Tax Research - Chapter 12: Working with the IRS

Organization of the Internal Revenue Service

IRS is a bureau within the Department of the Treasury

IRS mission statement

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

Commissioner is CEO of IRS

Appointed by president of the United States

Renewable five-year term

Responsible for planning and directing IRS policies and programs

Organization of the IRS

Important personnel in the IRS (in descending authority) are :

• The Commissioner of the Internal Revenue

• Deputy and assistant commissioners

• Regional commissioners

• 26 District directors

IRS Structured

1. Appeals

2. Communications & Liaison

3. National Taxpayer Advocate

4. Services & Enforcement

   1. Criminal Investigation

   2. Return Preparer Office

   3. Office of Professional Responsibility

   4. Whistleblower Office

   5. Four Operational Divisions

5. Office of Compliance Analytics

6. Equity, Diversity & Inclusion

7. Office of Research, Analysis and Statistics

8. Chief Counsel

9. Operations Support

Four Operational Division

1. Wage & Investment

2. Small Business/Self-Employed (SB/SE)

3. Large Business and International (LB&I)

4. Tax-Exempt & Government Entities (TE/GE)

Examination

Determination of Tax Due:

1. Occurs within the appropriate Operational Division.

2. Contact is with one of three different types of IRS employees

   1. Revenue Agents

   2. Tax Examiners

   3. Service Centers

Collections

Collection of Tax Due from Taxpayers:

• Revenue Officers

• At this point, taxpayer’s pre-payment options are audit reconsideration or collection alternatives –

  • Offer-in-Compromise

  • Installment Arrangement

  • Currently-Not-Collectable (CNC

Appeals

Administrative Review of IRS Actions:

1. Appeals Officers (for liability)

2. Settlement Officers (for collections alternatives)

• May be located in local offices or service centers.

• Appeals Officers are authorized to settle, something that Revenue Agents may not do.

Chief Counsel’s Office

1. Represents IRS in Tax Court.

2. Issues legal guidance from National Office.

3. Does not represent IRS in U.S. District Court or Courts of Appeal.

4. Chief Counsel is appointed by President.

5. Reports to Both Treasury (re policy) and the Commissioner (re enforcement).

Criminal Investigation Division (CID)

1. Special Agents.

2. Takes referrals from Revenue Agents, Revenue Officers, Taxpayer Advocate Office, tips from interested 3rd parties, and conducts investigations.

3. After investigation, CID refers cases to Criminal Section of DOJ Tax Division.

4. U.S. Attorneys/DOJ handle prosecution of criminal tax matters.

Tax Division of Department of Justice

1. DOJ handles cases in US Dist. Ct., US Ct. of Federal Claims, and all appeals.

2. Handles prosecution of criminal matters.

3. Not IRS employees.

National Taxpayer Advocate

1. Reports to Commissioner of IRS.

2. Appointed by Secretary of the Treasury.

3. Assist taxpayers in resolving problems with the IRS.

4. Must give annual report with 20 most serious problems faced by taxpayers.

• Identifies areas where taxpayers have problems, proposes changes in administrative practice, and suggests proposed changes.

What can the Taxpayer Advocate’s Office do for a Taxpayer?

To request help, submit Form 911

Significant hardship includes:

1. An immediate threat of adverse action.

2. A delay of > 30 days in resolving an account problem.

3. The incurring by taxpayer of significant costs including legal fees if not relief.

4. Irreparable injury to, or a long-term adverse impact on, the taxpayer if no relief.

5. If IRS does not follow own procedures, including IRM, construe factors in favor of taxpayer.

The Life Cycle of a Tax Return

The IRS Error Resolution System (ERS) automatically identifies some potential errors and then requires an employee to manually review the potential problem.

Mathematical/clerical error program

• Conducted at IRS service centers

• Checks returns for math errors and recomputes tax due

  • Considered a summary assessment, not an audit examination

    • Interest accrues

    • 60 days to request abatement of tax

    • If taxpayer overpaid, IRS usually sends corrected computation along with a refund

    • Not entitled to remedies available to taxpayers under a formal examination

Taxpayer Protection Program (TPP)

Used to identify potential identity theft cases that are tagged by various models and programs including the Return Review Program (RRP).

The Audit Process

Tax system based on assumption of self-compliance.

A small number of returns are audited each year

Preliminary review of returns

After the preliminary review by the IRS ERS, returns are further screened for potential issues.

Returns may be randomly selected for audit, flagged through the Information Document Matching Program (IDMP) or selected for audit based on statistical analysis after comparing a return against norms for similar returns.

Information Document Matching Program (IDMP)

The IDMP system matches information recorded on a return with corresponding data received from third parties.

