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ALSO VISIT IRS AUDIT PROCEDURES & WHO GETS AUDITED BY THE IRS ?
Overall Rates 1.120 As the overall audit rates for different income classes are shifting, the proportion of individual taxpayers who faced any kind of audit--either the more rigorous district audits or the semi-automated Compliance Center audits--dropped to its lowest rate in modern history, just under one percent (0.49%) in 2001 and rose slightly to .57% in 2002.
Reduced Audit Levels 1.130 Two developments have contributed to the dramatic shift in audit targets from the relatively rich to the relatively poor. One has been a Congressional mandate that the IRS reduce non-compliance in the Earned Income Credit program, a special tax benefit for low-income Americans. A second factor has been the substantial decline in the size of the IRS. After a buildup during the Reagan years, a series of cut-backs agreed to by the Bush and Clinton administrations and by Congress means that in 2001 the full-time IRS staff was 31% smaller than it was in 1988. (By contrast, the FBI is today larger than at any time in its history.) With substantially fewer employees, the face-to-face Area audits essential for the examination of larger and more complex tax returns have plummeted. This is true for both individuals and corporations. In fiscal year 2001, the chances for an Area audit fell to 0.16% per individual return filed -- less than 1 out of ever 600 returns. Only three years ago, the Area rate was more twice the 2001 rate.
Face to Face vs. Compliance Center Audits 1.140 Individual taxpayers can face two kinds of IRS audit -- the Area "face-to-face" audit or the semi-automated Compliance Center audit. While Area audits have long been a major focus of public concern, Compliance Center audits have become a significant component of the IRS's enforcement arsenal. The result of Compliance Center audits on individual taxpayers is far from negligible. In 2002, for example, the average additional taxes and penalties for simpler returns reporting $25,000 or less was $3,134 even though the time spent by the IRS Compliance Center staff averaged just one hour per ""audit.""
Examination Rates 1.150 There is a substantial variance in audit rates depending upon where you live. In 2000 Southern California District had the highest audit rate. Ohio District had the lowest audit rate.
IRS Compliance Center Notices Issued For Math Errors and Under-Reporting Adjustments From Computerized Document Matching
1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
93,052,000 94,013,000 95,419,000 95,541,300 96,496,900 99,529,000 101,750,800 103,251,000 107,029,000 109,868,400 112,304,900 113,829,200 114,718,900
Math Error Returns Percent
na na na na na na na na na na na 4,985,000 4,088,000 4.38 3.56
Under-Reporting Percent Returns
1,200,000 2,900,000 2,900,000 3,900,000 3,600,000 3,200,000 2,242,000 3,800,000 3,650,000 2,950,000 4,840,000 3,771,509 2,723,830 1.3 3.1 3.0 4.1 3.7 3.2 2.2 3.7 3.4 2.7 4.3 3.3 2.4
1994 1995 1996 1997 1998 1999 2000
113,754,400 114,683,400 116,059,700 118,362,600 120,342,400 121,829,470 124,887,140
4,059,000 6,102,000 4,751,000 *5,984,000 5,669,000 6,552,000 5,751,000
3.57 5.32 4.1 5.1 4.7 5.4 4.6
2,645,075 2,711,086 1,930,326 931,354 1,726,098 1,770,695 1,353,545
2.3 2.4 1.7 0.8 1.4 1.5 1.1
Corporations 1.160 Corporations also are being treated more gently, with a 2002 Area audit rate of only .97%. This was less than half of1998 (2.04%) audits. The decline was especially noticeable among the largest corporations with assets of $250 million or more. In 1992, over half (55%) of these giants were audited. In 2002, the audit rate had dropped to only one in three (34.37%).
Examination 1.170 The Examination Division administers an audit program involving the selection and examination of all types of federal tax returns to determine correct liabilities due from taxpayers. Examinations are conducted either through interviews or correspondence. Many audits are conducted via correspondence from Compliance Center Tax Examiners. Each Area Office has Tax Auditors (TA) and Revenue Agents (RA) assigned to conduct audits. The TA’s are not accountants and are only required to have two semesters of accounting to qualify for the job. Revenue Agents in field audit are required to have at least 30 semester hours of accounting. The respective Compliance Officers and/or Revenue Agents are assigned to groups of 10 to 12 persons managed by a Group Manager. The Group Manager reports to a Branch Chief who will be in charge of four to five groups in an area. That Branch Chief reports directly to the Chief of the Examination Division.
Tax Exempt and Government Entities 1.180 The IRS has a special function in charge of auditing employee plans and exempt organizations. Agents assigned to Tax Exempt and Government Entities specialize in determining issues with respect to pension plans and employee benefit plans. This division also has specialists in examining exempt organizations such as churches, municipalities and charities.
Criminal Investigation 1.190 Each Internal Revenue Area has special agents whose duty is to seek prosecution of persons who have criminally violated tax laws. As part of its compliance efforts, the Internal Revenue Service recognizes that the threat of criminal prosecution causes many people to voluntarily comply with the tax laws. If the Internal Revenue Service believes a matter indicates criminal intent it will be assigned to a special agent who will conduct a thorough investigation to determine if prosecution is appropriate. It takes a very unlucky person to be prosecuted for a tax crime. The IRS only prosecuted 1942 people in fiscal year 2002. Of that number 585 were part of special programs to prosecute narcotics offenders.
Types of Examinations 1.200 The IRS utilizes several different examination techniques to determine the accuracy of tax returns. At the Compliance Center, computers are utilized to verify the computations shown on each return. If it is determined that the computations are incorrect on a return, a notice is issued to the taxpayer adjusting the amount of taxes due on the return. The Compliance Centers also conduct correspondence audits on issues by initiating letters to taxpayers requiring verification of deductions and/or exemptions shown on a return. Office audits of simpler 1040 returns are conducted in local Area Offices. Field examinations are conducted by Revenue Agents of more complex 1040 returns and other types of tax returns.
Compliance Center Audits 1.210 Compliance Centers conduct most correspondence audits. Some of these audits are generated as a result of information return matches. When the Compliance Center receives 1099s and W-2's, it matches them with a return. If there is an indication that not all income has been reported, a letter known as a CP-2000 will be issued to the taxpayer. This letter requests that the taxpayer explain why particular income items were not reported on his return. The taxpayer may request that the matter be transferred to a local Area Office for consideration. Compliance Centers also conduct audits of other items which can be easily explained via mail. In 2002, over 70% of the audits of individual tax returns were made by the Compliance Centers. In 1994, the Internal Revenue Service conducted 405,475 Compliance Center Audits and in 2003it more that number was 544,848 of audits totaling 743,881.
Mathematical Errors 1.220 Each return received by a Compliance Center is checked for mathematical errors. If there is an apparent mathematical error, the Compliance Center computer will issue a notice to the taxpayer that the amount due on the respective return has been corrected because of the error. That computer generated notice will note the reasons why the change has been made on the return. A notice is not a deficiency notice where it is based solely upon a mathematical or clerical error appearing on the return. The taxpayer has 60 days after the notice to file a request for abatement for the assessment. Upon receipt of the request, the IRS is supposed to abate the assessment. Any reassessment must be made using the normal deficiency notice procedure. The IRS may not initiate collection procedures during the 60-day period [IRC Sec. 6213].
