UNIT ONE - Examination of Returns Learning Objectives After course completion you will be able to: • • •
I.
Identify the purposes for which Tax Audit are used. Distinguish the different Examination Selection Criteria.
Recognize when the IRS may and may not contact third parties, as well as notice requirements.
Examination of Returns A.
In General
1. A tax return may be examined for a variety of reasons, and the examination may take place in any one of several ways. 1 2. After the examination, if any changes to the tax return are proposed, the taxpayer can either agree with those changes or pay any additional tax the taxpayer may owe, or the taxpayer can disagree with the changes and appeal the decision. 2 B.
Examination Selection Criteria 1.
DIF System
a. A tax return may be selected for examination on the basis of computer scoring known as the Discriminant Index Function or “DIF”.3 b. DIF is mathematical technique used by the IRS to rate individual income tax returns and some corporate returns for examination potential. 4 c. audited.
As a rule, the higher DIF score the greater potential that the return will be
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d. The formulas used to rate the returns are confidential and developed by the Service through data obtained through its National Research Program 6. e. The potential is high that an examination of the tax return will result in a change to the taxpayer income tax liability.7
1 IRS Publication page 2. 2 Id. 3 IRM 4.1.3.2(3) (08-10-2012). 4 Id. 5 Id. 6 Id. 7 IRS Publication page 2.
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2.
Third Party Communication
a. A tax return may also be selected for examination on the basis of information received from third-party documentation, such as Forms 1099 and W-2 that does not match the information reported on the tax return. 8 b. The tax return may also be selected to address both the questionable treatment of an item and to study the behavior of similar taxpayers (a market segment) in handling a tax issue9. c. In addition, the returns may also be referred to Examinations from the following sources, among others: (1) By a state department of taxation through the Governmental Liaison Data Exchange Program.10 (2) By governmental agencies that administer certain activities which are subsidized by tax credits or deductions, such as the low-income housing credit (state housing administrations) or the historic rehabilitation credit the National Park Service Office of Historic Preservation) 11; (3) As the result of an Offer in Compromise based on doubt as to 12 collectability;
3.
(4)
As the result of an employee audit; 13
(5)
By referral from the Department of Justice, in criminal cases. 14
Other Sources
a. In addition, the tax return may be selected as a result of information received from other sources on potential noncompliance with the tax laws or inaccurate filing.15 b. This information can come from a number of sources, including newspapers, public records, and individuals. 16 c. The information is evaluated for reliability and accuracy before it is used as the basis of an examination or investigation. 17 8 Id. 9 Id. 10 IRM 4.1.4.2.4 (09-10-2013). 11 IRM 4.1.4.2.5 – 6 (09-10-2013). 12 IRM 4.1.4.2.8 (09-10-2013). 13 IRM 4.1.4.2.10 (09-10-2013). 14 IRM 4.1.4.2.11 (09-10-2013). 15 IRS Publication Page 2. 16 IRS Publication Pages 2-3. 17 IRS Publication Page 3.
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4.
II.
Other Selection Methods a.
Alien Returns
b.
Change in Accounting Method
c.
Frivolous Returns
d.
Bankruptcy
e.
Section 338 Elections
f.
Whipsaw Issues/Correlative Adjustments
g.
Related Taxpayers
h.
Multi-Year Examinations
i.
Miscellaneous Triggering Factors
Notice of IRS Contact of Third Parties
A. Sec. 7602(c) provides that the Internal Revenue Service may not contact any person other than the taxpayer with respect to the determination or collection of the tax liability of the taxpayer reasonable notice in advance.18 B. The IRS must also give the taxpayer notice of post-contact reports disclosing specific thirdparty contacts on both a periodic basis and upon the taxpayer request. 19 C.
This provision does not apply: 1.
To any pending criminal investigation,20
2.
When providing notice would jeopardize collection of any tax liability, 21
3.
Where providing notice may result in reprisal against any person 22, or
4.
When the taxpayer authorized the contact. 23
18 Reg. § 301.7602-2(a). 19 Reg. § 301.7602-2(e). 20 Reg. § 301.7602-2(f)(4). 21 Reg. § 301.7602-2(f)(2). 22 Reg. § 301.7602-2(f)(3). 23 Reg. § 301.7602-2(f)(1).
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Review Question Which of the following is correct? A. A tax return may not be selected as a result of information received from other sources on potential noncompliance with the tax laws or inaccurate filing. B. The lower the Discriminate Index Function (“DIF”) score the greater the potential that the return will be audited. C.
Sec. 7602(c) does not apply to any pending criminal investigation.
D. A tax return may not be selected as the basis of information received from third party documentation, such as Forms 1099 and W-2 that does not match the information reported on the tax return. Explanation A is incorrect because IRS Publication Page 2 states that a tax return may be selected as a result of information received from other sources on potential noncompliance with the tax laws or inaccurate filing. B is incorrect because IRM 4.1.3.2(3) (08-10-2012) asserts that, as a rule, the higher the DIF score, the greater the potential that the return will be audited. There is a positive correlation between the DIF score and the likelihood of being audited. C is correct because Sec. 7602(c) does apply to any pending criminal investigation. D is incorrect because IRS Publication page 2 permits the use of third party documentation received from third-parties as the basis of a tax audit.
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UNIT TWO - If a Tax Return Is Examined Learning Objectives After course completion you will be able to: •
Recognize the timeline and events of a Tax Audit. •
•
Identify who may represent an audited taxpayer. •
• •
I.
Distinguish the different types of Tax Audits.
Identify the scope of confidentiality privilege. Identify the scope of recordings and obtaining them.
Recognize the general examination procedures and policies of Tax Audits.
If a Tax Return Is Examined A.
Overview
1. The campus or examiner sends the taxpayer an initial contact letter (ICL)465 requesting information or explaining corrections to the return along with a solicitation of the taxpayer's agreement to the corrections. 2.
The possible responses of the taxpayer to the initial contact letter include: a.
agreement to the correction in tax liability.
b.
a request for additional explanation of the correction.
c.
an explanation by the taxpayer of the items questioned.
d.
a request for an interview; and
e.
no response or non-agreement.
3. In non-Automated Correspondence Exam (ACE) cases, if the taxpayer does not respond, telephone contact is initiated. 4. If the taxpayer agrees to a correction and has not indicated an inability to pay or requested an installment agreement, the case is closed. If the taxpayer does not have the ability to pay, the case is assigned to a tax examiner who will consider alternative methods of payment, such as an installment agreement. 5. If the taxpayer requests an additional explanation from the IRS, a tax examiner will prepare a letter within 30 days responding to the taxpayer's question and requesting a correction or agreement. Also, telephone contact will be made, if feasible.
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a. Where the taxpayer does not respond, or where an agreement cannot be reached, a proposed notice of deficiency (i.e., a “30-Day Letter”) advising the taxpayer of the proposed tax change and appeal rights is issued. b. If the taxpayer fails to respond to the 30-Day Letter, or if the initial contact letter is received by the taxpayer but the subsequent 30-Day Letter is returned undeliverable, a statutory notice of deficiency (a “90-Day Letter”) is issued at the expiration of the 60-day period. If the taxpayer does not respond to the 90-Day Letter, the return will be closed by default. Comment: The IRS must provide taxpayers with a written explanation of the entire process from examination through appeals and collection, including assistance available from the National Taxpayer Advocate with the first letter of proposed deficiency that allows the taxpayer an opportunity for administrative review at appeals.468 A copy of IRS Publication 1, Your Rights as a Taxpayer, should satisfy this requirement.469
II.
Types of Audits A.
Campus Examinations
1. Campus examinations, sometimes referred to as correspondence examinations,470 are conducted under the aegis of W&I and SB/SE, and are undertaken almost entirely by correspondence and telephone contact with the taxpayer. Most campus examinations are conducted out of one of the IRS Campuses or Service Centers. Campus examinations can involve income, estate, gift, employment, and certain excise taxes. 2. An examiner is only assigned to a campus examination after the taxpayer has responded to the initial correspondence from the IRS. 3. When documents are requested in a campus examination, the taxpayer should send copies to the IRS rather than originals, as the originals may well be lost. B.
Automated Correspondence Exam (“ACE”)
1. Automated Correspondence Exam (ACE), formerly Batch Processing, is an IRSdeveloped, multifunctional software application that fully automates the initiation, aging and closing of certain Earned Income Tax Credit (EITC) and non-EITC cases. 2. Using the ACE, Correspondence Exam can process specified cases with minimal to no tax examiner involvement until a taxpayer reply is received. 3. Because the ACE system will automatically process the case through creation, statutory notice and closing, tax examiner involvement is eliminated entirely in cases where no reply is received from the taxpayer. Where a taxpayer does reply, the reply is considered by an examiner, and in most cases the matter is reintroduced into ACE for automated aging and closing. 4. Within the ACE system, the following actions, among others, take place automatically without human intervention: inventory records are created; audit issues are created; 6
tax is computed; initial contact letters (ICLs) and reports are created; statutory notices are generated; and cases are closed. C.
IRS Area Office Examinations
a. Area Office examinations may take the form of a correspondence examination, an office interview examination, or a field examination, i.e., an examination outside of the IRS office, conducted at the taxpayer's premises. b. The determination of which type of examination should be used is to be made based on the complexity of the taxpayer's return, and the type of examination that is most conducive to effective and efficient tax administration. c. Examples of items which generally cause the return to be identified for field examination, requiring onsite inspection of the taxpayer's books, records or assets and/or visitation of the taxpayer's place of business are: returns which require an in-depth knowledge of accounting principles, issues which require onsite inspection of the taxpayer's books, records or assets and/or visitation of the taxpayer's place of business, complex Schedule D transactions, returns with unusually complex rental income and expenses, tax shelter returns, donations of real property which would involve an engineering specialist, alimony — if it appears there is a property settlement involving business property (accounts receivable, etc.), returns which would most likely have voluminous records, extensive time frame required to complete the examination, inventories that are substantial and material, termination of business before the end of the tax year, unusual issues that appear to be complex and time consuming to develop (complex oil or mineral explorations, unstated interest (IRC §483), nontaxable transfers, etc.), size of a business (high gross receipts, etc.), businesses not adaptable to office examination, such as manufacturers, auto dealers, and funeral parlors, and individual returns requiring the full accounting skills of a Revenue Agent, if a Tax Compliance Officer is not available in the geographical location of the taxpayer 7
d. IRS examiners are called on to follow certain standards when examining returns. An agent is instructed to examine all large, unusual or questionable items (“LUQs”) identified on a return. The definition of a large, unusual, or questionable item will depend on the examiner's perception of the return as a whole and the separate items that comprise the return. e.
Some factors to be considered when identifying LUQs are: (1) the comparative size of the item — an expense item of $6,000.00 with total expenses of $30,000.00 would be a large item; however, if total expenses are $300,000.00, the item would not generally be considered a large item. (2) the absolute size of the item — despite the comparability factor, size by itself may be significant. For example, a $50,000 item may be significant even though it represents a small percentage of taxable income. (3) the inherent character of the item — although the amount of an item may be insignificant, the nature of the item may be significant; e.g., airplane expenses claimed on a plumber's Schedule C. (4) evidence of intent to mislead — this may include missing schedules, incomplete schedules, misclassified entries, or obviously incorrect items on the return. (5) the beneficial effect of the manner in which an item is reported — e.g., expenses claimed on a business schedule rather than claimed as an itemized deduction. (6) the relationship to other items — incomplete transactions identified on the tax return; for example, the taxpayer reported sales of stock but no dividend income. (7) whipsaw issues, which occur when there is a transaction between two parties and characteristics of the transaction will benefit one party and harm the other. Examples include alimony versus child support, sale versus rental/royalty, employee versus independent contractor, gift versus income; and (8) missing items — consideration should be given to items which are not shown on the return but which would normally appear on the returns of similar taxpayers. This applies not only to the examination of income, but also to expenses, deductions, etc., that would result in tax changes favorable to the taxpayer.