• Discriminant Function System

  • Returns with high DIF (“discriminant function formula”) score are examined manually.

  • Scored are based on undisclosed factors.

  • The higher the DIF score, the greater the correlation to favorable audit potential.

• National Research Program (NRP)

  • Around 15,000 individual returns selected randomly.

  • Selected returns receive extremely thorough audit.

  • Results furnish IRS with statistics used to update DIF formulas

Other Selection Methods in Audit Process

• Informant

• Economic reality factors

  • Significant increases in interest, dividend, or other investment income

  • Significant decreases in mortgage or other reportable interest paid

  • Significant variance in self-employment or farming income during the period relative to industry norms

  • Business and other expenditures not seemingly justified by income levels

• Link to another return under audit review

  • Partners’ or shareholders’ returns pulled if partnership or S corporation audited

• Local offices may identify audit targets

  • Arises with local issues or market segments

Correspondence Audit

• When one or two items on a return questioned, audit can be done through correspondence

• Conducted by phone or mail

  • Informal examination, but same taxpayer rights as office or field audits

• Simple documentation issue usually involves verifying items by mailing copies of receipts or canceled checks, for example

Office Audit

• Conducted if audit involves one or more issues that will require some analysis

• Held 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

• Generally involve items like income from tips, rents, and royalties; income from partnerships; deductions for travel or entertainment; deductions for bad debts; and casualty and theft losses

Field Audit

• Complex issues requiring revenue agents that have more knowledge and experience

• IRS prefers to conduct on taxpayer’s premises

• Agent completely reviews financial operations of taxpayer

• Open-ended examination

  • Agent free to pursue any unusual items in tax returns or records

  • Tests gross receipts

  • Reviews expense documentation

Conclusion of Examination

• Revenue agent’s report (RAR) prepared for taxpayer

  • Documents case law and tax code that has been relied upon by IRS

  • Proposed adjustments explained

  • Lists tax balance due or in some cases to be refunded

• Next steps if taxpayer disagrees with RAR

  • First ask for meeting with agent’s supervisor

  • If no resolution from meeting, 30-day letter issued

    • Appeal choices next to be considered

• Next steps if taxpayer agrees with RAR

  • Advance payment often made to avoid any additional accrual of interest and penalties or taxpayer can wait until 30-day letter received (preliminary notice of deficiency)

30-Day Letter (insert form name)

• Taxpayer has 30 days from receipt to request conference with appeals officer

  • Written request required if tax and penalties less than $2,500

  • Formal protest required to trigger the appeal where the tax and penalties greater than $10,000

• If taxpayer doesn’t respond to notice, taxpayer receives statutory notice of deficiency—“90-day letter”

  • Issued by IRS next to trigger taxpayer’s choice within those 90 days for a path to litigation

File a Protest or Go to Court?

• Taxpayer may appeal for the following reasons

  • Appeals officer can consider hazards of litigation

  • Possible settlement without litigation costs

  • Delays payment of disputed tax

  • Discover more details of government’s position

  • Appeal sets taxpayer up to recover future possible court costs and attorney fees when case is litigated after appeal

• Reason taxpayer may bypass appeal

  • New issues could be raised on appeal by appellate officer

  • Taxpayer may want to convey a firm conviction of the tax position to increase negotiating position

  • Expedites conclusion of the issue

Appeals Process

• IRS encourages use of the administrative appeals process

• Appeals office has exclusive authority to settle cases within its jurisdiction

• Appeals officer

  • Supervised by IRS commissioner with input from chief counsel

  • May look at evidentiary issues, witness availability and credibility, and various arguments of law

• Final opportunity to settle without incurring litigation costs

Appeals conference

• An informal proceeding, the dispute is discussed informally, and the appeals office utilizes personal judgment in deciding how to handle.

• If a settlement is reached, Form 870-AD is typically signed by both parties, reflecting the terms of the agreement.

• Absent fraud, malfeasance, concealment, or misrepresentation of a material fact, the IRS will not reopen the case. At the same time, the taxpayer is precluded from suing for an additional refund.

90-Day Letter (insert letter number name)

• When taxpayer and IRS cannot agree on proposed adjustments after appeals conference

• Issued if the taxpayer does not appeal within the IRS process

  • Must be sent before assessing proposed taxes

  • Taxpayer has 90 days to

    • Pay tax and sue for a refund in U.S. District Court or the U.S. Court of Federal Claims, or

    • File a petition in Tax Court

• 90-day period begins when it is mailed to the taxpayer’s last known address in the IRS’s records

  • Unless there has been a notification to the commissioner of a change of address

  • Actual receipt of notice not required for 90-day period to begin

  • IRS documents sending the notice by certified or registered mail to document the actual mailing

Entering the Judicial System

Considerations in deciding to litigate

• Additional costs of attorney and accountant fees

• Preparation time and costs

• Coaching experts and other witnesses

• Travel expenses

• Chances of winning

  • IRS litigates only those cases it expects to win and will make a good precedent.