Omitted Schedules 1.230 The Compliance Center checks returns to be sure all appropriate schedules are attached to the return.
When schedules are not attached, the taxpayer receives a letter requesting that the appropriate schedule be filed. If the appropriate schedule is not provided, the Compliance Center will adjust the taxes due on the return.
Document Matches 1.240 Many IRS correspondence audits are the result of document matches. Most large providers of 1099s and W-2s are required to file via magnetic media. This magnetic media is fed directly into the Internal Revenue Service computers. The remaining paper 1099s and W-2s are manually encoded into the IRS computers by its clerical personnel. Once the information from 1099s and W-2s is encoded into the IRS computers, the IRS is able to conduct a matching of the information documents with income tax returns. If such matches indicate certain 1099s and/or W-2s have been omitted from a taxpayer’s return, a CP-2000 notice is issued to the taxpayer requesting an explanation of the omission. If the taxpayer fails to fully respond to the notice, the IRS will issue an adjustment notice.
Correspondence Audits 1.250 The Compliance Center computers are programmed to select those returns with high DIF scores which reflect issues that could be easily resolved by mail. The computers select those returns which are appropriate for correspondence audits and each respective return is reviewed by either a Tax examiner or clerk. [IRM 4(13)10]. The returns are DIF screened and quality reviewed using technically proficient examination personnel who are experienced in DIF screening operations. Returns which have apparent examination issues other than those appropriate for correspondence audit are referred to the local Area Office. Some examples of the kinds of items which can be verified by correspondence are itemized deductions, such as interest, taxes, contributions, medical expenses, and simple miscellaneous deductions such as union dues and small tools [IRM 4143.2(1)(a)]. Issues other than itemized deductions may be examined if they are single matters which would not be appropriate for office audit or field examination.
Correspondence Audit Procedures 1.260 When a return has been selected for a correspondence audit, the IRS has developed a series of computer generated notices with respect to various issues on a tax return. Once a reviewer has determined an issue for examination, he will cause the computer to generate the appropriate notice for that issue. The IRS notice will grant the taxpayer 30 das to respond to the notice. The Taxpayer may request that the audit be transferred to his local Area Office [IRM 4 (13)13.1].
Taxpayer Reply 1.270 When a taxpayer responds to a correspondence examination notice, his response is processed by a first read section at the Compliance Center which attempts to determine the nature of his response. If his reply requires a response by the Internal Revenue Service, the matter is referred to the Adjustments and Correspondence Branch for preparation of a reply. The Internal Revenue Manual provides that taxpayer replies should be processed within 30 days, but practitioners have found that in many instances the processing time far exceeds 30 days [IRM 4(13)13.41]. If the section determines that the reply from the taxpayer has an adequate explanation of items questioned, it is forwarded to a Tax Examiner for review. If the explanation is satisfactory, the return will be accepted without change. If the explanation is not satisfactory, the Service will issue a Notice of Deficiency advising the taxpayer of the proposed tax change. If the taxpayer requests an interview to discuss
the matter or it is determined that an interview is necessary to resolve issues, the case is transferred to the Area Office in which the taxpayer resides [IRM 4259].
Undeliverable Correspondence 1.280 When correspondence sent to a taxpayers is returned undeliverable, the IRS will search its systems in an effort to determine a new address. The IRS also may initiate requests to employers and the Post Office to determine a forwarding address. If a new address is not obtained after pursuing steps to determine it, the Service will issue the next appropriate letter, either a 30- or a 90-day letter to the taxpayer at his last known address [IRM 4(13)13.5].
1.290 If the taxpayer does not agree or does not respond within 30 days of issuance of the initial letter, the IRS will issue a 30-day letter. If the taxpayer requests an interview or an appeals conference in response to the 30-day letter, the matter is transferred to the appropriate Area Office for necessary action. Compliance Center personnel are instructed to attempt to avoid transferring matters to the Area Office [IRM 4(13)14.1(3)] If the taxpayer does not respond to the 30-day letter, the IRS normally will issue a notice of deficiency (90-day letter). If the taxpayer does not respond to the 90-day letter by initiating a suit before the Tax Court within 90 days, the Service will assess the proposed deficiency.
Quality of Service Examiners 1.300 The authors have found that Compliance Center examiners are not well trained by the IRS. On many occasions, clients have properly responded to IRS computerized notices only to have deficiencies improperly assessed against them. If such an erroneous deficiency should occur, the taxpayer will receive a balance due notice from the Internal Revenue Compliance Center. In that event, the practitioner should immediately approach local Area Collection personnel and request that the audit be reopened. Collection personnel have authority to reopen an audit if it is determined that the matter was not properly handled by the Compliance Center. This procedure is called an audit reconsideration. If collection personnel refuse to reopen an audit, contact the Taxpayer Advocate.
Office Audits 1.310 Most office audits are of income tax returns which indicate under $100,000 in total positive income. Most involve deductions taken on Schedule A and Schedule E. Of the 111,695 conducted by office audit in 2002, only 33,000 involved Schedule C taxpayers. The vast majority of audits conducted for taxpayers having total positive income of less than $100,000 are conducted by Compliance Officers. Office audits are conducted in a very summary fashion. Because of the poor training of Compliance Officers and the large volume of cases, results can vary greatly from one audit to another. Tax Auditors (TA) normally only audit one year at a time. They may, however, request that prior or subsequent years be opened for audit if they find an issue which they believe to have been incorrectly reported on other years. Audits of small businesses are normally conducted by a special group within the office audit section.
Initiation of Office Audits
1.320 The office audit commences with a notice to the taxpayer requesting his appearance at an IRS office on a certain date. The letter will list a series of documents which the taxpayer must bring to the audit. When the letter arrives for an office audit, you may request that a proposed audit date be changed to a date more convenient for your schedule.
Initial Interview 1.330 The IRS considers the initial interview to be the most important part of the examination process [IRM MT 4231-72-230]. The taxpayer has the right to have a representative at the interview and the Service may not require a taxpayer to accompany an authorized representative to an examination interview in the absence of an administrative summons [IRC Sec. 7521(c)]. IRS personnel, however, normally request the taxpayer’s voluntary presence at the interview with the representative. Only in rare instances should the taxpayer accompany the representative to an interview. During the initial interview, the Tax Examiner will seek information to develop a financial history and standard of living for the taxpayer. He will also seek information concerning the nature of employment, exempt income, and look for the potential for moonlighting income. The responses to the questions during an interview could result in an expansion of the issues under consideration during the audit.
Pro Forma Audit Aids 1.340 The Service has developed pro forma audit aids for use by Tax Auditors on the following frequently examined items:
(1) Miscellaneous deductions; (2) Taxes; (3) Interest expenses; (4) Medical expenses; (5) Casualty losses; (6) Moving expenses; (7) Contributions; (8) Rental income and expenses.
