A press release from the Red Cross dated Wednesday, April 18, 2007 read: “The American Red Cross Board of Governors has unanimously approved Mark W. Everson, currently serving as Commissioner of Internal Revenue, to become the next president and CEO of the Red Cross, effective May 29, 2007. Mark Everson brings to the Red Cross an accomplished management record in both the public and private sectors. Everson has served as the 46th Commissioner of the Internal Revenue Service since May 5, 2003.”
Former Commissioner Charles Rosotti introduced a concept called “Balanced Measures”. His intent was to provide equal emphasis on business results, customer satisfaction and employee satisfaction by all IRS employees. His successor, Commissioner Mark Everson did not necessarily revoke the prior guidance but has unquestionably restored top priority standing to the successful accomplishment of business results (i.e., making the Examination Plan). The most recent production results for examinations revealed that the number of IRS examinations more than doubled when comparing FY-2006 to FY-2000 (under Rosotti).
Within the IRS ranks, employees commonly refer to the varying degree of Commissioner emphasis on productivity as the “pendulum effect”. It will be interesting to see which way the pendulum swings regarding policy emphasis by the incoming IRS Commissioner.
IRS Strategies to Close the Tax Gap
IRS’s estimate of the gross tax gap for 2001, based on IRS’s 2001 National Research Program (NRP), the first detailed study of taxpayer compliance since ‘88 was $345 billion, consisting of $27 billion for non-filing, $285 billion for underreporting, and $33 billion for underpayment. IRS estimates that its enforcement efforts will recover around $55 billion of the tax gap, leaving a net tax gap of $290 billion for 2001. According to IRS, the net tax gap translates into a net compliance rate of 86.3% for 2001, a rate consistent with historical patterns. See also GAO-07-423R (http://www.gao.gov/new.items/d07423r.pdf) The NRP program involved an in-depth review of approximately 46,000 individual tax returns for tax year 2001 for statistical evaluation.
Information Gathering Projects, also known as “special projects” focus on a unique area of tax law noncompliance. These projects are usually streamlined to zero in on a single line item or business practice. Two of the most noted ongoing projects are:
A. Real Estate Professionals – A real-estate professional is defined as someone who spends more than half of his/her working hours in real estate and more than 750 hours a year managing real-estate activities. These individuals can fully deduct losses — including depreciation, interest expense on loans and property taxes. Those who don’t qualify as “professionals” are treated as “passive” real-estate investors with a limited ability to deduct their losses.
In a recent New York Times article, the following text appeared: “Robert Marvin, a spokesman for the IRS, said the tax agency can’t comment on individual taxpayer cases. However, he indicated that the agency is paying more attention to real-estate activity because it is one of the areas where research shows there is a large tax gap, meaning taxpayers are underreporting income to the IRS. The tax gap in income from rents and royalties is about $13 billion and $11 billion for capital gains. (Income from real-estate activity is included in, but not exclusive to, both categories.) Mr. Marvin said that several thousand returns of real-estate professionals have been audited since last year and approximately 3,000 are under audit now.”
B. Form 4136 Fuel Tax Credits for Off-Highway Use – Generally speaking, if a taxpayer uses gasoline to fuel a vehicle that is not used on a public highway, and he/she purchases the fuel at a pump where excise taxes have been added, a credit/refund for the excise taxes paid is refundable. The underlying Congressional intent was that since these vehicles are not contributing to the wear and tear of the roadways, they should not be subject to the excise taxes used to fund repairs thereto. Once again, the IRS has an ongoing project for a substantial number of these cases with primary focus on the construction industry.
The key to these type cases is to recognize that the local examiner may have little to say about the outcome of your audit. Projects are normally centralized and controlled by a nationally appointed project leader who provides oversight of the entire examination process from start to finish. The local examiner may also be provided with “pro-forma” audit reports that contain standardized narratives for the disallowance of claimed deductions. The point is that you can be at a considerable disadvantage when trying to present support for the position taken on the original return filed. The examiners tend to work these cases in almost a “cruise control” mode with tunnel vision as it pertains to any challenges by the taxpayer. The only viable option can often be an early request for an appeals hearing since you are unlikely to make any headway with the local auditor.