• The Tax Court will review case if petition filed with the court within 90 days after date of statutory notice of deficiency.

• District courts and Court of Federal Claims cannot hear case unless taxpayer is suing for a refund.

Statutes of Limitation

• Once this time frame expires, taxpayer is no longer required to pay taxes that he or she rightfully owes.

• Assessment must be made within three years of later of date return was filed or unextended due date.

  • (e.g. If filed before 4/15, then start date is 4/15. If filed after 4/15, start date is after)

  • Extended to six years if taxpayer omits gross income that is more than 25 percent of reported gross income

    • Two exceptions

    • Doesn’t pertain to deductions that are overstated

• (exception 1)Three-year assessment period is suspended with certain international transactions and foreign transfers.

• (exception 2) Tax may be assessed at any time when a taxpayer files false or fraudulent return.

• Filing amended returns does not affect length of the limitations period.

Statutes of Limitation cont.

Collection

• Taxes must be collected within 10 years after a timely assessment—if tax not collected administratively by levy, IRS must commence action in court before statute of limitations expires.

Claim for refund can be made by filing:

• Form 1040X (Amended 1040) or

• Application for Tentative Refund—Form 1045 (individuals) or Form 1139 (corporations)

  • Must be made within three years of date on which return was filed or two years of the date on which tax was paid

  • Different periods when net operating losses, capital losses, worthless securities, and other items impact claim

Suspension of Period of Assessment and Collection

• In certain circumstances, running of statutes of limitations on assessment and collection is suspended:

  • When a case is pending before U.S. Tax Court

  • When a taxpayer submits an offer in compromise

  • When assets are in custody of the court or wrongfully seized

  • When taxpayer is outside United States for six or more consecutive months

  • When a fiduciary or receiver is appointed in bankruptcy case

Mitigation of Statute of Limitations

• Generally, the IRS cannot make an assessment and a taxpayer cannot obtain a refund after the statute of limitations has expired

  • the mitigation provisions will allow a submission of the error to be corrected, even though the normal period of limitations has expired for that year

Closing Agreements

• Formal, written, binding agreement that enables both parties to finally and completely resolve tax controversy

• IRS authorized by Treasury to enter into closing agreements

  • In cases where the government benefits from closing the case permanently

  • In cases where the taxpayer needs to close the case and the government’s interest will not be harmed

• IRS discourages use of them because of finality

  • Consequently, informal agreements are preferred

Offers in Compromise

• IRS can settle civil or most criminal tax assessments when taxpayer files Form 656 or 656-L and

  • Tax liability is in doubt,

  • Collection of the assessment is in doubt, or

  • Economic hardship on taxpayer to pay full amount.

• Agreement can cover tax, interest, and penalties.

• Legally enforceable promise except in the following:

  • Where there is a false misrepresentation or concealment of taxpayer’s assets

  • Where there is a mutual mistake relative to a material fact

• Where taxpayer defaults, IRS has the following rights:

  • IRS can collect full original tax liability less prior taxpayer payments.

  • Alternatively, IRS can sue to enforce the agreement.

Taxpayer Rights

• Taxpayer may be represented by attorney, CPA, or other under a power of attorney.

  • Taxpayer must be advised of right or representation.

  • Taxpayer has right to suspend IRS interview to obtain a representative.

  • Taxpayer need not appear personally (unless summoned).

• Taxpayer has right to record IRS interview.

  • Requires 10-day notice to IRS of intent to record

  • IRS has right to record interview with taxpayer after giving 10-day notice with copy of recording upon request

• IRS must inform (ex)spouses of joint and several liability for tax deficiencies.

  • Each must receive separately mailed notices for all phases of the audit examination, appeal, and litigation where applicable.

• Under certain conditions, taxpayer may recover court costs and attorney fees from the Treasury if he or she defeats government in U.S. Tax Court.

• Qualified offers to IRS

  • § 7430(g) allows taxpayers to make qualified offers to IRS

  • May be made any time after 30-day letter is received or statutory claim of disallowance is received

  • Must be in writing and labeled as such

• Tax Confidentiality Privilege

  • § 7525 provides authorized practitioners a limited client confidentiality privilege

  • Confidentiality privileges exist between the taxpayer and his or her advising tax practitioner in noncriminal tax matters