Compliance Officers must use the pro forma forms when examining any of the above issues. The aids are designed to promote uniformity in examination technique and as a checklist for documentation.
Scope of Audit 1.350 The scope of an office audit is generally much more limited than a field examination. Examiners are generally expected to only audit issues raised by the classification section of the IRS. There is much less
emphasis on determining unreported income during an office audit than during a field examination. However, the Tax Auditor may expand the examination when significant issues become apparent as a result of information secured during examination. In most cases, the Auditor must secure Group Manager approval prior to opening new issues during the audit.
Discretion of Auditor 1.360 Tax Auditors are given great discretion as to the standard of proof required to support questioned items. For example, one Auditor might accept only cancelled checks as support for an expense, whereas another might literally accept an oral statement to support an expense. You can best represent you client by properly organizing all of his/her records which support the deductions and expenses under audit by the IRS. Compliance Officers are given a very limited amount of time to complete their examination. The more thorough and well organized your client’s records, the better the chance that you can prevent or reduce deficiencies. Because there is a great degree of discretion granted to an Auditor, you should attempt to develop a rapport with him at the outset. The greater the rapport between the practitioner and the Office Auditor, the greater the chance of a no-change audit. In 1993, 14% of office audits resulted in no change.
Office Audit Issues 1.370 Travel and entertainment expenses are always a favorite target of the IRS during audits. The Office Auditor will look at the travel expenses to be sure that they were necessary to the taxpayer’s occupation. Convention expenses and out-of town travel are particularly subject to review. With respect to entertainment expenses, the IRS will review the record system, if any, of the taxpayer. The ideal would b a quality diary system for each respective entertainment expense. If these records are not available, then some supporting documentation must be supplied in order to preserve your client’s deduction for travel and entertainment expenses. Receipts, affidavits, charge account records, and other supporting documents may preserve the deduction.
Automobile Expenses 1.380 Automobile expense are an issue in many audits. The Office Auditor will look at the records maintained by the client to assure that they meet the standard of adequacy. He will also try to contest the amount of personal use of the automobile by the taxpayer. Compliance Officers are not prone to believe that automobiles are used exclusively for business. Usually the advocate will be required to convince the Office Auditor with supporting documents and oral explanations.
Contributions 1.390 Contribution deductions have always been a favorite target of the office audit. Compliance Officers will seek to determine if payments were made to qualified organizations. They will also look at the nature of the taxpayer’s documentation. Obviously, canceled checks are the best supporting documentation during such audits, but are not always available. Acknowledgments from the donee organization are also appropriate. The IRS has recently placed greater emphasis upon determining if the taxpayer receives something of value as a result of the contribution. For example, the taxpayer may have paid $100 to attend a charity dinner. The value of the dinner itself would have to be excluded from the deduction for charitable expenses.
Casualty and Theft Losses 1.400 The IRS has always been prone to disallow casualty and theft losses. Compliance Officers continually hear stories regarding the alleged flood or fire which caused substantial losses. The taxpayer will be required to submit police and/or fire reports to support the claimed deduction. The taxpayer also must establish the value of the lost items. Even when confronted with such evidence, the IRS tends to place limited value upon the taxpayer’s assets [IRM MT 4231-46 575].
Educational Expenses 1.410 Educational expenses are an area of great scrutiny by the IRS The Service will seek to determine if expenses were primarily incurred for the purposes of maintaining or improving skills or meeting express requirements or retention of status. When auditing educational expenses involving overseas travel, the Auditor will review registration receipts and the transcript of students from the overseas educational institution. The Auditor will consider the amount of time devoted to educational pursuit in relation to total time spent overseas [IRM MT 4231-6 576].
Interest Expenses 1.420 When auditing interest expenses, the Service will verify the amount claimed and determine if the deduction was taken in the proper year. The Service will also seek to determine whether the payments are for interest or for some other item such as discounts. Special scrutiny will be given to loans from related individuals to determine if in fact there is a valid debt. Compliance Officers will request the supporting documents concerning the loan including the loan contract and other loan documents [IRM MT 4231-66-573].
Other Issues 1.430 Compliance Officers may scrutinize earned income credits, child care credits, and credits for the elderly. Personal business expenses are also high profile audit items.
Field Audits 1.440 Revenue Agents are accountants and have at least 30 credit units of accounting. They are much better trained than Compliance Officers. Field Agents are responsible for auditing high income non-business and business 1040 returns. Field Agents also conduct almost all of the audits of corporate tax returns. Normally, a Revenue Agent will audit more than one year at a time. For example, if 1999 is being audited, 2000 and 2001 may also be brought into the audit. On business audits, a field audit puts particular emphasis on determining whether all income was properly reported on the tax return. The Revenue Agent will review deposits to checking and savings accounts for the years at issue. He will also look at the disbursements form those accounts. Revenue Agents put more emphasis on the quality of records and methods of accounting than Tax Auditors. They will consider all of the deposits to a bank account as income unless the taxpayer is able to show that the funds came from bank transfers, loan proceeds, repayment of notes receivable, gifts and/or insurance proceeds. Revenue Agents tend to shift the burden for establishing these matters to the taxpayer. They also will raise specific accounting issues to be resolved during the audit. For example, you might be required to establish when assets were placed in service for the purposes of determining whether depreciation will be allowed in a particular year
for those assets. He may also question the quality of the records utilized within the taxpayer’s bookkeeping system. It is not unusual for an Agent to reconcile those records in an effort to find discrepancies and flaws in the system.
Unreported Income 1.450 In business audits, the primary focus is to find unreported income. Two methods are used to find unreported income: (a) cash reconciliation, and (b) net worth method. The cash reconciliation method requires all bank statements and savings deposit passbooks be analyzed for income and expenses. The Revenue Agent will analyze all deposits and compare those deposits to gross income reported on the tax return. He will then discount for non-taxable sources of income and transfer of funds between various accounts. A second method of determining under-reporting of income is the net worth method. This method requires analysis of the changes in the net worth of the taxpayer and a comparison of changes in income reported on the tax return. For example, if the value of the taxpayer’s cash in the bank had increased by $20,000, the amount of stock he owned increased by $10,000, and he had acquired a $10,000 car in a particular year for cash or cash equivalent, that taxpayer better have reported at least $40,000 in income or have some explanation as to the alternative sources of those funds.
Financial Status Examinations 1.460 During fiscal year 1995 the IRS trained all of its agents on techniques known as Financial Status Audits (also known as Economic Realty Audits). These audits emphasize looking at the taxpayer’s lifestyle. Agents were given extensive instructions on securing financial data prior to beginning the actual examination. As a matter of standard practice, the Internal Revenue Service now checks motor vehicle information, real estate databases and credit databases to secure more information regarding the taxpayer before an audit even begins. It also looks at Bureau of Labor Statistics for the taxpayer’s zip code to determine normal living expenses and per capita income. Armed with this information, the Internal Revenue Service then begins his Financial Status Audit. All agents have been trained in the use of T account methods for determination of unreported income. Using the T account method, the agent will attempt to reconstruct the taxpayer’s total expenditures in relations to known sources of income. To the extent that the taxpayer’s expenditures exceed known sources of income the Internal Revenue Service will assume that the taxpayer under reported income.