D. Correspondence Examinations a. Correspondence examinations are those in which information needed to resolve the classified issues can readily be furnished by the taxpayer through the mail. 8
b. As noted, most correspondence examinations are conducted by IRS campuses and generally are limited to simple issues that can be easily verified by correspondence. Only in very limited circumstances should an Area Office examiner conduct a correspondence examination. E. Office Interview Examinations a. Office interview cases are those in which the issues cannot be resolved through correspondence and the agent requests that the records be reviewed in an IRS office. b. Returns selected and classified by the campus for office interview examinations, sometimes referred to simply as office examinations, generally involve issues that may be too complex to be resolved by mail but not complex enough to warrant a field examination. c. Office interview examinations, often conducted by Tax Compliance Officers, should involve issues which lend themselves to an analytical approach and require individual judgment, in addition to direct verification. d.
Certain types of issues lend themselves to interview examination.
e.
Examples include: (1)
dependency exemptions;
(2) income from tips, pensions, annuities, rents, fellowships, scholarships, royalties, and income not subject to withholding; (3)
deductions for business related expenses;
(4)
deductions for bad debts;
(5)
determinations of basis of property;
(6)
deductions for education expenses;
(7)
capital gain versus ordinary income determinations;
(8) complex miscellaneous itemized deductions such as casualty and theft losses where determinations of fair market value are required; and (9) deductions for employees business expenses such as travel and entertainment. F. Field Examinations a.
Overview
i. All returns will be identified for assignment to a revenue agent or a tax compliance officer. The designation as revenue agent or tax compliance officer will be based upon the complexity of the issues involved and the degree of accounting and auditing skills required to conduct a quality examination.
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ii. Revenue agents do conduct office examinations where circumstances warrant. Field examinations, however, are normally conducted at the taxpayer's place of business or location where the books, records and source documents are maintained. b.
Initiation of Examination
i. The agent contacts the taxpayer to make an appointment for the time and place to start the examination. ii. iii.
The examiner will send the taxpayer the appropriate appointment letter.
If a return indicates that a power of attorney is on file or the taxpayer requests that IRS notification be made through the taxpayer's representative, the examiner will do so.
iv. Sec. 3502 of the 1998 IRS Restructuring Act, P.L. 105-206, requires the IRS to advise taxpayers more clearly of their right to be represented by a representative during an in-person examination interview and, if so represented, their right not to proceed without the representative unless the taxpayer consents. c.
Scheduling the Audit
i. The time and place of the examination are fixed by the IRS; efforts are made, however, to schedule times and places that are reasonable under the circumstances. ii. It is reasonable for the IRS to schedule an examination during the normal business hours on a normally scheduled workday for the IRS. iii.
Further, it is reasonable for the IRS to schedule examinations throughout the year without regard to seasonal fluctuations in the taxpayer's business.
iv. The IRS, however, will cooperate and work with taxpayers to minimize any adverse effects in scheduling the date and time of examination. d.
Small Business Cases
i. In the case of a small business, the IRS will not conduct an examination at such location if doing so would interrupt business operations or essentially require the taxpayer to close the business. ii. However, this does not preclude the IRS from visiting the taxpayer's business location or residence to establish facts that can only be established by a direct visit (e.g., an asset or inventory verification). e.
Initial Audit Procedure
i. At the beginning of an examination, the agent should ask whether the taxpayer has any questions regarding the examination process, regular selection procedures, and appeal rights. ii. If the taxpayer has any questions, the agent will give a clear and concise explanation of Publication, Examination of Returns, Appeal Rights, and Claims for Refund, and provide a copy to the taxpayer.
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iii.
The examiner must also include a copy of Publication 1, Your Rights as a Taxpayer, and Notice 609, Privacy Act Notice, with the contact letter. Information of a nature which may be considered by a taxpayer as confidential should be protected as such. Note: The IRS will often assure the taxpayer that examination of the taxpayer's return does not suggest a suspicion of dishonesty or criminal liability. However, the agent has no authority to assure a taxpayer that his books and records will be used solely for civil purposes. If a taxpayer insists upon such assurances, the agent is instructed to find out the reason why, and, if the taxpayer refuses to provide the requested information, may report the matter to his group manager and even refer the matter for criminal investigation. f.
Procedures and Techniques (1) As the first step in a field examination, the agent usually makes a pre-contact analysis of the return to determine which items should be examined and the scope of the examination. (2) As the examination progresses, however, new issues may be raised. The IRM generally instructs an agent to pursue the examination to a point where he or she can conclude that all items necessary for a substantially correct determination of tax liability have been considered. (3) Among other items, gross receipts are probed in the case of individual returns and returns of small corporations having assets below $1 million regardless of whether the taxpayer maintains a double entry set of books. (4) On nonbusiness returns, the taxpayer may be questioned concerning possible sources of income other than those reported. If the return contains a Schedule C or F, such schedules will be verified to the extent deemed appropriate by the agent. (5) On all types of business returns, the agent evaluates existing internal controls over receipts. On individual returns the taxpayer may be questioned with regard to sources of income, standard of living, purchases of assets, balances of cash on hand and in the bank, payments on loans and receipts of borrowed funds. (6) If, based on the answers to these questions, the agent has reason to believe that the taxpayer may have unreported income, alternative methods such as the cash transaction, T account analysis, sources and application of funds, bank deposit analysis, or net worth analysis may be employed to verify receipts.
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Note: In the examination of a corporate or partnership return, an examiner will often inspect the return of the major shareholder or partner and sometimes consider his or her standard of living and sources of income to determine the likelihood of diverted funds. Comment: As noted above, §7602(e) prohibits the IRS from using financial status or economic reality examination techniques to determine the existence of unreported income of any taxpayer unless the IRS has a reasonable indication that there is a likelihood of unreported income. C.
Representation.
1.
In General
a. Throughout the examination, the taxpayer can act on the taxpayer’s own behalf or have someone represent the taxpayer or accompany the taxpayer.24 b. Any attorney, certified public accountant, enrolled agent, enrolled actuary, or any other person permitted to represent the taxpayer before the Internal Revenue Service who is not disbarred or suspended from practice before the Internal Revenue Service may represent the taxpayer. 25 c. If the taxpayer filed a joint return, either the taxpayer or the taxpayer’s spouse, or both, can meet with the IRS.26 2.
Form 2848
a. A power of attorney is required by the Internal Revenue Service when the taxpayer wishes to authorize a recognized representative to represent the taxpayer in the taxpayer’s absence. 27 b.
The taxpayer can use Form 2848 or any other properly written authorization. 28
c. Under the 2012 revision of Form 2848, taxpayers filing joint returns must each complete and submit a separate Form 2848.29 d. If the taxpayer wants to consult with an attorney, a certified public accountant, an enrolled agent, or any other person permitted to represent a taxpayer during an interview for examining a tax return or collecting tax, the taxpayer should make arrangements with that person to be available for the interview. 30 e. If the taxpayer clearly states to an officer or employee of the Internal Revenue Service at any time during any interview (other than an interview initiated by an administrative summons) that the taxpayer wishes to consult with an attorney, certified public accountant, enrolled agent, enrolled actuary, or any other person permitted to represent the taxpayer before the Internal Revenue Service, such officer or employee must suspend the interview.31 24 IRS Publication Page 9 25 IRC §7521(c) 26 IRS Publication Page 3 27 Reg §601.504 28 IRM 4.19.13.7 (01-01-2015) 29 Id. 30 IRC §7521(c) 31 IRC § 7521(b)(2).
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3.
Third party Authorization
a. A taxpayer who has checked the box in the signature area of the taxpayer income tax return (Form 1040, Form 1040A, or Form 1040EZ) to allow the IRS to discuss the tax return with another person (a thirdparty designee), must still complete and file Form 2848 with the IRS. 32 b. The box the taxpayer checked on the tax return only authorizes the other person to receive information about the processing of the tax return and the status of the taxpayer refund during the period the tax return is being processed. 33 D.
Confidentiality Privilege
1. Communications between the taxpayer and his or her attorney can be protected as privileged confidential communication.34 2. With respect to tax advice, the same common law protections of confidentiality which apply to a communication between a taxpayer and an attorney also apply to a communication between a taxpayer and any federally authorized tax practitioner.35 3.
Confidential communications are those that:
a. Advise the taxpayer on tax matters within the scope of the practitioner's authority to practice before 36 the IRS, b.
Relate to noncriminal tax matters before the IRS 37, or
c.
Relate to noncriminal tax proceedings brought in federal court by or against the United States. 38
E.
Recordings
1.
The taxpayer may upon advance request make an audio recording of the examination interview. 39
2.
The IRS can also record an interview described if such officer or employee
a.
informs the taxpayer of such recording prior to the interview, and
b. upon request of the taxpayer, provides the taxpayer with a transcript or copy of such recording but only if the taxpayer provides reimbursement for the cost of the transcription and reproduction of such transcript or copy.40
32 IRS Publication Page 3. 33 IRC § 7521(b)(2). 34 Com. v. Schwarz, Kathryn M., (1957, CA Dist Col) 52 AFTR 46, 247 F2d 70, 57-1 USTC ¶9622. 35 IRC § 7525(a). 36 IRC § 7525(a)(3)(B). 37 IRC § 7525(a)(2)(A). 38 IRC § 7525(a)(2)(B). 39 IRC § 7521(a)(1). 40 IRC § 7521(a)(2).
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F.
General Examination Procedures and Policies
The preceding discussion provides a general overview of the different types of examinations and basic examination procedures. The discussion below outlines the general policies and procedures of the IRS applicable to all examinations. 1.
Case Transfers
a. An examination usually is conducted in the area in which the taxpayer resides or conducts its business or maintains its principal office. If the taxpayer requests, however, the examination may be transferred to another area. In considering the request for a transfer, the convenience of the taxpayer is balanced with the requirements of a sound and efficient tax administration. Generally, the place where the records of the taxpayer are located, where the principal investigative work will be performed, or where the major tax issues can most conveniently be disposed of, will control the decision as to where the examination will be conducted. A taxpayer may make a transfer request if the taxpayer no longer resides or conducts business at the site shown on the original return. The request must be in writing and should allow the IRS to take into account the following factors: (1)
location of the taxpayer's residence;
(2)
location of the taxpayer's business;
(3)
where the taxpayer's books and records are maintained; and
(4) factors that indicate that conducting the examination at a particular location could pose undue inconvenience to the taxpayer. The IRS considers all such requests on a case-by-case basis. b. The business location of the taxpayer's representative is generally not considered in determining the place for examination. However, based on the factors described above, the IRS may, in its discretion, transfer the place of examination to the representative's office. c. The Treasury regulations provide that the IRS should grant a taxpayer's request to move the examination to another location under the following circumstances: (1) for office examinations, if the taxpayer's current residence, or the location of the taxpayer's books and records in the case of a taxpayer entity, is closer to a different office or post-of-duty in the same area as the office initially selected for the examination, the IRS normally will transfer the case to the closer office; (2) for office examinations, if the taxpayer's current residence, or the location of the taxpayer's books and records in the case of a taxpayer entity, is in an area other than the area initially selected for the examination, the IRS normally will transfer the case to the closest office in the other area;
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(3) for field examinations, if the taxpayer does not live at the residence where an examination has been scheduled, the IRS will transfer the examination to the taxpayer's current residence; and (4) for field examinations, if the taxpayer's books, records and source documents are maintained at a location other than the location at which the examination is scheduled, the IRS will transfer the examination to the location where the books and records are maintained. d.
The IRM provides that requests to transfer a field examination must be in writing and include: (1)
the reason for the transfer;
(2)
the taxpayer's current address and current phone number;
(3) the address/location of the taxpayer's current principal place of business; (4) the address/location at which the taxpayer's books, records, and source documents are maintained; (5) sufficient information to establish that the transfer will result in an examination where the books, records, and source documents are maintained; (6) why the requested location is more efficient for the examination of the taxpayer; and (7) other factors which indicate that conducting the examination at a particular location could pose undue inconvenience to the taxpayer. e. The following circumstances may also be considered in determining whether a case should be transferred: (1)
change of the taxpayer's domicile (before or during examination);
(2)
taxpayer's books and records are in another area;
(3) change of domicile of an executor or administrator (before or during examination); and (4)
effective administration of tax laws.
f. The IRS generally will not transfer a case from one area to another if the period of limitations on assessment or collection will expire within 13 months from the date of the taxpayer's request, unless the taxpayer agrees, in writing, to extend the limitations period for up to a year. Campus transfers to area offices will not be initiated with less than seven months remaining on the statute of limitations. g. The Treasury regulations provide additional prohibitions against transfers, including situations where the IRS office to which the taxpayer requests a transfer lacks adequate resources to conduct a 15
proper examination or where the safety of IRS employees might be threatened if the transfer were approved. h. In addition to taxpayer requests to transfer a case, the IRS may initiate a transfer if it believes that the transfer would promote the efficient and effective conduct of the examination. The taxpayer, however, may request that such a transfer not be made. The IRS will consider the request, taking into account the principles and criteria applicable to taxpayer-initiated requests. 2.
