Tax Attorney – Bellevue And Seattle IRS Audit
Most examinations begin-and end-within two years of the filing of the return. The timing of examinations depends on the statute of limitations, which in most cases expires three years after the return is filed. Although not unheard of, it is unusual for the Service to begin an examination with less than a year left on the statute of limitations. The rare exceptions to this general rule track the exceptions to the three-year statute of limitations set out in section 6501: fraud, substantial understatement of income, and consent are the three main reasons the statute of limitations-and therefore an examination-is held open for more than three years after the return is filed.
Correspondence examinations, the most common type, are generally conducted by tax examiners and audit accounting aides located either in a Service campus or service center. Somewhere between seventy and eighty percent of all examinations in 2010 were correspondence examinations. As their name suggests, correspondence examinations are conducted by mail and usually involve only a few items that can be resolved by producing documents. Although the scope of a correspondence examination is generally defined at the outset, the Service may expand the examination if other issues arise.
Common issues in correspondence examinations include: (1) claims for credits, including the child tax credit and the earned income credit; (2) questions about whether a worker has properly reported self-employment income; (3) discrepancies between the taxpayer’s return (or absence thereof) and an information return created by someone else, reflecting items such as self-employment income, IRA withdrawals, mortgage interest, and the like; or (4) the need to substantiate simple itemized or business deductions, such as medical expenses.
Field examinations are conducted by revenue agents operating out of a local Service office. Field examinations involve a more detailed review of the books and records of the taxpayer than a correspondence examination and generally involve interviews or discussions with the taxpayer or the taxpayer’s representatives. All examinations of corporate taxpayers with gross receipts greater than $250,000 are handled by revenue agents. Taxpayers who do not run businesses are not likely to experience field audits. Field examinations usually take place at the taxpayer’s place of business. Revenue agents are better trained and generally are more skilled than other Service examiners. In LMSB, which examines large corporations and partnerships, a field examination team may include international examiners, financial services advisors, engineers, economists, industry specialists, technical advisors, or counsel. A field examination can be extended to earlier and subsequent years and to related tax returns and related taxpayers, provided the statute of limitations for assessment remains open. Field examinations can take up to 18 months or more to complete, although the Service is working hard to close more field examinations sooner.
Office audits are conducted at local Service offices. They usually involve more complicated fact issues than those presented in correspondence examinations, but less complicated issues than those encountered in field examinations. Office audits generally involve an interview or discussion with the taxpayer or the taxpayer’s representative. Typical issues handled in office audits include fact-intensive questions, such as entitlement to dependency exemptions, head of household filing status, and whether earned income was fully reported. Office audits are conducted by tax compliance officers.
The client should bring the following items to the first meeting:
- All notices and reports received from the Service.
- Tax returns (federal and state) for the relevant years.
- All correspondence between the Service and the taxpayer, return preparer, or any previous representative.
- Issue-related documentation such as receipts, canceled checks, child custody or divorce decrees, books and records. It is a good idea to define the types of issue-related documentation to which you refer so that the taxpayer does not overwhelm you with irrelevant records.
The Service enjoys broad powers, established by statute and confirmed in case law, to gather information from taxpayers and third parties. Most examinations proceed informally with the Service making simple requests for information. An Information Document Request (Form 4564) is a written request used in field examinations to request specific information from the taxpayer. An IDR specifies the information the agent seeks. Sometimes, however, IDRs are poorly drafted or the documents sought may contain more information than the agent needs.
If a taxpayer refuses to turn over documents or other records, the Service may issue a summons for the information. Both testimonial and documentary evidence are proper subjects of a summons. A summons is not self-enforcing, however. If the summoned party fails to respond to the summons, the Service must petition a district court to enforce the summons. Generally, the summoned party will be given a last chance to comply with the summons before an enforcement action is filed.
Third-Party Requests for Information by the IRS
Anyone “the Secretary may deem proper” can be ordered by the Service to provide documents or testimony. At the same time, third-party contacts by the Service run the risk of disrupting your personal and business relationships. Service employees know this: conscientious examiners seek to minimize third party contacts for this reason, while over-aggressive examiners sometimes use third-party contacts tactically.
Time and Place of Audit
The examiner will schedule a time and place for the audit. If it is an office audit, the audit will take place in the Service’s district office closest to the taxpayer. If the time or place is inconvenient for the taxpayer, or if they need more time to prepare, rescheduling is often an option. Reasonable requests are usually honored, as long as they are not a pretext for delay. If the examination is a field examination, the agent will request to hold it at the taxpayer’s place of business. This may not be the best place for the audit.
In many cases, taxpayers do not have direct evidence to support an item reported on a return. Under the Cohan rule, if a taxpayer can provide a reasonable and credible basis for approximating an item (generally a deduction), the item may be allowed. Therefore, credible affidavits by the taxpayer or third parties, or at least evidence relating to similar items for other tax years, may suffice in the absence of better evidence. This makes it vital to contact an experienced tax attorney at this stage.
Resolution of Audit
If the Service concludes that there should be no change in the taxpayer’s tax liability as reported on the return, the Service will issue a “no-change letter.” It should go without saying that the taxpayer should keep this document as part of the permanent records associated with the return(s) at issue. If there are adjustments in reporting that may affect future periods, the Service will also send a report detailing those adjustments.
If the taxpayer and the Service agree on adjustments that will affect the taxpayer’s liability for that year, the Service will prepare one or more documents to memorialize that agreement. Generally, one of these forms will be a variation on Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax, which the taxpayer signs to waive restrictions on the assessment of the additional tax so the Service can proceed to collect the additional amounts. The different versions of the Form 870 bind the parties to varying degrees.99 The Form 870 will probably not contain a detailed description of the adjustments agreed upon. If there is a detailed description, it will probably be contained in Form 4549, Income Tax Examination Changes. More detail may be appended in Form 886-A, Revenue Agent’s Report (RAR). After the taxpayer signs and returns the Form 870 or Form 4549, the Service will commence collection.
If the Service and taxpayer do not agree on all adjustments at the end of the audit, the ensuing procedures are more complicated. At the conclusion of the examination, the Service will probably request that the taxpayer sign a Form 870 with respect to any issues. With respect to the unagreed issues, the taxpayer will receive what is known as a “30-day letter” in most cases. This will include the RAR. The length and detail of the RAR varies with the complexity of the case and the skills of the agent. It may be less than a page in simple cases. Together with the
RAR, the Service will also send a Form 870 and a publication describing the taxpayer’s rights to contact the Appeals Office. The taxpayer usually must file a “protest” for Appeals consideration within 30 days, hence the name “30-day letter.”
If the taxpayer does not contact Appeals within the designated time, the Service will issue a Notice of Deficiency to the taxpayer in unagreed cases. The taxpayer then has three options: (1) file a petition with the United States Tax Court within 90 days; (2) pay the tax and file a claim for refund, with the possibility of filing a refund suit in either district court or the Court of Federal Claims, or (3) pay the tax upon demand and let the matter rest.
If the Taxpayer responds to the “30-day letter”, and files a protest for Appeals consideration within the 30 day deadline, the matter will be heard by IRS Appeals.