IRS Must Prove Statistically Computed Income 1.470 When the IRS uses statistical information from unrelated taxpayers solely to reconstruct an individual taxpayer’s income (such as found in life-style or financial status audits), the burden of proof is also on the IRS with respect to the income items reconstructed (Act §3001(b), Code §7491(b)).
Use of Financial Status Audits Limited 1.480 The Bill prohibits the IRS from using financial status or economic reality examination techniques to determine the existence of unreported income unless there is a "reasonable indication" that there is a likelihood of unreported income (Act §3412; Code §7602; effective on July 22, 1998).
Location of Audit
1.490 Generally, a Field Agent conducts an examination of the taxpayer’s place of business. The authors recommend that the taxpayer request that the audit be conducted at the practitioner’s office. By conducting the audit at the practitioner’s office the Agent will not gain the extraneous information which becomes available to him via observing the day-to-day operations of the client’s business. It might be somewhat inconvenient to continually have your client deliver records to your office during the course of an audit, but this method is preferable to the IRS gaining an advantage by being present at the taxpayer’s place of business.
Agent’s Interview 1.500 The best way to represent your client at the audit interview is to give the impression that you know what you are doing and that you are fully organized. IRS Agents tend to be the harshest on persons who are disorganized. When you appear at the audit, have your client’s records organized in a logical fashion and be able to support those deductions that are at issue. If adequate records do not exist, have the alternative documents which support the respective deductions and expenses. If there are unusual issues with respect to the case, be prepared to discuss them in depth. It would be best to research complex issues in tax reporters prior to appearing at the audit if you anticipate a particular issue will be raised by the Agent. Don’t volunteer information! It never hurts to be chatty with the Revenue Agent but remember, if you discuss an issue which hadn’t come to the Agent’s mind, it may become an issue. You should maintain a professional demeanor during the discussions with Revenue Agents. Personalities play an important role during an audit. If the Agent doesn’t like you, you can bet your client will receive harsh treatment. Given the power that Agents have, you must approach them in a polite manner. Even is he is extremely officious, try to maintain a professional, polite manner. Shouting and power play negotiations are ineffective in dealing with IRS Agents. If the Agent is totally unreasonable, be aware that you have several levels of appeal prior to the assessment becoming final. Use of Computers by Agents 1.510 Agents are now assigned portable personal computers which they bring to audits. The IRS extensively utilizes its portable computers during an examination. The Agent has programs available to him for reconciling bank statements and disbursements. Once an Agent has determined a tax deficiency, he may enter those deficiencies into the computer and it will compute all applicable taxes, interest and penalties.
Audit Plans 1.520 Prior to initiating a field examination, Revenue Agents are required to prepare a plan of examination. The plan sets forth the issues which the Agent expects to audit and a time budget for conducting the audit. The IRS requires this plan in an effort to promote an efficient audit process. The Agent will discuss the plan with his manager and adjustments with respect to time allocations and emphasis of the audit will be made during the conference. For the practitioner, it is important to realize that the Agent has a time budget for each audit. If the audit becomes much more complex than originally expected, some Agents may let issues fall by the wayside. On the other hand, if the Agent is able to develop a matter rapidly with respect to some issues and still has time remaining in his budget, he may pursue new issues during the audit.
Closely Held Businesses 1.530 When an Agent is examining a closely held corporation, he will normally also review the individual tax returns of the corporate shareholders. The individual returns might be surveyed subsequent to that review, but in many instances the Agent decides to open audit issues with respect to the individual returns. On many occasions, alleged unreported income of a corporation is then double taxed. The Agent will allege under-reporting by the
corporation and then attribute a dividend to the shareholders. Such an allocation results in the income being taxed at both the corporate level and the individual level. Audits of other shareholders of closely held corporations may also be opened as a result of an examination of one of its shareholders. In such an event, other shareholders may suffer an audit because of misstatements by one officer.
Audit Coordination Between Officers and Corporation 1.540 If the returns for respective officers and the corporation are assigned to different Agents, the IRS has developed procedures for coordination of the examination. Agents apprize each other of the progress of the respective audits and/or open new issues when they arise on one of the respective returns. During the course of the examination, Agents may also determine payments to family members which may not be for services rendered. For example, a corporation may show the owner’s son on the payroll as an employee when, in fact, that son has not performed any services. In such an event, the son’s return might then become the subject of an examination. Some clients might also utilize bank accounts of friends and relatives to conceal unreported income. Such schemes may lead to a criminal investigation.
Large Case Audits 1.550 The IRS has developed a program to audit the largest corporations conducting business in the United States. That program is known as the Coordinated Examination Program. Teams of the most experienced examiners and specialists of the IRS conduct examinations of the 1,650 largest and most complex domestic and foreign controlled corporations
Audit Team 1.560 A large case examination is conducted by a team of specialists which is assigned to a particular company. Each team is managed by a large case manager. Each of the respective specialists will be assigned various issues to review within the corporation. At one time, the IRS would assign Agents to one corporation for years and years, but the Service now has a policy of periodically rotating Agents so that personal relationships are less likely to develop between corporate staff and the Agents.
Audit Plan 1.570 As with small audits, the audit team will develop an audit plan. Normally, this plan will also be shared with the tax department of the corporation and its representative.
Industry Specialization Program 1.580 The IRS has developed a program for identifying industry groups requiring centralized coordination expertise. Industries are designated for this program based upon the complexity and significance of tax issues. This information is obtained through an industry study which is coordinated nationally. Currently, there are 27 designated industries in the program. Once an industry is designated for a specialized program, a team of experts from examination and chief counsel functions is established, and they become the focal point for providing legal and audit direction to front line examining agents.
Market Segment Specialization Program 1.590 In 1993, the Internal Revenue Service began developing a program called the Market Segment Specialization Program (MSSP). The IRS decided that it was in its best interests to create specialists in various industries to conduct exams. In the past, agents would be assigned 15 or 20 cases in various industries. Such an approach was not very effective because an agent was required to become familiar with the accounting methods and procedures of each new industry. The Market Segment Specialization Program is designed to create guidelines for audits in many industries.
Audit Guidelines 1.600 As part of the MSSP, the Internal Revenue Service has issued audit guidelines for each identified industries. The guidelines are, in effect, a manual of procedures for examination of each respective industry. Among the first guidelines to be issued, were those for examination of attorneys. The practitioner might be surprised to find that those guidelines suggest that if an attorney pays costs on behalf of a client, it should not be expensed but shown as a loan to client.