Conflict of Interest
Examiners must disqualify themselves from the examination or survey of any return assigned to them where a relationship impairs impartiality. A conflict of interest will exist if the examiner's personal relationship or private interest (e.g., financial or economic interests) conflicts (or raises a reasonable question of a conflict) with the examiner's public duties and responsibilities. 3.
Furnishing Identification
During personal and telephone contacts and on all manually generated correspondence by an employee working on tax related issues, an employee title (e.g., Mr., Mrs., Miss) or first name, last name, and unique identification number must be provided. Agents generally are prohibited from using pseudonyms except where necessary to protect themselves from potential harassment from taxpayers. 4.
Conduct of IRS Agents in Criminal Investigations
a. Agents are specifically instructed to avoid alleged improper conduct or lack of propriety which may be used as part of a defense strategy in a criminal tax evasion case. For example, each agent must avoid: (1) situations which may result in the agent becoming obligated in any way to the person under investigation; (2) statements or questions which may be construed as offers of immunity or attempts to settle civil liabilities in pending criminal cases; (3)
expressions of personal views as to the merits of the case;
(4) advising and counseling the taxpayer under investigation of possible defenses to a prosecution for the alleged crime; (5) statements, remarks or the commission of acts that are subject to misinterpretation to the disadvantage of the government; (6) records; and
irregular arrangements for the examination of a taxpayer's books and
(7) leading the person under investigation to believe that prosecution is not contemplated. b. Because claims of misconduct and irregularities may be made in any case, agents are instructed to exercise care and good judgment in all of their dealings with persons under investigation, as well as their representatives. 16
5.
Furnishing Advice and Counsel to Taxpayers
Any oral guidance given to the taxpayer is advisory only and the IRS is not bound by it. Agents, however, should make an effort to ensure that any oral advice to taxpayers correctly reflects the position of the IRS. 6.
Bribery Attempts
If any agent has reasonable grounds for believing that an attempt to bribe him or her has been made or will be made, he or she is instructed to: • avoid any statement or implication that he or she will or will not accept the bribe, and to try to hold the matter in abeyance; • immediately report the matter by telephone to the Treasury Inspector General for Tax Administration (TIGTA); •
submit as soon as possible a memorandum to TIGTA stating the circumstances of the matter; and
•
cooperate fully in any ensuing investigation, and
•
avoid any unnecessary discussion of the case with anyone.
7.
Use of Witness on Behalf of Taxpayer
A taxpayer has the right to use the services of any person he or she selects as a witness for the purpose of explaining his or her books, records, or returns to the agent during the examination process. The witness does not have to be qualified to practice before the IRS in order to undertake this function but is not permitted to act as an advocate for the taxpayer. 8.
Assistance of Area Counsel
Examination personnel may obtain legal advice from Area Counsel concerning cases under examination on matters not related to the Code and regulations. Examples include: the meaning, force and effect of legal terms in a contract; the enforceability of a contract; the application of state laws to the elements of a contract; information regarding applicable state statutes which bear upon a corporation's existence; and the status of a transferee of assets. 9.
Recognition of Taxpayer's Representative
a. A taxpayer's representative has the right to be present whenever the taxpayer is interviewed, interrogated or requested to furnish information to the IRS in connection with an examination. A taxpayer has the right to suspend any interview with an IRS employee and consult with his or her representative, unless the interview was initiated by an IRS summons. In addition, the IRS cannot require the taxpayer to accompany his or her representative to an interview unless a summons requesting the taxpayer's presence has been issued. Comment: As noted above, since the 1998 IRS Restructuring Act, the IRS has been required to include a statement in Publication 1 which clearly explains the taxpayer's right to be represented by a representative and to have the representative present during any interview with the IRS.
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Comment: Although §7521(d) states that §7521 (i.e., the provision dealing with a taxpayer's right to representation during interviews) does not apply to criminal investigations, a taxpayer who is the target of a criminal investigation has the right to be represented by counsel during any interview with an IRS special agent. This right is based on a broader and more fundamental rule. b. If a taxpayer's representative unreasonably delays or hinders an examination, the IRS may notify the taxpayer that the representative is responsible for such delay or hindrance, and seek the information directly from the taxpayer. Bypassing a recognized representative does not result in automatic disqualification of the representative — however, such representative may be referred to the IRS's Office of Professional Responsibility for possible disciplinary proceedings. c. Any notice or other written communication given to a taxpayer in a matter before the IRS will also be given to the taxpayer's recognized representative. However, if such notice or communication contains tax information of a confidential nature, the notice or communication will be given to the representative only if there is a valid power of attorney (Form 2848), tax information authorization, or similar form on file which authorizes the disclosure. For a corporate taxpayer under examination, Form 4764, Large Case Examination Plan, contains agreements with the taxpayer, work assignments, and examination procedures, and suffices to allow the taxpayer to designate one or more employees to discuss tax matters, provide and receive information, and receive and discuss adjustments. However, Form 4764 does not replace Form 2848 and therefore if the employee advocates, negotiates, disputes or does anything beyond mere delivery of facts, general explanation, or acceptance of materials, the employee is engaged in representation activities and Form 2848 is required. Note: In 2012, the IRS altered its practice to require that spouses each sign a separate Form 2848 and will no longer accept a joint form for married persons. 10.
Tax Practitioner Privilege
a. With certain limitations, §7525 extends the attorney-client privilege of confidentiality to tax advice that is furnished to a client-taxpayer or potential client-taxpayer by any individual who is authorized under federal law to practice before the IRS, including attorneys, certified public accountants, enrolled agents and enrolled actuaries. b. The privilege of confidentiality may be asserted in any noncriminal tax proceeding before the IRS, as well as in noncriminal tax proceedings in the federal courts where the IRS is a party to the proceeding. 11.
Repetitive Examinations
a. The IRS has a policy against conducting repetitive examinations of a taxpayer. If a taxpayer responds to an initial contact letter by indicating that the same issue was examined in either of the two preceding years and resulted in no change or a small tax change, the examiner is directed to follow certain procedures. If the taxpayer's response is received before a scheduled initial interview, the examiner will advise the taxpayer that the interview is postponed pending a review of IRS files to determine whether the examination should be continued.
18
b. If the taxpayer supplies sufficient evidence, or a transcript of the taxpayer's accounts for the two preceding years show no change or a small tax change for the years referred to in the taxpayer's initial contact letter, the current year examination should be terminated. In office examinations, approval by the group manager must be obtained, but not in field examinations. If a substantive tax change is shown for either prior return year, the taxpayer is informed that the repetitive examination procedures do not apply and the examination is continued. 12.
Audio and Stenographic Recording of Conferences
a. The taxpayer has the right to make an audio recording of any in-person interview relating to the determination or collection of any tax by IRS personnel. No such rights exist with respect to videotaping or otherwise filming examination proceedings or recording telephone conversations in any manner. b. The taxpayer must follow certain procedures to obtain permission to record conferences. The IRS representative conducting the interview generally will grant permission to record if: i.
the taxpayer supplies the recording equipment;
ii.
the IRS may produce its own recording of the conference;
iii.
the recording takes place in a suitable location;
iv. and
all participants to the proceeding consent to the recording and identify their roles at the conference;
v.
the taxpayer provides the IRS with 10 days advance notice of its intent to record.
Group manager approval is required. Note: The IRS also has the right to request to record an interview. In such case, it must similarly provide the taxpayer with advance notice of its request no less than 10 calendar days before the interview.584 c. With respect to stenographic recordings, a witness is not generally permitted to have his or her own private or public stenographer present to take shorthand notes or transcribe testimony. Only a stenographer employed by the IRS is permitted routinely to record an interview. However, with the permission of the agent's immediate supervisor, the witness may engage a qualified stenographer employed by the U.S. attorney, a court reporter of the U.S. district court, a reporter licensed or certified by any state as a court reporter or to take depositions, or an independent reporter known to the IRS to be qualified to take depositions for use in a U.S. district court, to be present at his or her expense, provided that the IRS may secure a copy of the transcript at its expense. Requests by taxpayers to make stenographic or verbatim recordings of examination procedures are generally allowed. 13.
Interview of Witness: Dual Representation
a. Attorneys, certified public accountants, and enrolled agents are required to refrain from representing taxpayers with conflicting interests in their practice before the IRS except where all directly interested parties expressly consent after full disclosure has been made. Dual representation exists when a summoned third-party witness is represented by a representative who also represents the taxpayer or another interested party.Dual representation also exists when an attorney under investigation represents a 19
third-party witness in that investigation or when an attorney-witness seeks to represent another witness in the same investigation.For these purposes, an interested party is one who has a significant pecuniary interest in the testimony of the witness or who, by virtue of the nature of the investigation and the known facts, may be incriminated by the witness. b. A practitioner may represent clients having conflicting interests, however, if the practitioner reasonably believes he or she can provide “competent and diligent representation” to each of the affected clients; the representation is not prohibited by law; and each affected client gives informed consent at the time the practitioner learns of the conflict. The client's informed consent must be confirmed in writing no later than 30 days after the client gives his or her consent. c. If the agent learns that counsel represents both the taxpayer, or other interested party, and a summoned witness, the agent may discuss with the attorney whether the attorney is aware of the dual representation and the potential conflict of interest. If the issue is not resolved with the attorney, the agent should consider whether it would be appropriate to explore the potential conflict with the witness. If so, the agent should ask the following questions of the witness: i.
Does the witness wish the attorney to be present?
ii.
Has the witness hired the attorney?
iii.
Is the witness paying the attorney's fees and, if someone else is paying the fees, does the witness know who it is?
iv.
Does the witness realize that there is a potential conflict of interest?
d. If, after the foregoing questions, the witness clearly states that he wants the attorney to represent him or her or that he or she is utilizing the services of the attorney in this matter, then the interview should proceed. If, however, the witness states that he or she does not want to retain the attorney because of the possible conflict of interest, the witness may continue with the interview without an attorney or adjourn the interview to a specified future date. If the witness refuses to engage a new attorney within a reasonable period of time, the witness should be notified that a summons enforcement proceeding may be initiated.596 14.
Suspending Cases
a. In certain cases, the IRS may suspend an examination. For example, an examination may be suspended if a key issue is pending in a similar case in a federal court. An examination will be suspended, however, only if the pending court case is so factually and legally similar that a decision in the court case may ultimately determine the outcome of the case under examination. b. In some cases, a national or area directive will instruct that issues be suspended pending administrative action.598 c. When a case is placed in suspense, a Revenue Agent Report (RAR) or claim disallowance that addresses the unagreed issue(s) being suspended must be in the file. A claim allowance must also be included in the file should the taxpayer's position prevail. The examiner must determine if the RAR has been shared with the taxpayer for purposes of §6404(g), discussed at I.D.8., above. All issues, other than 20
the suspense issue(s), must be resolved to the extent possible and any partial assessment should be made before the case is placed in suspense. The only issues that may be suspended are unagreed issues meeting suspense criteria. If a partial agreement cannot be secured and the taxpayer has failed to file a protest, a statutory notice of deficiency will be issued. A case will only be placed in suspense if there is at least 24 months remaining on the statute of limitations, unless an extension is secured.599 15.