IRS Reengineers Its Examination Process
In 2005, the IRS completely re-engineered the examination process for both office and field audits. In view of the fact that this process had remained unchanged since the early 1950’s the alterations comprised a rather significant makeover. The changes of most extensive impact include:
Streamlined Audit Selection Process
One of the most dramatic changes brought about by the reengineering effort in 2005 was the introduction of a mandatory classification system for Revenue Agents (RAs). Although Tax Compliance Officers always had a system where issues were limited (an average of 2 to 5 line items on a tax return), Revenue Agents pretty much had a free hand in determining the scope and depth of an examination (with a few minor exceptions such as claims, reopened audits, etc). Even though a classification sheet might have been attached to a field agent’s assigned tax return, Revenue Agents did not feel compelled to follow the pre-selected issues. The re-engineered process clearly provides for a formalized classification process that results in the predetermination of a limited number of issues for audit review.
An overly broad scope or depth of examination can materialize in punitive results - the foremost of which is the addition of substantial time to representation costs. Two specific examples include:
1. A “boilerplate” IDR seeking an excessive number of issues for examination (see TIGTA’s Final Audit Report - “Additional Efforts Could Further Improve the Execution of the National Research Program ” (Audit # 200330013); and
2. The improper use of financial status audit techniques.
Managerial Approval of Examiner’s Audit Scope
The final step of the preplanning process for revenue agents is to seek managerial concurrence with his/her audit plan. A diligent front-line manager should review the issue selection sheet provided by the up line classification process and carefully scrutinize any attempts by the revenue agent to expand the pre-determined scope.
One of the keys to the re-engineered audit process was the telephone conversation that should take place when responding to the newly designed “call-back” letter. The examiner is required to discuss the return, the issues to be looked at, taxpayer rights and the records to bring to the initial appointment.Unfortunately, a frequent TIGTA finding during IRS reviews in the taxpayer burden arena is the examiner’s overuse of “boilerplate” information requests (Final Audit Report - Additional Efforts Could Further Improve the Execution of the National Research Program (Audit # 200330013). Many examiners do not refine the Information Document Request (IDR) according to the joint phone discussion but default to the extensive shopping list they developed over the years. They continue to insert a generic paragraph on the accompanying Information Document Request (IDR) that reads, “The above list is not intended to be all-inclusive” and “Additional information may be requested if needed”. This option should not be loosely interpreted but rather based upon a solid foundation for scope expansion.The end result is that you are more than likely going to be asked to dig up considerably more information than will ever be used by the examiner during his/her audit.
The re-engineering process was implemented for the entire United States. There are no exceptions for any individual state. A significant benefit is the standardization of workpaper format. Hence, a transfer from one office to another should not create a significant challenge to the examiner in your incoming office.
Simplified Preparation of Unagreed Audit Reports
With the advent of uniform workpaper content, the IRS appeals division and legal staff agreed to allow examiners to attach the standardized “leadsheets” to the examination report in lieu of the traditional rewrite of all proposed issues as an integral part of the unagreed report. The potential downside of this abbreviated feature is a premature disposition due to the simplicity of closing a case from the examiner/manager’s level to the next step in the appeals process.]]>
Without question, the most dangerous tool in the IRS auditor’s toolbox is the interview. We highly recommend that you hire someone to represent you before the interview. You do not want to allow yourself to fall into the disadvantaged position of blindly navigating through an IRS interview. Nonetheless, if you insist upon representing yourself, here are some helpful hints:
1. Prepare in advance for the issues being audited - You need to either obtain a clear understanding of the purpose for each interview question or seek the assistance from a knowledgeable tax practitioner to prepare you for the IRS interview. For example, issues such as filing status, dependency exemptions, transportation expenses and many other deductions are often resolved exclusively using oral testimony. If you have not prepared beforehand on the key facts for sustaining your deductions, you will not likely be able to undo the damage once the auditor has gathered the oral testimony he/she needs to disallow your claimed deductions.