Market Segment Specialization 1.610 Industries which the IRS had issued audit guides for as of December 2003 are as follows:
Air Charters Released May 1993 Alaska Commercial Fishing: Part I - Catcher Vessels Released July 1995 Alaska Commercial Fishing: Part II – Processors and Brokers Released July 1995 AMT for Individuals Released Dec 1999 Architects Released Jan 1995 Artists and Art Galleries Released April 1997 Attorneys Revised June 1994 Auto Body and Repair Industry Released August 1995 Auto Industry Released Sept 2000 Aviation Tax Released Feb 1999 Bail Bond Industry Released July 1997 Bars and Restaurants Released Feb 1995 Beauty and Barber Shops Released July 1995
Bed & Breakfasts Released May 1993 Business Consultants Released April 2001 Carpentry and Framing Released Feb 1999 Car Wash Industry Released August 1998 Cattle Industry Released May 1996 Child Care Providers Released May 2000 Coal Excise Tax Released Feb 1998 Commercial Banking Industry Released July 2001 Commercial Printing Industry Released April 1997 Computers, Electronics and High Technology Released March 1998 Construction Industry Released July 1998 Drywallers Released August 1998 Entertainment - Important 1040 Issues Released April 1995 Entertainment - Music Industry Released March 1994 Farm Hobby Loss Released April 2001 Farming - Specific Income Issues and Farm Cooperative Released July 1997 Foreign Athletes & Entertainers Released Oct 1994 Furniture Manufacturing Released July 1997 Garden Supplies Industry Released Feb 2000 Garment Contractors Released June 1997 Garment Manufacturers Released April 1997 Gasoline Retailer Industry Released July 1995 Grain Farmers Released July 1995 Hardwood Timber Industry Released Feb 1998 Independent Used Car Dealers Released April 1996 Laundromat Industry Released June 2000 Lawsuit Awards & Settlements Released Jan 2001 Livestock Released May 2000
Low-Income Housing Credit Released August 1999 Manufacturing Industry Released May 1998 Masonry and Concrete Industries Released August 1998 Ministers Released May 1995 Mobile Food Vendors Released April 1995 Mortuaries Released May 1993 Net Operating Losses for Individuals Released Feb 1999 Oil & Gas Industry Released May 1996 Passive Activity Losses Released Feb 1996 Placer Mining Industry Released July 1999 Pizza Restaurants Released Sept 1995 The Port Project Released August 1995 Reforestation Industry Released August 1995 Rehabilitation Tax Credit Released Dec 1994 Retail Gift Shops Released Oct 2001 Retail Liquor Industry Released July 1997 RTC Debt Cancellation on Returns Released March 1995 Scrap Metal Industry Released Feb 1999 Shareholder Loan Released April 2001 Sports Franchises Released August 1999 Taxicabs Released May 1993 Tobacco Industry Released March 1996 Tour Bus Industry Released June 1997 Trucking Industry Released Sept 1995 Veterinary Medicine Released Feb 1999 Wine Industry Released April 1995
Market Segment Understandings
1.620 The IRS has also entered Market Segment Understandings (MSUs) with certain industries as to the treatment of worker compensation and other issues. The following are the current MSUs:
Cosmetology & Barber Industry TRAC Released December 2000 Farm Labor Released December 1994 Food & Beverage Industry TRAC Released December 2000 Food & Beverage Industry TRDA Released December 2000 Gaming Industry Released January 2000 Generic TRAC Released December 2000 Generic TRDA Released December 2000 Hairstyling Industry Released January 2000 Limousine Industry Released March1997 Moving Industry Released December 1998 Television Industry Released May 1994
MSSP Approach 1.630 When conducting audits in the future, the IRS will rely more and more on the MSSP guidelines. The new practice has led to audits being done more efficiently and with fewer errors.
Potential Benefits to IRS of MSSP 1.640 The IRS sees a number of potential benefits from the MSSP:
1. Information learned from examining a specific market segment will be systematically fed into databases and analyzed to determine levels and trends of compliance for the entire segment rather than individual taxpayers.
2. Market segment specialization will increase auditors’ knowledge of taxpayer businesses. Taxpayers will become more confident in the ability of the IRS to administer the tax laws.
3. As Examiners become specialists, their professional development will be aided.
4. Sharing of expertise should assure more competent and consistent treatment of issues.
5. Release of the audit technique guides will tell taxpayers what the IRS wants, which will lead to better kept records and easier identification issues.
6. The IRS envisions that the MSSP will be cross-functional. For example, input from Appeals, Collection, Area Counsel, etc., will more likely ensure that examinations are consistently and efficiently conducted and resolved. This is also consistent with the premise of the IRS reorganization--to cluster the agency along functional lines, such as overall compliance rather than Collection and Examination in separate components.
Exam Reengineering 1.650 The Small Business/Self Employed (SB/SE) division of the Internal Revenue Service initiated its Examination Reengineering effort to improve the quality and consistency of income tax examinations. SB/SE interviewed a wide range of individuals both internally and externally to find and identify best practices and potential areas of improvement in its examinations. Among the individuals the reengineering teams interviewed were previously audited taxpayers, tax practitioners, federal and state government agencies, financial institutions, examination employees, and many others involved in the tax community. SB/SE tested the redesigned examination process in both rural and urban areas to ensure the new process is equally effective and consistent throughout the country. The reengineered process was adjusted according to the feedback from taxpayers, practitioners and employees involved in the examinations during the test period.
Features of the New Process 1.660 Some of the features of the reengineered field examination process are:
- ?Clearly communicated expectations of both the taxpayer and field agent through mandatory discussions between the revenue agent and taxpayer regarding the specific examination issues, required documentation, and a mutually agreed upon date to complete the examination.
- ?At the beginning of each examination, field agents and their managers will meet to discuss the agent’s approach to the examination, the plan to close the examination, and the mutual commitment date arrived at with the taxpayer.
- ?Field agents will use standardized templates for every examination issue to gather the information necessary to resolve issues. Agents will use a standardized guide when deciding if additional issues need to be added to the
examination. The agent will explain to the taxpayer if any additional issues are included in the examination.
Some of the features of the reengineered office examination process are:
- ?Clearly communicated expectations of both the taxpayer and the examiner prior to the initial appointment. Office examiners will provide the taxpayer with focused document requests that specifically identify the information needed.
- ?Improved flexibility in the scheduling process will enable examiners and taxpayers to reduce the time it takes to complete an examination.
- ?Office examiners will use standardized templates for every examination issue to gather the information necessary to resolve issues. Examiners will use a standardized guide when deciding if additional issues need to be added to the examination. The examiner will explain to the taxpayer if any additional issues are included in the examination.
Training Has Begun 1.670 With the final adjustments made, SB/SE will train all of its income tax field agents and office examiners during the 2004 fiscal year. Field agent training began in December 2003 and training for the office examiners began in January 2004. The redesigned examination process will benefit taxpayers and practitioners because the audits will be better focused on relevant issues, expectations between the examiner and taxpayer will be clearly communicated, and the time it takes to complete the examination may be reduced.
Why Is the IRS Undertaking This Process Now? 1.680 It's imperative that the IRS make continual improvements while seeking efficient and effective new ways to achieve its mission of service to each taxpayer through a quality work environment. These goals can be met only by making specific changes to examination work processes and developing approaches that are specifically tailored for the agency's customer base and employee needs. Moreover, the Exam Reengineering Project isn't just about change; it's about making a long-lasting, positive impact on the entire SB/SE organization. Commissioner Kehoe said, "We’re going to give our employees the means to work smarter and more efficiently, and when we’re done, we will not only meet but exceed the expectations of our employees and our customers."