Examination Cycle
a. The IRS seeks to follow a 26-month examination cycle for completing examinations of individual returns, and a 27-month cycle for corporation income tax returns.600 These cycles start at the beginning of the period of limitations on assessment (i.e., the later of the return due date or date the return is actually filed).601 This means that most returns are generally examined within about two years after they are filed, if at all. There are exceptions to this general policy (e.g., tax shelter returns, returns involving fraud).602 b. The examination cycle may be exceeded if failure to conduct an examination would result in a serious criticism of the IRS's administration of tax laws; establish a precedent that would seriously hamper subsequent attempts by the IRS to take corrective action; result in inconsistent treatment of similarly situated taxpayers; or be contrary to an established IRS position (the IRS position must be clear at the time the approval to initiate the examination is granted, and not in the developmental stages).603 c. An IRS examination for one tax year may lead to an expansion of the examination to include other years. IRS policy, however, has been not to expand an examination to a prior year after the due date of the return for the year after the return under examination, absent special circumstances. d. No examiner or specialist may survey or examine a tax return of a taxpayer for more than five consecutive years (60 months) from date of assignment. If the examination is in process at the five consecutive year point, the examiner or specialist is allowed to complete the examination provided the current cycle or audit has less than 12 months remaining from the five consecutive year point. An examiner or specialist will not be reassigned to the same taxpayer for at least one intervening examination or two intervening surveys.604 16.
Duty/Authority of IRS Examiners
a. Because an IRS examiner is instructed to determine the correct amount of a taxpayer's tax liability, the examiner should not attempt to collect more tax than the taxpayer legitimately owes and should inform the taxpayer if he or she has overpaid. b. To assist examiners, the IRS provides detailed examination guidelines, presented primarily in a series of sections contained within the IRM.605 17.
Documentation
a. Although examinations typically are initiated by the IRS, the taxpayer is expected to show that the items on a return are correct. Section 6001 requires every taxpayer to “keep such records, render such statements, make such returns, and comply with such rules and regulations as the Secretary may from time to time prescribe.” Thus, every taxpayer must maintain adequate books and records to substantiate both the fact and the amount of items reflected in the return.606 If a taxpayer fails to comply with the law and 21
regulations for maintaining adequate books and records, the IRS will issue an Inadequate Records Notice.607 Comment: Section 7491 provides that the IRS shall have the burden of proof in any court proceeding with respect to a factual issue if the taxpayer introduces credible evidence with respect to the factual issue relevant to ascertaining the taxpayer's income tax liability. Certain conditions apply, however, including, first, that the taxpayer comply with the requirements under the Code and Treasury regulations to substantiate an item, and second, that the taxpayer maintain all records required by the Code and Treasury regulations.608 b. While taxpayers are required to maintain adequate books and records, the books and records do not need to be maintained in paper form. The IRS sets forth specific conditions for the following: i. the requirements for microfilm (including microfiche) reproductions of a taxpayer's general books of account (i.e., cash books, journals, voucher registers, ledgers and supporting records of detail) to be considered adequate books and records under §6001;609 ii. the information that must be included in certain financial account statements for them to be treated as proof of payment of an expense;610 iii.
the requirements for books and records maintained on an electronic storage system that either images their hardcopy books and records or transfers their computerized books and records to an electronic storage media, to be considered adequate books and records under §6001;611 and
iv. the requirements for books and records maintained on an automatic data processing system to be considered adequate books and records under §6001.612. Note: An examiner has discretion in deciding whether to allow items for which the taxpayer lacks adequate documentation. An examiner may accept a close approximation established through reliable secondary sources and collateral evidence.613 An examiner may also accept a taxpayer's oral statements if he or she finds the evidence credible based on all the surrounding circumstances.614 Review Question Which of the following statements is correct? A) If the taxpayer requests an additional explanation from the IRS, a tax examiner will prepare a letter within 45 days responding to the taxpayer’s questions and requesting a correction or agreement. B) When documents are requested in a campus interview, the taxpayer should send the original documents to the IRS. C) Area Office Examinations may take the form of a correspondence examination, an office interview examination, or a field examination, i.e. an examination outside of the IRS office, conducted at the taxpayer’s premises. D) If a taxpayer insists upon an assurance that the taxpayer’s books and records will be solely used for civil purposes, the tax agent is forbidden from finding out the reason why, and may not report the matter to his group manager nor refer the matter for criminal investigation. 22
Explanation A) is incorrect because a tax examiner must prepare a letter within 30 days, not 45 days. B) is incorrect because the originals may get lost, so copies should be sent. C) is correct because those are the identified methods of examination. D) is incorrect because a tax examiner must find out the reason why and may report the matter to his group manager and refer the matter for criminal investigation.
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Course Learning Objectives After course completion you will be able to: Distinguish the possible outcomes and consequences of examinations. Recognize how to read an examination report. Identify quality review. Distinguish the processing of no change and agreed cases.
III.
Conclusion of Examination
A.
Possible Outcomes of Examination There are four possible outcomes to an examiner's review of a return: 1. No Change — the examiner proposes no change in the taxpayer's tax liability; 2. Agreed — the examiner proposes adjustments to the taxpayer's tax liability and the taxpayer agrees to sign a consent with respect to all of the adjustments; 3. Unagreed — the examiner proposes adjustments to the taxpayer's tax liability and the taxpayer does not agree to sign a consent with respect to all adjustments; or 4. Partially Agreed — the examiner proposes adjustments to the taxpayer's tax liability and the taxpayer agrees to sign a consent with respect to some of the adjustments, but not to others.
Comment: The ramifications and consequences of the four possible outcomes are discussed below. In many cases, the course that the taxpayer adopts is dictated by the taxpayer's intentions. If the taxpayer intends to litigate the tax liability, the taxpayer's representative will probably decide procedural questions with reference to the ultimate forum considered most favorable for disposition of the case (i.e., the Tax Court, the U.S. Court of Federal Claims, or a federal district court). B.
No Change Cases 1. If the examiner proposes no change in the taxpayer's liability, the tax liability shown on the return is accepted by the IRS as filed. The taxpayer is notified of the outcome: either the taxpayer is present when the determination is made or a no-change report will be issued to the taxpayer or his or her representative.615 In cases where adjustments are made but the tax liability is unaffected, the taxpayer will be notified so that the taxpayer may properly reflect the changes in subsequent year's returns, if necessary.616 2. The no-change report ordinarily constitutes a final administrative determination of tax liability and the case will not be reopened to try to change the taxpayer's tax liability, except under the limited circumstances described in the IRS's policies regarding the 24
reopening of closed cases (e.g., fraud, malfeasance, collusion, concealment or misrepresentation of a material fact).617 In cases in which the IRS has accepted the taxpayer's own determination of tax liability, if the taxpayer subsequently concludes that the tax was overpaid, he or she may still file a claim for refund with the IRS. 3. 617 Rev. Proc. 2005-32, 2005-23 I.R.B. 1206, superseding Rev. Proc. 94-68, 1994-2 C.B. 803. See IRS Policy Statement 4-3 (12-21-84) at IRM 1.2.13.1.1. A no-change letter, unlike a closing agreement under §7121, does not denote a final resolution of a tax controversy, however. See Miller v. Commissioner, T.C. Memo 2001-55. C.
Agreed Cases 1. If the examiner proposes adjustments to the taxpayer's liability, the basic choice for the taxpayer is whether he or she wishes to contest the adjustments.618 When the taxpayer agrees to the proposed adjustments,619 but the examination results are subject to review or additional processing or some other condition, the taxpayer may waive the statutory restriction upon assessment and collection of the deficiency of tax by signing the standard Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment, and pay the deficiency. Paying the deficiency obviously stops the running of interest. In addition, signing the waiver stops the running of interest 30 days from the date of receipt if the assessment and notice for payment are not made within the 30-day period. In short, by signing the Form 870, the taxpayer waives the right to a notice of deficiency and thus permits the IRS to assess the tax immediately.620 The taxpayer will be furnished a copy of the examination report in the agreed case.621 2. If the taxpayer wants to contest the adjustments but does not wish to avail himself or herself of the IRS appeals procedures or litigation in the Tax Court, he or she may also sign the Form 870, pay the tax, and then file a claim for refund, which may be pursued in district court.
D.
Unagreed Cases, Fast Track Mediation and Fast-Track Settlement 1. If the examiner proposes adjustments to the taxpayer's tax liability and the taxpayer does not agree, the taxpayer will be informed of his or her right to discuss the proposal with the examiner's group manager. All taxpayers will be informed of formal appeal rights, as well as the right to pay any deficiency and file a claim for refund.622 2. Thus, managerial involvement is required in unagreed examinations. A 30-Day Letter generally will not be issued to the taxpayer unless the manager has contacted the taxpayer and/or representative to attempt to resolve the tax controversies and reach an agreement.623 3. If no agreement is reached at the manager conference, then fast track mediation or fast track settlement (FTS) may be an option for the taxpayer.624 If neither fast track mediation nor FTS results in an agreement, the IRS will issue a 30-Day Letter to the 25
taxpayer.625 As noted, receipt of such a letter permits the taxpayer to file a protest with the IRS Appeals office within 30 days.626 If the taxpayer does not file an appeal, or is unsuccessful in the appeals procedure, a 90-Day Letter (i.e., a statutory notice of deficiency) is issued to the taxpayer; the taxpayer can then file a petition for redetermination with the Tax Court before assessment of the deficiency is permitted. 4. The Fast Track Mediation — Collection (FTMC) program replaced the Fast Track Mediation (FTM) program effective November 18, 2016. See Rev. Proc. 2016-57, 2016-49 I.R.B. 786, obsoleting Rev. Proc. 2003-41, 2003-25 I.R.B. 1047.. E.
Partially Agreed Cases 1. A partially agreed case contains more than one issue, at least one of which is agreed and at least one of which is not agreed to by the taxpayer.628 a. In these cases, the examiner prepares Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment, with respect to the agreed adjustments.629 If the taxpayer signs a waiver of restrictions, the taxpayer may still utilize the IRS appeals procedures or petition the Tax Court for a determination concerning the proposed adjustments not covered by the waiver of restrictions. b. With respect to the proposed adjustments covered by the waiver of restrictions, the IRS will assess a deficiency and collect the tax attributable to such proposed adjustments.630 Signing Form 870 does not preclude assertion of a further deficiency by the Commissioner or a request for further consideration of the issues by the taxpayer. c. That is, the case is “excepted” from application of the case reopening criteria discussed previously.631 d. The taxpayer may subsequently take the position that the proposed adjustments covered by the waiver of restrictions were incorrect and file a claim for refund for the tax paid with respect to such proposed adjustments, or, if there is Tax Court litigation, request that the Tax Court determine the correctness of the proposed adjustments covered by the waiver of restrictions. • 631 IRM 4.10.8.4 (8-11-06). After the examination is closed by the signing of Form 870, however, the IRS will not reopen the case to assert additional changes in the tax liability of the taxpayer, except in limited circumstances. See Rev. Proc. 2005-32, 2005-1 I.R.B. 1206, superseding Rev. Proc. 94-68, 1994-2 C.B. 803.
F.
Examination Reports 1. Overview
26
a. As part of the examination process, the examiner prepares a report of his or her examination. These audit reports should contain all the information necessary to ensure a clear understanding of the adjustments, and document how the tax liability was computed. b. Examination reports, unlike workpapers, are legally binding documents and, when executed, serve as the basis for assessment and collection action. Thus, examiners should take all necessary steps to ensure report accuracy.632 The nature of the examination report and its handling depends on in which of the categories discussed above the case falls. 2. Regular Agreed Cases a. Form 4549, Income Tax Examination Changes, is the basic report form for regular agreed individual and corporate cases.633 Form 1902-B, Report of Individual Tax Examination Changes, is used to secure agreements from the taxpayers in deficiency cases. These forms contain a statement to the effect that the report is subject to acceptance by the area director. b. Form 4605, Examination Changes Partnerships, Fiduciaries, S Corporations and Interest Charge Domestic International Sales Corporations, is the basic report form for use in these cases.634 c. A written explanation on Form 886-A, Explanation of Items, may be incorporated in the basic report form.635 3. Unagreed and Partially Agreed Cases a. The basic report forms for unagreed and partially agreed cases are similar, but not identical, to the basic report forms for regular agreed cases, as discussed above. The basic forms for unagreed and partially agreed cases differ primarily in that they do not contain a space for the taxpayer's consent to assessment and collection, or a statement regarding acceptance of the report by the area director.636 b. Form 4665, Report Transmittal, is an internal form used to transmit cases to Appeals. Its main purpose is to provide a place for the agent to list unagreed issues.637 Exam employees are prohibited from including recommendations concerning what Appeals should consider and how Appeals should resolve the case.638 G.
