even between the 5th -10th day) after the initial letter is issued, an examination report is issued. The 10 day letter (letter 3572) does not take into consideration mailing time.
Possible Resolution: Recommended to the IRS, is to send a second appointment letter or allow more than 10 days for a response. The Examination Division should also, take into consideration vacations and personal issues of the taxpayer in the timing.
Not being followed is IRM 4.10.2.7.2.8, Case Closing Procedures, for No- Show Cases which states, “Follow up attempts must be made to contact the taxpayer to encourage him/her to schedule and keep the appointment or to solicit an agreement.”
2. The initial contact letter for an examination notifies the taxpayer that he or she is under examination. The initial contact letter states which year or years are under examination. Reports issued at the conclusion of the examination should only be issued for the period or periods that were opened for examination. Office examiners are usually required to issue a report at the conclusion of an examination. (It’s like going home with a goodie bag). The report should only be issued for the year or years appearing on the initial contact letter and document request. The Examiner must issue a letter to the taxpayer to inform him or her that a new period is open and must provide additional time for the taxpayer to prepare for the examination, if a new year is opened during the office examination appointment.
3. Issues appearing on the examination report that were not subject to the examination. Watch out and look carefully, because they may be there. Taxpayers are to be notified of examination issues throughout the examination process. Document requests should be issued for all items under examination. Expense items cannot be and should not be arbitrarily disallowed.
IRM 4.10.2.9 discusses “Requesting Information or Documents from the Taxpayer” and states: “On office examination cases, the examiners will prepare Form 4564 to mail to the taxpayer with the initial contact letter. On field examination cases the Form 4564 will generally be sent with the appointment confirmation letter. See IRM 4.10.2.7.3.1 and IRM 4.10.2.7.3.2
4. When a examination report is revised and the assessment is increased, the taxpayer should be given a new 30 day letter not a reminder letter that he or she has 15 days to respond. If a new examination report is issued with a lower amount, the 30 days should in most cases continue to run with the initial examination report. ( Letter 915 is the 30 day letter and Letter 1915 is the 15 day Letter). In other words, when Letter 915 and 1915 differ in assessments, Letter 1915 should never be a higher amount than Letter 915. Normally the 30 day period to appeal will not be extended by exam. As with the initial contact letter, examination reports do not take into consideration mailing time. For Office Exam, the examination report is usually handed to the taxpayer with a smile.
5. The Accuracy penalty should not be automatically proposed or asserted if the liability is less than $5,000. The Accuracy Penalty should not be automatically asserted. Remember we have to earn a living somehow.
IRM 20.1.5.62, states: “Generally, the most important factor in determining whether the taxpayer has reasonable cause and acted in good faith is the extent of the taxpayer’s effort to report the proper tax liability.” The simple stuff seems to be forgotten.
6. IRM 4.10.1.5.1 discusses “Focus on Problem Solving” and states: Examiners should assist taxpayers in solving any tax problem identified during the examination, even if the problems are not associated with the examination. (Timelines and deadlines typically prevent this section from being followed)
I recently had a taxpayer who underwent an Office Examination of Schedule C issues. The taxpayer informed the examiner by telephone that she did not own a business and did not file a tax return with a Schedule C. The return was prepared by a tax professional. The tax return provided to the taxpayer by the tax preparer did not have a Schedule C. The taxpayer provided to the Office Examiner (by fax) a copy of the return. The return was E filed by the professional with a Schedule C. The Examination resulted in the disallowance of Schedule C items, (Expense items were disallowed in full, however the phantom income of $5,000 was allowed on the Schedule C), The Examiner disallowed Charitable Contributions without notice and without a document request by the Independent Reviewer. The Accuracy Penalty was assessed. I requested a FOIA of the examiners workpapers and requested an Audit Reconsideration.
7. IRM 4.10.2.9.2 discusses Requesting Information or Document from the Taxpayer. Paragraph 2 states Form 4564 will be used to document all request information and documents needed to support items being examined. As mentioned earlier all items being examined should be stated on Form 4564.
8. IRM 4.10.1.5, states referrals should be made to the Taxpayers Advocate when appropriate. As in the example in item 6, the Advocate was not notified.
9. IRM 4.10.1.6, Taxpayers Rights: “Examiners have the ongoing responsibility to ensure that all taxpayers’ rights are protected and observed whether these rights are mandated by statute or provided as a matter of policy” (Yea Right!).
10. Last but not least IRM 4.10.1.5.3, “Ensure Quality Taxpayer Communication states: Effective communication with taxpayers is a significant factor in conducting a quality examination and in minimizing the taxpayer burden. All communication with the taxpayer should be courteous, professional and clear.” A two day turn around time is considered timely.
I wanted to share these items of concern with my fellow CPA’s in Illinois. The Taxpayer Advocate Office has created an information gathering project in the Chicago Area (See PDF). I welcome your comments and concern. Please feel free to contact me or any member of my committee with any issues that you are facing during the exam process regarding Individuals.
Disclaimer: This article is designed to provide information in regard to the subject matter and has been prepared with the understanding that neither the Illinois CPA Society nor the author of this article is providing accounting, tax or legal advice or is performing any legal, accounting or other professional service. If accounting, tax or legal advice or other expert assistance is required, the services of a competent professional person should be sought.
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Beware of Issues Causing Examinations
March 25, 2013
Larry J. Wolfe
Larry J. Wolfe, ltd
larry@Larryjwolfe.com
With the filing season coming to a close, be aware of the following issues that could cause an examination. The list is not all inclusive:
1. High itemized deductions in relation to income.
2. Continued Schedule C and/or Schedule E losses.
3. Large deductions for Mortgage Interest (watch for the $1,000,000 level).
4. High charitable contributions.
5. Numerous Schedule D entries.
6. Gambling income from W-2G and no other reported winnings.
7. CTR’s.
8. High cost of goods sold on Schedule C.
9. High 2106 expenses.
10. Real Estate losses in excess of $25,000.
11. Numbers on the return ending in 0 or 5 (Even dollar amounts are a red flag).
12. Low income, high expenses.
13. Earned income credit, be sure to attach form 8867 and answer all questions.
14. Real Estate Professional- number of hours and test.
15. Understatement of Income.
If in doubt, ask to see substantiation. If you have done your homework, don’t be afraid of an examination. A win could prevent future exams.
Disclaimer: This article is designed to provide information in regard to the subject matter and has been prepared with the understanding that neither the Illinois CPA Society nor the author of this article is providing accounting, tax or legal advice or is performing any legal, accounting or other professional service. If accounting, tax or legal advice or other expert assistance is required, the services of a competent professional person should be sought.