1.690 The IRS leadership believes that all stakeholders--including employees--have the opportunity to contribute to the Exam Reengineering effort by providing input into process improvements as they evolve. Commissioner Kehoe said, "Improving our business processes is a team effort, and by sharing your knowledge and experience, the Exam Reengineering Project will be a success. Incremental change isn't enough to bring us closer to our goal of providing the best service to our customers. Together, we can rebuild the Exam Reengineering process, and when we’re done, we will all reap the benefits of working better and smarter for years to come."
Other Sources 1.700 Other sources of workload are Collection referrals, Criminal Investigation referrals, EP/EO referrals, Information Reports and Return Preparers. Detailed information is located in the Compliance Initiative Projects Handbook.
Midwest Automated Compliance System -- MACS 1.710 MACS is an automated compliance tool that provides the capability to profile a population, identify market segments, and identify issues during screening. MACS contains Return Transaction File data and certain Master File information for three years for all taxpayers who filed within a district or service/customer service center area (IMF, 1120, 1120S, 1065 and 1041 only). MACS has stringent operating restrictions to ensure the securing of the data and that taxpayer privacy is not compromised. MACS may be used for information on specific taxpayers even if only a partial name or address is known. This includes a return facsimile in either a one year or three year comparative format and a Cash-T analysis. This information may be used for case building or return selection decisions. A MACS facsimile may be used in lieu of the original tax return. MACS may be used to identify potential noncompliance within a market segment, and to select a sample of returns to test the level of noncompliance.[IRM 4.1 4.21]
Return Preparer Enforcement Program 1.720 The IRS Criminal Investigation Return Preparer Program (RPP) was implemented in 1996, and established procedures to foster compliance by identifying, investigating and prosecuting abusive return preparers. The program was developed to enhance compliance in the return-preparer community by engaging in enforcement actions and/or asserting appropriate civil penalties against unscrupulous or incompetent return preparers. This is a significant problem for both the IRS and our taxpayers. Abusive return preparers frequently prepare bad returns for large numbers of taxpayers who, at best, are stuck with paying additional taxes and interest and at worse, depending on culpability, are subject to penalties and maybe even criminal prosecution.
FedState Initiative Procedures 1.730 FedState initiatives are developed and shared using a common format (template) that is available from Regional FedState Program Managers, the National Office FedState Relations, and the FedState web page. Using the template to guide initiative development enables a business case proposal to be developed for projects that should be replicated nationwide. Completing the template
will also provide much of the information needed to prepare a Compliance Initiative Proposal (CIP) where applicable. The FedState template is used for all new FedState initiatives unless an exception applies or regional approval for non-use of the template is obtained.
IRS Sets New Audit Priorities 1.740 The Internal Revenue Service is realigning its audit resources to focus on key areas of non-compliance with the tax laws. The strategy represents a new direction for the agency's compliance effort.
1.750 Following months of research and planning, the new approach will focus on high-risk areas of non-compliance. The IRS effort will generally focus first on promoters and then on participants in these various schemes. The initiative will feature new and enhanced efforts on several priority areas, including:
Offshore credit card users. High-risk, high-income taxpayers. Abusive schemes and promoter investigations. High-income non-filers. Unreported income. The National Research Program.
Increased Resources For Audits – Also Known As Examinations -- Will Be Devoted To These Projects In Fiscal Year 2003, Which Will Be A Year Of Transition And Training As New Audit Cases Move Into The IRS System.
1.760 The IRS Small Business/Self-Employed Division will handle the new effort in these key areas affecting individuals and businesses. Compliance efforts will continue in other parts of the agency, such as the tax shelter initiative in the Large and Mid-Sized Business Division. This initiative reflects part of a broader, agency-wide plan at the IRS. This strategy places a top priority on pursuing promoters of abusive schemes, shelters and trusts and then identifying participants in these efforts to evade taxes. To address these problems, the IRS has revamped its compliance programs to refocus on problem areas. The IRS will use a full scope of tools and techniques ranging from summons enforcement, injunctions and criminal investigation of promoters to civil audits of participants.
Strategy 1.770 The strategy reflects the new way of doing business at the IRS. Several of these efforts -- such as the National Research Program and the credit card initiative -- reflect innovative approaches to tackle long-standing tax problems. The new audit initiative will include similar emphasis for the agency's collection area. And new levels of cooperation and coordination are underway on initiatives that involve both civil actions and criminal investigation. These illustrate how the new IRS business
model positions the agency to respond to high-risk tax areas. For the six new areas, the agency will direct more examination resources to address these issues. However, the IRS will maintain a presence in other audit areas to maintain core tax administration responsibilities. Additional exam resources will help meet this requirement.
Key areas for the new initiative include:
Offshore Credit Card Project 1.780 It is not illegal to have an offshore credit card. However, there is a reasonable basis for believing that some people are using offshore credit cards to evade paying U.S. taxes. Credit cards provide easy access to offshore funds and accounts in tax haven countries that allow income to be hidden. U.S. citizens must pay tax on their worldwide income.
The IRS has taken several major steps to combat tax-avoidance schemes involving credit cards issued by offshore banks. According to public records:
1. On October 30, 2000, a federal judge in Miami issued an order authorizing the IRS to serve John Doe summonses on American Express and MasterCard. These summonses were designed to obtain limited information for 1998 and 1999 revealing U.S. participants in offshore arrangements who hold credit cards issued by banks from Antigua and Barbuda, the Bahamas, and the Cayman Islands.
2. On March 27, 2002, a federal judge in San Francisco issued an order authorizing the IRS to serve a John Doe summons on VISA International seeking records on transactions for 1999-2001 using cards issued by banks in over 30 tax haven countries.
3. On August 21, 2002, a federal judge in Miami issued an order authorizing the IRS to serve a John Doe summons on MasterCard for records on transactions for 1999-2001 using credit cards issued by banks in over 30 tax haven countries.
4. On August 29, 2002, the IRS asked seven courts across the nation (Atlanta, Chicago, Dallas, San Francisco, Seattle, Newark, Alexandria, Va.) for permission to serve John Doe summonses on over 40 businesses to assist in the identification of credit card owners.
Mastercard 1.790 The first summons alone yielded data from MasterCard on 237,000 cards issued through 28 banks in three countries. The majority of the cards appear to have been issued to U.S. customers. If
the MasterCard information is representative of the industry, there could be 1 million to 2 million U.S. citizens with debit/credit issued by offshore banks. This compares with only 170,000 Reports of Foreign Bank & Financial Accounts being filed in 2000 and only 117,000 individual 1040 filers indicating they had offshore bank accounts (tax year 1999).
Number of Taxpayers 1.800 Credit cards do not equate to taxpayers. The IRS must utilize an extensive process to identify the taxpayer associated with each card. Spending patterns, unusual expenses, proximity of spending and repetitive expenses are all considered in the process. Once taxpayers are identified from cards, case building begins. The IRS already has developed hundreds of cases for civil audits or potential criminal investigations. The IRS is increasing resources in Fiscal Years 2003-2004 devoted to working these cases.