Quality Review 1. With respect to SB/SE matters, the primary responsibility for case quality is at the group level. A group manager conducts both technical, procedural and administrative reviews.639 In LB&I, the team manager is responsible for reviewing the primary case and all effectively controlled entities that are included in the examination.640 27
2. Case reviews are also conducted by Technical Services Support. These reviews are conducted to evaluate case quality and examination processing requirements. a. Some areas utilize reviewers to conduct reviews of both in-process and closed cases. b. Case reviews include determining the scope of the examination, evaluating case documents to support the examiner's conclusions, determining if technical conclusions are correct, ensuring proper completion of internal procedures, interpreting and evaluating the application of the quality attributes, processing the case, documenting the review results, and providing feedback to both examiners and management to improve case quality.641 3. Within Technical Services, Examination Quality Measurement Staff (EQMS) are used by SB/SE to collect information, measure examination quality and assess the long term trends of system performance.642 H.
Processing of No-Change and Agreed Cases 1. Generally, when the examination of a return results in no change in tax liability, the IRS sends a Letter 3401, No-Change Report Transmittal Letter, and the no-change report to the taxpayer and his or her representative.643 The no-change determination is subject to review and the formal reopening procedures do not apply before the issuance of a formal no change letter.644 2. For agreed cases, a Form 4549, Income Tax Examination Changes, is completed for individual and corporate cases.645 If the case involves a partnership or S corporation, the IRS prepares a Form 4605, Examination Changes, Partnerships, Fiduciaries, S Corporations, and Interest Charge Domestic International Sales Corporations.646
Review Question Which of the following is incorrect? A) If the examiner proposes no change in the taxpayer’s liability, the tax liability shown on the return is accepted by the IRS as filed. The no-change report ordinarily constitutes a final administrative determination of tax liability and the case will not be reopened to try to change the taxpayer’s tax liability, except under the limited circumstances described in the IRS’s policies regarding the reopening of closed cases. B) If the tax examiner proposes adjustments to the taxpayer’s liability, and if the taxpayer agrees to the proposed adjustments, but the examination results are subject to review or additional processing or some other condition, the taxpayer may waive the statutory restriction upon assessment and collection of the deficiency of tax by signing the Standard Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment, and pay the deficiency. C) Examination reports, like workpapers, are not legally binding documents and, when executed, do not serve as the basis for assessment and collection action. 28
D) A partially agreed case contains more than one issue, at least one of which is agreed and at least one of which is not agreed to by the taxpayer. In these cases, the tax examiner prepares Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment, with respect to the agreed adjustments. If the taxpayer signs a waiver of restrictions, the taxpayer may still utilize the IRS appeals procedures or petition the Tax Court for a determination concerning the proposed adjustments not covered by the waiver of restrictions. Explanation A) is incorrect because the answer is correct as stated. B) is incorrect because the answer is correct as stated. C) is correct because it is incorrect; examination reports, unlike workpapers, are legally binding and, when executed, serve as the basis for assessment and collection action. D) is incorrect because the answer is correct as stated.
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Course Learning Objectives After course completion you will be able to: Identify the procedures before the issuance of a 30-day letter. Distinguish between a 30-day letter and a 90-day letter. Recognize the elements of reopening a closed case.
IV.
Processing of Unagreed Cases; 30-Day Letters and 90-Day Letters
A.
Procedures Before Issuance of a 30-Day Letter 1. In office examinations, the examining agent will discuss issues as they are concluded during a scheduled appointment or at the conclusion of the appointment. Whenever possible, the examiner will prepare an audit report at the conclusion of the appointment and discuss audit issues with the taxpayer and/or representative in a face to face meeting rather than simply mailing the agent's report.647 2. In field examinations, the examiner should discuss issues as they are concluded. This allows the resolution process to begin as the examination continues. Each issue is discussed as it is completed and resolved so that at the conclusion of field work the status of each issue is known. The examiner can then take the appropriate steps to close the case.648
B.
30-Day Letter 1. In unagreed income, estate, gift, excise and employment tax cases (except for those cases involving criminal fraud, tax protesters and transferee liability), the taxpayer is furnished with a copy of the examination report and advised of his or her rights to appeal. As noted above, the IRS issues a 30-Day Letter for this purpose.649 2. Thirty-Day Letters are prepared by the examiner and could include the examiner's name or group manager's name, in the contact area of the letter. The authority to sign and issue the letters is delegated to group managers.650 3. The 30-Day Letter requests that the taxpayer sign and return a waiver of restrictions on assessment (Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment) if the taxpayer agrees with the findings, or that the taxpayer exercise his or her appeal rights. The 30-Day Letter informs the taxpayer that if he or she fails to take appropriate action within 30 days, the case will be processed on the basis of the proposed adjustments and a 90-Day Letter will be issued.
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4. The IRS sends 30-Day Letters by ordinary mail except when the IRS considers it necessary to use certified or registered mail. If certified or registered mail is used, the IRS requests return receipts.651 5. In the case of a joint return, a complete original 30-Day Letter will be sent to each spouse.652 In addition, a copy of the 30-Day Letter with enclosures is normally mailed to the taxpayer's representative if there is a document on file authorizing him or her to receive such communications.653 Comment: As noted above, §3504 of the 1998 IRS Restructuring Act655 requires the IRS to provide taxpayers with a complete description of the entire process from examination through collection, including the assistance available from the National Taxpayer Advocate, with the first letter of proposed deficiency that allows the taxpayer an opportunity for administrative review at Appeals. A copy of the updated version of Publication 1 should satisfy this requirement. Publication 1 also contains cross references to other useful IRS publications, including Publication 5 and Publication 594, Publication 556, Examination of Returns, Appeal Rights, and Claims for Refund, and Publication 1660, Collection Appeal Rights. 6. In partially agreed cases involving individuals and corporations, a Form 4549-A, Income Tax Examination Changes, will be prepared showing both the agreed and unagreed adjustments. Agreed adjustments will be included in the section for “Total Tax Per Return or as Previously Adjusted.” A 30-Day Letter will be issued for the unagreed issues.656 C.
Response to 30-Day Letter 1. Extension of Time — A 30-Day Letter allows the taxpayer 30 days to request Appeals consideration of his or her case, but the IRS, upon request by the taxpayer or his representative, grants extensions of time almost as a matter of course. Justification, however, should be provided.657 2. Agreement — If an agreement is received in response to the 30-Day Letter, the case is closed within 10 days under the agreed case closing procedures.658 3. Request for Appeal or Protest a. If the total amount of proposed additional tax, additions to tax and penalties, proposed overassessment, or claimed refund, credit, or abatement for any tax period, does not exceed $25,000, a request for an appeal is made using small case procedures, which simply require a written request asking for Appeals consideration, indicating the changes the taxpayer does not agree with, and stating any reasons for the disagreement.659 b. A case with a deficiency exceeding $25,000 requires a formal written protest. A protest generally will be reviewed at the group level within seven calendar days of receipt to determine whether the protest is adequate, whether the case requires further development by the examiner, whether the examination 31
report should be modified, and whether the written protest includes the requested information.660 When a protest is inadequate, the protest is returned to the taxpayer for improvement.661 If the protest contains information that is deemed to warrant consideration, the case will be given expedited consideration if additional development is required.662 D.
Issuance of the Notice of Deficiency or 90-Day Letter 1. The Notice of Deficiency or 90-Day Letter a. A notice of deficiency, also called a “statutory notice of deficiency” or “90-Day Letter,” is a legal notice in which the Commissioner determines the taxpayer's tax deficiency in connection with income or estate and gift tax liabilities.663 Under §6213(a), the taxpayer has 90 days, 150 days if the notice is addressed to a person outside the United States, after the notice of deficiency is mailed (not counting Saturday, Sunday, or a legal holiday in the District of Columbia as the last day) to file a petition with the United States Tax Court for a redetermination of the deficiency.664 b. The notice of deficiency is a legal determination by the IRS that is presumptively correct, i.e., the taxpayer must petition the Tax Court to dispute the proposed adjustments in the notice. The 90-Day Letter consists of: i.
a letter explaining the purpose of the notice, the amount of the deficiency, and the taxpayer's options;
ii.
a waiver to allow the taxpayer to agree to the additional tax liability;
iii.
a statement showing how the deficiency was computed; and
iv.
an explanation of the adjustments.665
c. The purpose of a notice of deficiency is: i.
to ensure the taxpayer is formally notified of the IRS's intention to assess a tax deficiency; and
ii.
to inform the taxpayer of the opportunity and right to petition the Tax Court to dispute the proposed adjustments.
d. A notice of deficiency must be issued when there is a proposed tax deficiency with which the taxpayer does not agree and the statute of limitations is imminent and no extension can be obtained; the taxpayer does not respond to, or file a valid protest to, a 30-Day Letter; or the taxpayer requests the issuance of the notice in order to petition the case to the Tax Court.666 e. Notices of deficiency generally are issued within 60 days after the case is received by Technical Services.667 Notices of deficiency are sent by certified mail to the last known address of the taxpayer, or if the taxpayer is outside the 32
United States, by registered mail. The “last known address” for this purpose is the address shown on the most recently filed and properly processed return, unless the IRS has been given clear and concise notification of a different address.668 Comment: Section 3463 of the 1998 IRS Restructuring Act669 instituted a provision requiring the IRS to include in each 90-Day Letter the date determined by the IRS as the last day on which the taxpayer may file a petition with the Tax Court. It also amended §6213(a) to provide that a petition filed with the Tax Court by the specified date will be treated as timely filed. E.
No Response to Thirty-Day Letter 1. If the taxpayer fails to respond to the 30-Day Letter a statutory notice of deficiency (i.e., a 90-Day Letter) is issued subject to all of the following conditions: •
it reasonably appears that the taxpayer or his or her representative received the 30-Day Letter or, if not received, that the IRS exercised due diligence in determining the taxpayer's last known address;
•
the taxpayer is temporarily away and is not expected to return within a reasonable period of time (or has not returned after a reasonable extension of time is granted);
•
follow-up action, where appropriate, was taken without success; and
•
the notification required by §534(b) in cases involving alleged unreasonable accumulation of earnings and profits has been issued.670
2. Regardless of the above conditions, and in all events, a 90-Day Letter will be issued within the time frame fixed by law if the period of limitations will expire within 150 days and the taxpayer will not execute a consent to extend the period.671 3. In a LB&I examination, if a taxpayer who previously indicated his or her intent to file a protest fails to do so within the time allowed, the examiner may issue a letter to allow an additional 15 days within which to file the protest.672 In a SBSE examination, a follow-up letter will be sent if the taxpayer does not respond to the preliminary letter.673 4. If the 30-Day Letter is returned as “undeliverable” to the address on file, the IRS attempts to obtain the current address.674 If the IRS obtains a current address, it will remail the 30-Day Letter to the new address, and the period in which the taxpayer may reply will commence with the date the letter was remailed.675 If no response is received to the follow-up letter, or a current address cannot be obtained, a 90-Day Letter will be issued.676 F.
Issuance and Review of the Notice of Deficiency 1. Notices of Deficiency are prepared and reviewed by Technical Services Tax Examiners, Tax Compliance Officers, Tax Auditor Reviewers, and Revenue Agent 33
Reviewers.677 Tax Examiners will prepare Notices of Deficiency for cases that were handled by Tax Compliance Officers or Tax Analysts where the taxpayer did not respond, where the taxpayer did not file returns, and in cases with simple issues and deficiencies of $10,000 or less. 2. The deficiency may exceed $10,000 if it is a non-filer or no show case. Tax Examiners may not sign Notices of Deficiency, however.678 3. Cases that should not be reviewed by Tax Examiners include: cases in which an indirect method was used to determine income; cases asserting the fraud penalty; transferee cases; cases involving a community property issue; cases involving a whipsaw issue; Notices of Determination of Worker Classification; high profile taxpayers; and cases which the manager feels are beyond the scope of the Tax Examiner.679 Tax Compliance Officer/Tax Analyst Reviewers prepare statutory notices of deficiency for all other unagreed Tax Compliance Officer cases.680 Revenue Agent Reviewers prepare statutory notices of deficiency for all unagreed SB/SE Field Examination cases, all unagreed LB&I cases, and all unagreed estate and gift tax cases.681 4. 678 The following have the authority to issue notices of deficiency: a.