2. When in doubt, ask why – The middle of an IRS interview is not the time to be shy or passive. If you thought you prepared properly but are asked a question that you cannot see the impact the answer you give will have on the final outcome of your audit, come right out and ask the auditor directly: “Why do you need to know this information? How does this relate to any of the issues that you told me you would be looking at as part of my audit?”
3. If you are unsure of a date, time or amount – particularly information that might lead to the disallowance of your claimed expenses, DO NOT GUESS – At the beginning of the interview, the auditor will advise you that it is okay to estimate dates, times or amounts, yet he/she will be the first to reject your subsequent request to change your response without a host of supporting information as to why you felt your original response was incorrect. Further, the auditor will NOT likely challenge the “guestimates” you give, particularly if they result in a punitive outcome. They are not trained to ask you to reconsider the negative impact of a response before you commit to it. This is not the “You can be a Millionaire Show” where Regis is going to ask: “Are you sure?” or “Is this your final, final answer?” The auditor’s general expectation is that you should know better than to give an estimate that will result in a detrimental tax effect.
4. Watch out for the follow-up questions - The secret to a good interviewer’s technique is the use of follow-up questions. As an untrained taxpayer, you are at a considerable disadvantage since you may often have no idea where the auditor is headed.]]>
If you have not filed a tax return, the computer will discover that there is none in the system for matching purposes and create one for you. This computer generated return is referred to as a “Substitute for Return (SFR)”. The SFR process, however, does not allow for ANY DEDUCTIONS for the income sources it receives from employers, banks, stockbrokers or your business customers.
Example 1: You sold stock in the year 2006 for $50,000, which you purchased for $55,000. The correct taxable transaction should be a net capital LOSS of $5,000 with no tax consequence. To the contrary, when the computer creates a substitute for return (SFR), you will be charged with a $50,000 gain (no deduction is allowed for the $55,000 you spent to buy the stock).
Example 2: Another harmful illustration would be where you have a business for which your clients issued Form 1099s that total $70,000. Again, there are no records submitted to the IRS for business expenses, so the substitute returns program will show a Schedule C business with $70,000 income and NO EXPENSES thereby resulting in a net taxable profit of $70,000. The self-employment taxes alone would total approximately $10,000. The NO DEDUCTION tax computation for SFRs applies to business income, stock sales, rental activities and any other revenue sources.
It is highly likely that the engagement of a skilled representative from Tax Repair Experts to challenge the substitute returns assessment will result in a SUBSTANTIAL decrease in taxes due. As former IRS employees, they have the insight to assist you with the preparation of a delinquent return including:
Immediate Procurement of All IRS Documents - The IRS computers rely on a document-matching program called the Information Returns Program (IRP). As a starting point, our staff will secure a detailed listing from the IRS of the exact same information their computers used to prepare your substitute for return.
Organization of Records – We will assist you with the organization of your records and help prepare an accurate tax return.
Location of Missing Records - If you failed to keep records for business expenses, we can help pinpoint key third party contacts to secure duplicate copies.
Determination of Reasonable Expense Estimates - If you are unable to secure documents from third parties, the IRS allows reasonable estimates of business expenses when the original records are no longer obtainable. As former IRS employees, our professionals can assist you determine reasonable estimates. Keep in mind that most IRS auditors feel no obligation to assist you with this process, hence in most cases, without the assistance of a skilled professional, you are on your own.
Preparation of an Indirect Method For Inadequate Records Cases - If you have no records, the IRS uses an “indirect method” for determining your net profit. Once again, having previously worked for the IRS, our professionals are fully trained on indirect methods and will ensure that the tax you pay is fair.