High-Risk, High-Income Taxpayers 1.810 High-income returns are often more complex and, generally, upper income taxpayers have resources to engage in pass-through entities such as partnerships, trusts and corporations. Even utilizing IRS’s various matching programs, income and deductions from such activities are more difficult to verify.
K-1 Matching 1.820 While the IRS has begun to match K-1 forms from pass-through entities, the technique does not provide any verification of income reported by the entity itself. Verifying the income on these returns requires an examination. Starting in fiscal year 2003, the IRS will be utilizing a combination of filters to identify high-risk, high-income returns. The returns selected for examination will be those most likely to have unreported income or structured transactions.
Structured Transaction 1.830 A structured transaction is one with limited economic benefit and whose primary purpose is to reduce or eliminate a tax liability. Structured transactions are generally done through one or more pass-through returns, such as Forms 1065 or 1120-S. The pass-through returns create paper losses that flow back to individual income tax returns offsetting income from other sources.
Abusive Schemes And Promoter Investigations 1.840 IRS efforts to combat abusive schemes and scams (including the Offshore Credit Card Project) will significantly increase from FY2002 to FY2003. Schemes and scams on the rise include:
1. Schemes, reducing a person’s tax liability by claiming inflated expenses, false deductions,
unallowable credits or excessive exemptions.
2. Frivolous return arguments, telling taxpayers compliance is voluntary or the U.S. Constitution does not provide for tax collection.
3. Promotion of slavery reparation claims, scams that claim compensation for people who have ancestors who were slaves.
4. Abusive shelters and trusts, investments established for the purpose of hiding income from taxation.
5. Employment tax schemes, employee leasing, paying in cash and filing false payroll tax returns.
Abusive Scheme Groups are being established in each Area and the use of Fraud Specialists will increase. To identify and address promoter activity, a Promoter Lead Development Center has been created. The Center systematically monitors the Internet to identify promoters of abusive activities and develops cases for injunctive investigations.
High-Income Non-Filers 1.850 The IRS efforts to address non-filers in FY 2003 will focus on the most egregious and high-risk segments of the population.
The non-filer strategy will be pursued on many fronts:
1. Re-engineered processes and work streams to improve efficiency and productivity.
2. Identification and expedited assignment of the most egregious non-filers.
3. Expanded and centralized automated enforcement.
4. Outreach and education efforts.
Unreported Income 1.860 Unreported income represents the largest component of the tax gap. IRS has developed a new tool for identifying returns with a high probability of unreported income. The new tool is known as Unreported Income Discriminant Index Formula (UI DIF). All individual returns have traditionally been assigned a DIF score rating the probability of inaccurate information on the return. The new UI DIF score rates the probability of income being omitted from the return. The IRS has customarily used indirect examination methods to identify unreported income but until now has had no systemic method for selecting the returns at highest risk for unreported income. UI DIF gives the IRS the ability to systemically identify returns at high risk for unreported income and beginning this fall all returns will receive a UI DIF score in addition to the traditional DIF score.
National Research Program 1.870 National Research Program (NRP) examinations, which begin this fall, will measure reporting compliance and identify compliance issues. NRP will enable the IRS to improve the examination selection process. NRP is very different from its predecessor, the Taxpayer Compliance Measurement Program (TCMP). NRP no longer relies heavily on time-intensive, "line-by-line" audits for establishing a baseline measure of reporting compliance.
The IRS has not conducted updated research on the distribution of errors on returns for more than 13 years, a period when the economy and the tax law have changed dramatically. Without the information that will be gathered through NRP, the IRS will have less ability to direct examinations and other compliance activities with accuracy and precision. With updated information, the NRP effort will prevent thousands of "no change" audits each year.
Small Sample 1.880 The NRP effort will review a small, statistically valid sample of individual returns for tax year 2001, less than 47,000 returns out of 132 million individual returns filed. The new NRP process will have four main categories:
1. No IRS contact. About 8,000 returns will be checked relying solely on information already available to IRS.
2. Correspondence. These will be less intrusive correspondence exchanges with taxpayers – rather than the old standard of sit-down audits. About 9,000 returns will be included in this process.
3. Less intrusive audits. Instead of the old "line-by-line" examination approach, the IRS will gather more information beforehand from agency records and focus only on selected parts of approximately 30,000 returns.
4. Calibration audits. These will consist of about 2,000 examinations that will check each line of the return. But, in a major change from earlier programs, taxpayers will not be required to provide line-by-line substantiation.
Abusive Trusts 1.890 It is estimated that $4.8 trillion in wealth will be inherited or transferred from one generation to the next by 2015, with much of it transferred through a variety of trusts. Filings of trust returns (Form 1041) are now the third most frequently filed income tax return behind individual and corporate returns. Although the vast majority of these transfers are legal, there is widespread potential for fraud. In the last few years, the Internal Revenue Service has detected a proliferation of abusive trust tax evasion schemes. These promotions are targeted towards wealthy individuals, small business owners, and professionals such as doctors and lawyers.
Promotion 1.900 Abusive trust arrangements typically are promoted by the promise of such benefits as:
Reduction or elimination of income subject to tax. Deductions for personal expenses paid by the trust. Depreciation deductions of an owner's personal expenses paid by the trust. Depreciation deductions of an owner's personal residence and furnishings. A stepped-up basis for property transferred to the trust. The reduction or elimination of self-employment taxes. The reduction or elimination of gift and estate taxes.
Hidden Ownership 1.910 Abusive trust arrangements often use trusts to hide the true ownership of assets and income or to disguise the substance of transactions. Although these schemes give the appearance of separating responsibility and control from the benefits of ownership, as would be the case with legitimate trusts, the taxpayer in fact controls them.
More Than One Trust 1.920 These arrangements frequently involve more than one trust, each holding different assets of the taxpayer (the taxpayer's business, equipment, home, automobile, etc.), as well as interests in other trusts. The trusts are vertically layered, with each trust distributing income to the next layer. Funds may flow from one trust to another trust by way of rental agreements, fees for services, purchase and sale agreements, and distributions. The goal is to use inflated or nonexistent deductions to reduce taxable income to nominal amounts.
Two Basic Schemes 1.930 Although the individual abusive promotions vary, two basic schemes have been identified:
The domestic package, and The foreign package.
These schemes are often promoted by a network of promoters and sub-promoters who have charged $5,000 to $70,000 for their packages. This fee enables taxpayers to have trust documents prepared, to utilize foreign and domestic trustees as offered by promoters, and to use foreign bank accounts and corporations. In some instances, tax return preparer services are also made available.
Abusive Home-Based Business Schemes 1.940 Abusive home-based business tax schemes have gained popularity over the last few years for a variety of reasons, including:
1. Taxpayers being inappropriately advised they can deduct all or a portion of their personal assets and living expenses.