Appeals Team Managers and Appeals Team Case Leaders (as to their respective cases);
b.
Large Business and International (LB&I) Territory Managers;
c.
Small Business/Self-Employed (SB/SE) Field Directors: Accounts Management and Submission Processing;
d.
Campus Department Managers in SB/SE Compliance Services;
e.
SB/SE Compliance Field Territory Managers;
f.
SB/SE Technical Services Revenue Agent Reviewers GS-12 and Tax Compliance Officer Reviewers GS-09;
g.
Tax Exempt/Government Entities (TE/GE) Reviewers GS-12;
h.
Wage & Investment (W&I) Directors: Accounts Management, Field Compliance Services and Submission Processing;
i.
W&I Territory Managers. IRM 1.2.43.9 (9-4-12), Delegation Order 4-8.
5. All cases that require a statutory notice of deficiency require a limited review of unagreed issues and procedural requirements. The IRS reviewer should ensure that the case can withstand the scrutiny of Appeals and potential litigation in U.S. Tax Court.
34
a.
The scope of the case review should be sufficient to ensure correct technical conclusions; proper consideration and computation of penalties; accurate computation of the tax deficiency; proper completion of all procedural requirements; proper managerial involvement; and proper protection of taxpayer rights.
b.
Reviewers must determine if the case is sufficiently correct to support the issues, which may require returning the case to the group examiner for clarification or correction of errors, but the reviewer should correct the error(s) in the case without returning it to the examiner if at all possible.
c.
If a case contains an error, Technical Services will revise the report, if possible and to the extent necessary, and prepare the notice of deficiency package in order to support the examiner's intent.682
6. Reviewers have up to 45 days to review field cases and 15 days to review office audit cases. Certain cases require mandatory review by Area Counsel, including: •
cases involving a fraud penalty, including notices where no fraud penalty is asserted against the taxpayer, but the statute of limitations is open because the case involves a fraudulent return prepared by a return preparer;
•
notices of transferee liability;
•
notices asserting substantial deficiencies (in excess of $100,000 per tax period, excluding penalties and interest) based on indirect methods of determining unreported income, Bureau of Labor Statistics, or information returns (IRP) in which the burden of proof has shifted to the IRS;
•
captive insurance cases;
•
any notice asserting the economic substance doctrine and the related penalty under §6662(b)(6);
•
notices in cases where there has been or will be a jeopardy or termination assessment;
•
notices in cases where there is doubt as to the proper party to whom the statutory notice of deficiency should be sent;
•
notices in cases where the issues affect parent and subsidiary corporations, corporate distributions, corporate reorganizations, or similar issues or facts;
•
notices in high profile media attention cases where the appropriateness of conducting the examination may be questioned (e.g., cases where the taxpayer is famous or notorious, had a prior criminal case which was the subject of media attention, or any case involving politicians, congressional
35
hearing witnesses, or allegations that the IRS has examined the taxpayer for impermissible reasons);
G.
•
notices that involve difficult, complex, or unique legal issues, including notices with alternative positions and complex international issues;
•
notices issued on the recommendation of the Department of Justice or the Office of Chief Counsel;
•
notices in cases involving coordinated issues;
•
notices involving Munro calculations or notices involving oversheltered returns.
•
notices involving listed transactions, transactions of interest, or other reportable transactions unless excepted from mandatory review by the Abusive Transaction Issue Management Team Counsel in consultation with the Issue Management Team;684
•
all Final Partnership Administrative Adjustment (FPAA) letters;
•
notices where the deficiency plus penalty exceeds $1 million in the aggregate (excluding interest and without considering offsets); and
•
any notice, regardless of amount, that the Area Director (or designee) believes warrants Area Counsel review.685
Rescinding the Notice of Deficiency 1. The IRS has the authority to a rescind a notice of deficiency with the taxpayer's consent.686 Rev. Proc. 98-54687 provides taxpayers with instructions for entering into an agreement with the IRS under §6212(d) to rescind a notice of deficiency. Either the taxpayer or the IRS may initiate a rescission of a notice, but the notice may only be rescinded with the consent of both the IRS and the taxpayer.688 A rescission essentially places the parties in the same position that they were in before the notice was issued. The IRS, however, may later issue a new notice of deficiency.689 2. The decision whether to rescind a notice of deficiency is made on a case-by-case basis. A notice of deficiency may be rescinded if: •
a notice of deficiency has been issued for an incorrect amount. The taxpayer must be advised that, once rescinded, another notice may be issued, which may be for a greater amount;
•
the notice was issued to the wrong taxpayer;
•
the notice was issued for the wrong tax period;
•
the notice was issued without considering a properly filed Form 872, Consent to Extend the Time to Assess Tax, or Form 872-A, Special Consent to Extend the Time to Assess Tax; 36
•
the taxpayer submits information establishing that the actual tax due is less than the amount shown in the notice. Rescission is generally unnecessary in such cases because supplemental deficiency procedures can be used to resolve the case within the time allowed to file a petition with the Tax Court.690 However, rescission may be considered on a case-by-case basis. For example, if the information submitted results in no change to the taxpayer's return, the taxpayer may still wish to rescind the notice of deficiency to preserve the right of Tax Court appeal in the unlikely event the case is reopened; or
•
the taxpayer requests a conference with the appropriate Appeals office. However, the notice may be rescinded only if the Appeals office first decides that the case is susceptible to agreement.691
3. The IRS will not rescind a notice of deficiency if: •
on the date of the rescission, 90 days or less would remain before the expiration date of the period of limitations on assessment. However, a notice of deficiency may be rescinded if, before the rescission, the taxpayer and the IRS execute a consent to extend the period of limitations on Form 872 or Form 872–A;
•
the 90-day or 150-day restriction period during which the taxpayer may file a petition with the Tax Court has expired without the taxpayer filing a petition;
•
the taxpayer has filed a petition with the Tax Court; or
•
before the notice of deficiency was issued, the taxpayer and the IRS executed a Form 872–A, Special Consent to Extend the Time to Assess Tax, covering any of the tax periods in the notice of deficiency. A notice of deficiency may be rescinded in this situation, however, if the IRS executes a new Form 872–A covering the same tax periods as the earlier Form 872–A.692
4. If the IRS does not agree that a notice of deficiency should be rescinded, it will notify the taxpayer of this decision, in writing, and the notice will remain in effect. H.
Protests, Correspondence, and Waivers Received After Issuance of Notice of Deficiency 1. A protest, correspondence, or a request for interview or conference received by the IRS after the issuance of the notice of deficiency generally will be acknowledged and the taxpayer will be informed that reconsideration of the case will not suspend or extend the period for filing a petition with the Tax Court.693 Following acknowledgement, a valid protest will be transmitted to the appropriate Appeals office.694 Other correspondence is dealt with by a designated technical person within the IRS.695 In any event, unless the statutory notice is rescinded, the taxpayer will be informed that reconsideration of the case will in no way serve to suspend or extend the period for filing a petition with the Tax Court.696
37
2. If during the 90-day period specified in the notice of deficiency the taxpayer waives the restrictions on assessment and collection of the entire deficiency, the case is transmitted immediately to Centralized Case Processing for assessment of the deficiency.697 If during the 90-day period the taxpayer waives the restrictions on the assessment and collection on only part of the deficiency, the waiver and the return or the returns that are involved are transmitted to Centralized Case Processing for assessment of the agreed portion of the deficiency.698 I.
Appeals Waiver of Jurisdiction After Issuance of 90-Day Letter 1. In protested cases, all settlement jurisdiction is vested in the Appeals offices during the 90/150 day period in cases in which the Area Director issued the notice of deficiency.699 However, the Chief Appeals may relinquish this jurisdiction by waiver to the office of the Area Director that issued the notice, except in those cases in which criminal prosecution is pending or a civil fraud penalty is involved)700 2. When issued, the waiver of jurisdiction operates to vest in the Area Director complete jurisdiction of the case during the 90 day or 150 day period, including the authority to transfer the case to another jurisdiction, but does not increase the authority of the examiner.701 3. A waiver of jurisdiction will in no way deny the taxpayer a right to have a hearing before the Appeals office, if sufficient time remains during the deficiency period. Such situations will be coordinated with Appeals on a case-by-case basis.702
J.
Reopening Closed Cases 1. Overview a. Section 7605(b) provides that “[n]o taxpayer shall be subjected to unnecessary examination or investigations, and only one inspection of a taxpayer's books of account shall be made for each tax year unless the taxpayer requests otherwise or unless the Secretary, after investigation, notifies the taxpayer in writing that an additional inspection is necessary.”703 b. Rev. Proc. 85-13704 first set forth the conditions under which a case closed after examination could be reopened to make an adjustment unfavorable to the taxpayer, and contained a listing of certain types of cases in which reconsideration is not considered a reopening and made clear that cases closed after examination by Service Centers require application of reopening procedures. That revenue procedure was superseded by Rev. Proc. 9468,705 which was in turn modified and superseded by Rev. Proc. 2005-32.706 2. When Cases Are Considered Closed a. Agreed Cases — An examined agreed case is considered closed when a taxpayer has been notified in writing after a conference, if any, of adjustments 38
to the taxpayer's liability or acceptance of the taxpayer's tax return or exempt status without change.707 However, a case involving a refund or credit in excess of $2 million ($5 million for C corporations) that is subject to review by the Joint Committee on Taxation is not closed until Joint Committee review procedures and any necessary follow-up procedures are complete.708 In addition, in a fully agreed case where the taxpayer and IRS have entered into a closing agreement under §7121 following examination, the case is not closed until the closing agreement is signed by an appropriate IRS official. b. Unagreed Cases i. Unagreed cases referred to Appeals are not considered closed. An unagreed income, estate, or gift tax case, or an excise tax case subject to the deficiency procedures under §6211 through §6215,710 or a worker classification or plan qualification case subject to §7436 or §7476, is closed after examination when the period for filing a petition with the Tax Court expires and no petition is filed.711 An unagreed excise tax case not subject to the deficiency procedures under §6211 through §6215, or an employment tax case not subject to the employment status determination procedures under §7436, is considered closed when the period specified in the preliminary letter for requesting a hearing with Appeals expires and no request has been made.712 ii. Code chapters 41 through 44 address excise taxes on public charities, private foundations and certain other tax-exempt organizations, qualified pension and other plans, and qualified investment entities. Those matters are subject to the deficiency procedures of §6211 through §6215. iii. An unagreed classification or qualification case subject to §7428 is closed after examination when the period expires for bringing an action in the U.S. Tax Court, the U.S. Court of Federal Claims, or the U.S. District Court for the District of Columbia, and no action has been filed.713 An unagreed TEFRA partnership case is closed when the period for bringing an action in the U.S. Tax Court, a district court, or the U.S. Court of Federal Claims with respect to a Notice of Final Partnership Administrative Adjustment (FPAA) expires and no action has been filed.714 c. No Change Cases — If the IRS accepts the return, the case is treated the same as an agreed case for purposes of determining when a case is closed. 3. Conditions for Reopening Closed Cases 39
a. The IRS will not reopen any case closed after examination by a field office or service center to make an adjustment unfavorable to a taxpayer unless one of the following criteria is met: i. there is evidence of fraud, malfeasance, collusion, concealment, or misrepresentation of a material fact; ii. the prior closing involved a clearly defined substantial error (as defined at II.E.6.c., below) based on an established IRS position existing at the time of the previous examination; or iii. other circumstances exist that indicate that failure to reopen would be a serious administrative omission (as defined at II.E.6.d, below). b. A case may also be reopened if there are items or transactions that present significant potential for abuse for which a limited examination was performed.715 c. Of course, cases may be reopened by the IRS to make adjustments favorable to the taxpayer.716 d. All reopenings must be approved by, and all notices of additional inspection of a taxpayer's books must be signed by, an appropriate IRS official.717 e. The following four categories describe contact or actions on the part of the IRS which are not considered to be an examination, inspection, or reopening: i. Narrow, limited contacts or communications between the IRS and a taxpayer that do not involve the IRS inspecting the taxpayer's books of account,718 including:
f.
•
looking at a tax return;
•
matching information on a tax return with, or preparing a missing return from, other records or information items that are already in the IRS's possession; or
•
considering any records the taxpayer voluntarily provides to explain an apparent error on a tax return or a discrepancy between either a filed tax return or a substitute for return and information from third parties that may be used for matching information as described above.
IRS-administered programs for selective issue resolution that are open to the voluntary participation of taxpayers and which invite the IRS's involvement with respect to one or more taxable periods earlier than otherwise under the normal audit procedures, such as accelerated issue resolution, the Advance
40
Pricing Agreement program, the Pre-Filing Agreement program or the Industry Issue Resolution program.719 g. Reconsiderations of a taxable period previously examined or adjusted that arise from and are affected by the treatment of tax return items or transactions by the same taxpayer in a different taxable period or by a related taxpayer in any taxable period, such as a correction under §1311, a change to an item carried back that affects liability for the carryback year, or §1033 gain on the involuntary conversion of property.720 h. Contacts, compliance checks, examinations, or investigations of a taxpayer or third-party for one purpose, tax or period (even if a dual purpose is present at the outset) resulting in the IRS obtaining information relevant or useful for a different purpose, tax or period that may be used for matching information or that may lead the IRS to open an examination for the different purpose, tax, or period. Examples are contact by a TE/GE agent with the employer sponsor of a deferred compensation plan to investigate compliance with the requirements for exempt status, and contact to determine if the taxpayer or person is required to maintain a list under §6112(a) or to verify the accuracy of or need for disclosure of a reportable transaction required under §6111.721 K.
Clearly Defined Substantial Error 1. A “clearly defined substantial error” means that the error is clearly apparent as opposed to being vague or uncertain. “Substantial” refers to the dollar amount of tax that would not be assessed if the case were not reopened. In this regard, a return may be reopened with less than complete certainty as to the amount of the anticipated deficiency as long as it is known at the outset to be within certain guidelines. Because of the overall effect of various types of adjustments which may be made to a taxpayer's return, there is no fixed dollar amount, in the sense that changes to a tax liability in excess of this amount would require a reopening in all instances. However, there are general guidelines. Any proposed change to a case involving net additional tax totaling $10,000 or more, regardless of the number of years involved, is normally regarded as substantial.722 2. 722 IRM 4.8.2.9.1.1 (6-27-13). Reconsideration of the dollar levels seems to be in order. For example, would $10,000 be “substantial” to Microsoft or Bill Gates?
L. Serious Administrative Omission — A “serious administrative omission” involves a situation where a failure to reopen could: (i) result in serious criticism of the IRS's administration of the tax laws; (ii) establish a precedent that would seriously hamper subsequent attempts by the IRS to take corrective action; or (iii) result in inconsistent treatment of similarly situated taxpayers.723
41
M.
Interest 1. During the period of time that a taxpayer's return is undergoing examination and/or Appeals consideration, as well as when the case is pending in the Tax Court, interest generally accrues on the amount of tax ultimately determined to be due and unpaid. There are procedures, however, to allow the taxpayer to make remittances to the IRS to avoid the accrual of interest on deficiencies during such periods.724
Comment: Section 6404(g) suspends the accrual of interest after 36 months if the IRS has not sent a notice “specifically stating the taxpayer's liability and the basis for the liability” (presumably the 30-Day Letter)725 within 36 months following the date which is the later of (1) the original due date of the return, or (2) the date on which the taxpayer filed the return.726 The provision applies only to individual taxpayers who file timely returns. Interest resumes 21 days after the IRS sends the required notice to the taxpayer.727 Rev. Proc. 2005-38728 provides guidance for taxpayers to seek relief where the IRS has failed to properly suspend interest accrual in such instances. If, after the return for a tax year is filed, the taxpayer provides to the IRS a signed written document showing that the taxpayer owes an additional amount of tax for the tax year, then the 36-month period begins on the later of (1) the date the last of the documents was provided, or (2) the due date of the return without regard to extensions.729 2. 725 Chief Counsel Notice N(35)000-172 (3/22/00) includes 30-Day Letters with accompanying revenue agent reports (RARs), statutory notices of deficiency with accompanying Form 886-A, Explanation of Items, RARs, math error notices, and Underreporter Program (URP) notices as examples of sufficient notices under §6404(g). See also IRM 8.17.6.9.3 (11-06-09) for further examples. •
Every IRS notice that includes an amount of interest required to be paid by an individual taxpayer must include a detailed computation of the interest charge and a citation to the section of the Code under which such interest is imposed.730
Comment: If a taxpayer signs a Form 870 and the IRS does not issue a notice and demand for payment of the tax within 30 days, interest on the tax deficiency is suspended from the 31st day until the IRS issues a notice and demand for payment of tax.731 Given the availability of the procedures for making an advance payment to the IRS, the limitation on the accrual of interest resulting from the signing of a Form 870 should not be given any weight in favor of signing the Form 870, if there are countervailing reasons for not signing the Form 870. Rather, an advance payment should be considered to avoid accrual of interest if other factors weigh against signing the Form 870. Review Question In which of the following scenarios would a taxpayer NOT be furnished with a copy of the examination report, be advised of his rights to appeal, and have a 30-Day Letter issued to them by the IRS? A) Unagreed income tax case. B) Unagreed estate tax case. 42
C) Unagreed tax case involving criminal fraud. D) Unagreed employment tax case. Explanation A) is incorrect because a taxpayer does get furnished a copy of the examination report, be advised of his rights to appeal, and has a 30-day letter issued to them by the IRS. B) is incorrect because a taxpayer does get furnished a copy of the examination report, be advised of his rights to appeal, and has a 30-day letter issued to them by the IRS. C) is correct because in a tax case involving criminal fraud, tax protesters and transferee liability, a taxpayer does not get furnished with a copy of the examination report, be advised of his rights to appeal, and has a 30-day letter issued to them by the IRS. D) is incorrect because a taxpayer does get furnished a copy of the examination report, be advised of his rights to appeal, and has a 30-day letter issued to them by the IRS.
43
Course Learning Objectives After course completion you will be able to: Identify collateral procedures used by the IRS related to Tax Audits. Recognize the circumstances when the IRS will summon people. Identify the rights of persons summoned by the IRS. Distinguish the different types of summons used by the IRS. Identify the scope and limitations of the IRS’ powers related to Tax Audits. Identify the privileges and defenses of summons.
V.
Collateral Procedures A.
Obtaining Information 1. Authority a. Subtitle F, chapter 78 of the Code grants the IRS the basic authority to examine tax returns and determine taxpayers' liability. The introductory provision of this chapter (i.e., §7601) has remained the same for more than 50 years and reads as follows: The Secretary shall, to the extent he deems it practicable, cause officers or employees of the Treasury Department to proceed, from time to time, through each internal revenue district and inquire after and concerning all persons therein who may be liable to pay any internal revenue tax, and all persons owning or having the care and management of any objects with respect to which any tax is imposed.845The concept of a platoon of IRS agents marching through the streets, knocking on doors and inquiring whether all persons have paid their taxes, is, of course, unreasonable. This provision's survival through the various Taxpayer Bills of Rights is probably attributable to the fact that it has been ignored all these years. b. Section 7602, however, grants the IRS broad examination authority to facilitate administration and enforcement of the internal revenue laws. This authority is granted in order for the IRS to: i. ascertain the correctness of any return; ii. make a return where none was made; iii. determine the liability of any person (including a transferee or fiduciary) for any internal revenue tax; and iv. collect any internal revenue tax liability.846 44
c. To accomplish these purposes, the IRS is specifically empowered: i. to examine any books, papers, records or other data which may be relevant or material to the examination;847 and ii. to summon a taxpayer or any other person having possession, custody or care of books, papers, records or other data of the taxpayer, to appear before the IRS for a hearing at a time and place named in the summons, and to produce such books, papers, records or other data, and give testimony under oath, as may be relevant or material to the examination.848 d. The IRS also is empowered to share returns and return information with contracted persons, to the extent necessary for purposes of tax administration.849 To this end, these contracted persons may receive books, papers, records, or other data summoned by the IRS, and take testimony of a person who the IRS has summoned as a witness, under §7602.850 e. The IRS usually starts an examination with oral or written requests for documents and other information from the taxpayer, or, subject to certain restrictions, from third parties (e.g., such as the taxpayer's employer, banks or creditors). If the taxpayer or third-party fails or refuses voluntarily to comply with such requests, the IRS generally issues a formal administrative summons to obtain such information.851 The federal district courts have jurisdiction to compel attendance, testimony or the production of books, papers, records or other data that has been summoned.852 f.
In 1982, the IRS's authority to issue a summons was clarified to expressly include the purpose of inquiring into any criminal offense connected with the administration or enforcement of the internal revenue laws.853 Before this amendment, a summons issued by the IRS solely for criminal investigation purposes and absent the actual existence of a valid civil tax determination or collection purpose was not enforceable.854 Although the IRS now has this additional summons power to investigate tax crimes, it is barred from using its summons power after a criminal tax case has been referred to the U.S. Department of Justice.855
2. Circumstances Under Which Issuance of Summons Is Considered a. The IRS generally has exercised some restraint in the use of its summons power. IRS examiners are instructed that, before issuing a summons, they should attempt to obtain information voluntarily from the taxpayers and witnesses.860 Moreover, IRS examiners are instructed to consider the following: i. the tax liability involved; 45
ii. the time and expense of obtaining the records; iii. the probability of having to institute court action; iv. any adverse effect on voluntary compliance by others if the enforcement efforts are not successful; and whether a criminal case is pending.861 b. IRS examiners are also instructed, however, to consider issuing a summons under the following circumstances: i. if no records are made available to permit an adequate examination within a reasonable period of time; ii. if submitted records are known or suspected to be incomplete; iii. if taxpayers or taxpayers' representatives will not seriously attempt to provide documentation to the examiner because they intend to offer records and explanations at another level or after a notice of deficiency has been issued; or iv. if the existence and location of records are in doubt.862 A summons may be issued to require testimony, under oath, as to what records exist and the location of such records. A subsequent summons may be issued describing the records. If the records are in the possession or custody or subject to the control of the person who has testified, the follow-up summons may be served at the time of the testimony or thereafter.863 Comment: The IRS has used its summons power more frequently in recent years in its drive against tax shelters and tax shelter promoters. It remains to be seen whether this activity leads to a more general increased use of the summons as a means of obtaining information. 3. Issuance and Service of Summons a. An IRS summons must either identify the taxpayer whose liability is under examination or comply with the “John Doe” summons requirements discussed in III.A.7., below. 864An attached copy of the summons must be hand delivered to the person to whom it is directed or, alternatively, must be left at his or her “last and usual place of abode.”865 If the summons is left at a person's last and usual place of abode, it must be left with a person of suitable age and discretion, with instructions that it be given to the summoned individual, or affixed to the front door.866 b. When a summons is directed to a specific corporate officer, the officer may be
served personally or the summons may be left at the officer's last and usual abode.867 When a summons is directed to a corporation itself, however, as 46
opposed to an identified custodian of records, the summons must be served on a corporate officer, director, managing agent or other person authorized to accept service.868 The summons must be served personally at the corporation's place of business, not at the abode of the person being served. 869 c. For summonses served on “third-party recordkeepers,” the IRS is permitted to serve the summons either in person, or by certified or registered mail to the last known address of the recordkeeper.872 In enacting this rule, Congress was concerned that the service of a summons at a recordkeeper's place of business would be unnecessarily disruptive. A third-party recordkeeper for this purpose is defined to include any: i. bank, ii. savings and loan institution or credit union, iii. any consumer reporting agency (as defined under the Fair Credit Reporting Act), iv. anyone extending credit through the issuance of credit cards or similar devices, v. any broker (as defined in the Securities and Exchange Act of 1934), vi. any attorney or accountant, vii. any barter exchange (as defined in §6045(c)(3)), viii. any regulated investment company or agent thereof, ix. any enrolled agent, and x. any owner or developer of a computer software source code.873 d. An IRS summons sets forth the time and place for the appearance and response of the person summoned. The IRS's authority is limited only by the requirement that the time and place be “reasonable under the circumstances” and that the date fixed for appearance be not less than 10 days from the date the summons is served.874 e. Unless a taxpayer or summoned person has a valid claim of privilege, the courts will generally enforce a summons if: i. there is a legitimate purpose for the IRS examination; ii. the information demanded may be relevant to that purpose; iii. such information is not already in the possession of the IRS; and iv. the IRS has complied with the administrative steps required by the
Code and regulations.875 47
f.