2. Unscrupulous promoters and tax practitioners selling "tax relief" and "audit assistance" packages.
3. The desire of individuals to reduce the amount of taxes they pay.
4. Aggressive marketing of multi-level pyramid schemes.
Non-deductible Personal Expenses 1.950 Many taxpayers accurately report their income and expenses, while enjoying the benefits that a home-based business can offer. However, there are individuals who have received advice that they can operate any type of unprofitable "business" out of their home and claim personal expenses. Non-deductible personal living expenses cannot be transformed into deductible expenses regardless of how convincing the information in marketing materials may seem.
Applicable Internal Revenue Code sections include, but are not limited to:
Educational Assistance Programs
Trade or Business Expenses
Activities Not Engaged in for Profit
Expenses for the Production of Income
Personal, Living, and Family Expenses
Disallowance of Certain Entertainment, etc., Expenses
Disallowance of Certain Expenses in Connection with Business Use of Home, etc
Examples 1.960 The following are a few examples of items that are generally not deductible as business expenses:
1. Deducting the cost and operation of a personal residence. Placing a calendar, desk, file cabinet, telephone, or some other business-related item in each room does not increase the amount that can be deducted. Individuals may attempt to deduct a portion of the total house payment, which is not allowable. (Even in cases of appropriate home-business deductions, depreciation recapture rules are applicable when assets are later sold.)
2. Paying children a salary (e.g. answering telephones, washing cars, etc.).
3. Deducting education expenses for children without regard for Internal Revenue Code §127.
4. Deducting excessive car and truck expenses when the asset has been used for both business and personal use.
5. Deducting personal furniture, home entertainment equipment, children’s toys, etc.
6. Deducting travel, meals, and entertainment under the guise that everyone is a potential client.
Any investment scheme or promotion that claims to allow a person to deduct normal personal expenses should be considered highly suspect. A business must truly exist prior to claiming expenses.
Tax Protestor Arguments 1.970 Since shortly after the federal income tax was enacted in 1913, some individuals and groups have encouraged others not to comply with the law. There have been unsuccessful challenges about the applicability of tax laws using a variety of arguments. There have been assertions that the 16th Amendment was not properly ratified, the tax law was unconstitutional, the tax law did not apply to certain types of income, the tax law only applied to certain individuals, and the tax law violated one or more constitutional rights.
Courts Reject 1.980 Despite the courts having consistently rejected these arguments, their promoters continue to expound them, even incurring penalties for bringing frivolous cases into court or for filing frivolous tax returns. They often present their arguments in a pseudo-legal format, luring unsuspecting people into participating in their schemes to evade taxes.
Americans with Disabilities Act Schemes 1.990 Title I of the Americans with Disabilities Act of 1990 (ADA) prohibits private employers with 15 or more employees from discriminating against a qualified individual with a disability. To implement this prohibition, the ADA also requires that employers provide reasonable accommodations to the known physical or mental limitations of a qualified individual with a disability, unless to do so would impose an undue hardship on the operation of an employer's business. In order to comply with this requirement (and other requirements imposed by the ADA, e.g. those of Title III), an employer may have to make significant outlays.
More Dollars for IRS 1.1000 The Bush administration has proposed adding more IRS resources for compliance. Specifically, the budget request would add an additional $109.8 million and 1,599 staff members to enhance compliance. Most of the extra resources will he allocated to five areas.
First, nearly half of the extra money would go to the IRS Small Business/SelfEmployed (SB/SE) Division, which would apply the extra resources to beef up many of its existing compliance programs and "leverage new workload selection systems and case building from on-going reengineering efforts." The rationale is in a new IRS acronym: ABLE (achieving balanced levels of enforcement). ABLE would provide $55.5 million and 887 additional staff members in 2004. Areas receiving additional attention include organized tax resistance, abusive trusts and shelters (including offshore credit cards), special purpose entities, and employment tax schemes. The abusive trusts and shelters and special purpose entities effort would primarily affect high-income individuals who use structured transactions and flow-through entities (for example, partnerships) to conceal tax liability and avoid payment of taxes. The IRS estimates that abusive tax schemes cost the government up to $40 billion annually in lost tax revenue. With the ABLE funds, the IRS expects to close 20,999 examinations on flow-through returns in fiscal 2004. This is a 110 percent increase over expected fiscal 2003 levels, according to the IRS. Also, the IRS expects to close 78,244 individual examinations on returns with income in excess of $100,000. This represents a 33 percent increase — or more than 19,600 more return closures — over expected fiscal 2003 levels.
Second, the White House budget proposes for the IRS Wage and Investment Operating Division (W&I) an extra $3.6 million and 67 extra staff members to reduce the existing nonfiler inventory. The IRS has a nonfiler inventory of 6.8 million taxpayers, of which 1.6 million will be selected for potential contact in fiscal 2004. The IRS also intends to focus on a questionable Form W-4 program as a first step in establishing higher levels of voluntary compliance with the filing requirements. One way for taxpayers to avoid filing is by inflating the number of dependents for withholding purposes on the Form W-4. Although the number of questionable Forms W4 reviewed in recent years has decreased, the IRS believes that reviewing additional W4s will improve filing and payment compliance across the W&I population. W&I would also devote more staff to the automated substitute for return (ASFR) program, which allows the IRS to create a return for a potential nonfiler so collection action on a possible tax debt can begin. With increased ASFR efforts, the IRS hopes to reduce the inventory of non-filers. Specifically, the IRS hopes ASFR will result in approximately 82,000 closures, $74 million net assessments, and $14.5 million collected. The effort could create $60 million in extra accounts receivable.
Third, W&I expects to reduce the size of the accounts receivable by devoting $4.5 million and 100 more staff members to this effort. According to the IRS, it estimates that this will allow for the closure of 16,000 more cases in 2004 that should result in an additional $22 million in revenue.
Fourth, W&I would devote an extra $2.2 million and 51 staff members to automated underreporter (AUR) cases. The IRS contends that it can work only 30 percent of the five million cases currently in inventory. The extra staff would
allow the IRS to work an additional 116,000 cases in 2004, which could result in roughly $98 million in additional assessments.
Fifth, LMSB would apportion an extra $22.4 million and 258 staff members to increase examinations of large flow through entities and abusive corporate transactions. The Service has designated abusive tax shelters as one of the highest priorities. With existing staff allocations, this means that 949 staff members will be working in the tax shelter area. In the short-term, this group’s productivity is likely to decrease because experienced auditors will probably spend their time training newly hired staff rather than focusing on examinations.
K-1 Matching 1.1010 In 2002 the IRS attempted to begin a K-1 matching program. The program had serious flaws and the was withdrawn after loud protests from the practitioner community. Once again in 2003 the Service will attempt a K-1 matching program. With changes in place, the matching program will begin issuing notices to some taxpayers later this year requesting more information about their 2001 tax return. For the enhanced matching program, the IRS will use additional filters during screening to substantially reduce the number of notices issued. The IRS expects the changes recommended by external stakeholders and implemented by the agency will reduce taxpayer burden and increase the overall effectiveness of the matching program. Copyright 2005 07/16/2009
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