The IRS need not establish that it has probable cause to believe the taxpayer misstated its tax liability.876
4. Rights of Persons Summoned a. Any person summoned must appear personally at the time and place specified in the summons, but has the right to be accompanied, represented, and advised by counsel or other designated representative.877 The summoned person also is entitled to be accompanied by, and to consult with, his or her accountant during any part of the interview that deals with technical matters.878 If the summoned person cannot speak or understand English, the government must provide an interpreter or permit the person to furnish his or her own.879 b. If the examiner considers it necessary, the summoned person may be put under oath.880 Because the type of information sought through the issuance of a summons generally does not tend to develop criminal potential of a case, the summoned person will not necessarily be informed by the IRS of his or her constitutional privilege against self-incrimination. However, in any case in which the revenue officer believes the criminal potential is so manifest that a warning may be appropriate, Area Counsel should be contacted.881 c. The IRS has established procedures to deal with situations where the summoned person claims a privilege to avoid complying with the summons or otherwise refuses to comply.882 An examiner issuing a summons is instructed to inform the summoned person or his or her representative that: (1) the person must appear in person with the records to be produced pursuant to the summons and either comply or refuse to comply, stating the reasons for a refusal; and (2) in the event of refusal or failure to comply, consideration will be given to enforcement of the summons by judicial action. d. The summoned person is also informed that his or her representative is not permitted to appear in lieu of him or her on the appearance date set forth in the summons. In the event the summoned person cannot appear for a valid reason, such as illness, on the date fixed, the date can be changed by mutual agreement.883 e. If a taxpayer or summoned person appears in response to a summons and invokes either the self-incrimination privilege under the Fifth Amendment or the attorney-client privilege, the examiner may continue with the examination even though it is clear that the questions will not be answered. i. IRS policy is to ask all questions necessary to develop the required information and make requests for production of each document summoned so that the person asserting the privilege is required to
48
respond to each inquiry by either answering or asserting the claimed privilege. ii. However, if the summoned person refuses to submit to questioning and requests for documents, the examiner cannot compel the person to remain and continue with the examination. iii. The examiner is instructed not to attempt to overcome a blanket claim of privilege or a refusal to submit to specific questioning. Instead, the examiner should prepare a memorandum describing the facts and occurrences during the interview, including the questions asked and the responses given.884 f.
Any person who appears before a hearing officer in response to a summons is entitled to be paid a witness fee and mileage.885 In addition, if the summons calls for the production of books, papers, records, or other data, the summoned person may also be entitled to reimbursement for costs reasonably incurred in searching for, reproducing, or transporting the summoned documents.886 No reimbursement for costs will be made, however, if: i. the person with respect to whose liability the summons is issued has a property interest in the books, papers, records, or other data required to be produced; or ii. the person summoned is the person with respect to whose liability the summons is issued or an officer, employee, agent, accountant or attorney of that person who, at the time the summons is served, is acting as such.887 Prepayment of costs is not a prerequisite to enforcement of a summons; a taxpayer must comply with a summons and await reimbursement.888
B.
Practitioner/Taxpayer Privilege 1. Section 7525 extends the traditional attorney-client privilege of confidentiality to tax advice that is furnished to a client-taxpayer (or potential client-taxpayer) by any individual who is authorized under federal law to practice before the IRS if such practice is subject to regulation under §330 of Title 31 of the U.S. Code.891 Such individuals include attorneys, certified public accountants, enrolled agents and enrolled actuaries. For this purpose, tax advice means advice that is within the scope of authority for such individuals' practice with respect to matters under the Code. 2. The privilege applies only to the extent that communications would be privileged if they were between a taxpayer and an attorney. The privilege may be asserted in any noncriminal tax proceeding before the IRS, as well as in non-criminal tax proceedings in the federal courts where the IRS is a party to the proceeding. This privilege is limited in 49
scope and may not be asserted to prevent the disclosure of information to any regulatory body other than the IRS. 3. Moreover, this privilege does not apply to any written communication between an authorized tax practitioner and any director, shareholder, officer, employee, agent or representative of a corporation in connection with promoting the direct or indirect participation of such corporation in a tax shelter.892 This latter restriction reduced the benefits of the law for large accounting firms and law firms that had engaged in the lucrative practice of marketing corporate tax shelters. 4. The 2004 American Jobs Creation Act (2004 AJCA)893 further limited the §7525 tax practitioner privilege by expanding the restriction to include all tax shelters. Section 7525(b), as amended, provides that the privilege does not apply to communications with respect to all tax shelters, whether entered into by corporations, individuals, partnerships, tax-exempt entities, or any other entity. Section 7525(b), as amended by the 2004 AJCA, is effective with respect to communications made after October 21, 2004. C.
Notice of Third-Party Contacts and Issuance of Summonses — 1. In the course of an examination, the IRS may seek to obtain information from parties other than the taxpayer being examined. a. However, the IRS may not contact any person other than the taxpayer with respect to the determination or collection of the tax liability of the taxpayer without providing reasonable notice in advance to the taxpayer that the IRS may contact persons other than the taxpayer.894 b. Further, the IRS must periodically (or upon the taxpayer's request) provide the taxpayer with a record of persons contacted by the IRS during the period with respect to the determination or collection of the taxpayer's tax liability.895 c. The aforementioned notice and record requirements do not apply if it is a criminal tax matter, if the collection of the tax liability is in jeopardy, if the IRS determines for good cause shown that disclosure may involve reprisal against any person, or if the taxpayer authorized the contact.896 2. Under regulations governing any third-party contacts made with respect to the determination or collection of tax liabilities,897 a “third-party contact” is a communication that:898 a. is initiated by an IRS employee;899 b. is made to a person other than the taxpayer, i.e., a third-party; c. is made with respect to the determination or collection of the tax liability of such taxpayer; 50
d. discloses the identity of the taxpayer being investigated;900 and e. discloses the association of the IRS employee with the IRS.901 3. The following are not considered third parties: a. an IRS officer or employee acting within the scope of his or her employment; b. a computer database or web site; or c. the taxpayer's current employee, officer, or fiduciary when acting within the scope of his or her employment or relationship with the taxpayer.902 4. A contact is “with respect to” the determination or collection of the tax liability of the taxpayer if it is made for the purpose of determining or collecting a particular tax liability and is directly connected to that purpose.903 5. The regulations generally require that pre-contact notice be given to the taxpayer, either orally or in writing.904 If written notice is given, it may be given in any manner which the IRS employee reasonably believes will be received by the taxpayer. Written notice is deemed reasonable if it is mailed to the last known address of the taxpayer, given in person, left at the taxpayer's dwelling or usual place of business, or actually received by the taxpayer.905 6. The regulations permit a taxpayer to request, in any manner which the IRS reasonably permits, that a record of persons contacted be mailed to the taxpayer's last known address or such other address as the taxpayer specifies.906 The record should contain information that reasonably identifies the persons contacted, such as the persons' names, but need not contain the nature of the inquiries, the content of the third parties' responses, or the occurrence of multiple contacts with a person during the reporting period.907 For contacts with an entity's (i.e., a business, trust, estate, partnership, association, company, corporation, or similar organization) employee, officer, or fiduciary who is acting within the scope of his or her employment or relationship, the IRS may record the entity as the person contacted.908 Also, if the taxpayer received a similar third-party post-contact record pursuant to another statute, regulation, or administrative procedure, the IRS does not need to provide this postcontact record.909 7. Under the regulations, §7602(c) does not apply: a. to contacts authorized by the taxpayer; b. when the IRS employee making a contact has good cause to believe that providing the taxpayer with either a general pre-contact notice or a record of the specific person being contacted may jeopardize tax collection; c. when the IRS employee making a contact has good cause to believe that providing the taxpayer with either a general pre-contact notice or a specific 51
record of the person being contacted may cause any person to harm any other person whether physically, economically, emotionally, or otherwise; d. to contacts made during a pending IRS criminal inquiry or investigation made for evaluating the potential for criminal prosecution; e. to contacts which, if reported to the taxpayer, could interfere with a known pending criminal investigation being conducted by any local, state, federal, foreign or other governmental law enforcement entity; f.
to any contact with any local, state, federal or foreign governmental entity unless it concerns the taxpayer's business with the office contacted, such as contracts with or employment by the office;
g. when the employee making the contact has good cause to believe that providing either the pre-contact notice or the record of the person contacted would identify a confidential informant who would be protected under §6103(h) (4); or h. to contacts made in the course of a pending court proceeding.910 In addition, exemptions to the Freedom of Information Act (FOIA) may apply despite the provisions in §7602(c).911 Note: It is important to note that §7602(c) imposes no requirements upon the IRS other than notification. Thus, the taxpayer does not have a statutory right to preclude the IRS from contacting the third-party, nor does the taxpayer have the right to be present during the contact. The IRS has also not afforded any such rights through the issuance of regulations or internal operating procedures. Moreover, it is important to note that the IRS does not have to provide the taxpayer with the identity of the third-party that the IRS will contact. Rather, the regulations merely require that, upon the taxpayer's request, the IRS provide the taxpayer with a record of persons who have already been contacted. Consequently, as detailed in the IRM, the IRS may issue one general notification informing the taxpayer that contacts will be made with respect to specific tax years.912 Then, on an annual basis, or upon the request of the taxpayer, the IRS will issue a list identifying all third-party contacts that have occurred.913 Note that a taxpayer may not make a blanket request to receive notice of the identity of all future third-party contacts. Comment: Special notice requirements under §7609 apply to summonses issued to third parties which require the giving of testimony, the production of books, papers, records or other data, or the production of computer software with respect to any person (other than the summoned person) that is identified in the summons.914 Amendments to §7609 in 1998 expanded the IRS notification requirements regarding the issuance of a summons from “third-party recordkeepers” to any third-party (i.e., any person other than the taxpayer). Congress believed that expanding the notice requirement to cover all third-party summonses would ensure that the taxpayer will receive notice and an opportunity to contest the summons issued to a third-party in connection with the determination of his or her tax liability.915
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8. A notice of a summons issued to a third-party must be given to the taxpayer within three days of the date on which service is made on the third-party (in the manner prescribed by §7603 as described at III.A.3., above), and no less than 23 calendar days before the date fixed in the summons for examination of the records.916 The IRS generally allows no less than 23 days from the date of service of the summons to the time for compliance to ensure sufficient time for the notice of issuance of the summons and the filing of a petition to quash.917 If the taxpayer believes that a valid basis exists for quashing the summons, he or she has the right to commence proceedings in a federal district court within 20 days from the day after the day notice of the summons is mailed to him or her at his or her last known address.918 In such a case, the taxpayer must notify the third-party and the IRS agent who issued the summons of the commencement of such proceeding by sending a copy of the petition by registered or certified mail.919 Any petition to quash is reviewed by IRS Counsel, DOJ, and the U.S. Attorney.920 In any such proceeding, the third-party has the right to intervene. Regardless of whether or not such right is exercised, the third-party is bound by the outcome of the proceeding.921 9. Where a summons is directed to a third-party, he or she must assemble the materials summoned and be prepared to produce them on the date set for the examination.922 No examination of the summoned records is permitted before the close of the 23rd day after notice is given to the taxpayer, or if a proceeding to quash is begun, until the court so orders or the taxpayer consents.923 If the taxpayer fails to commence an action to quash the summons within the appropriate time, or if the taxpayer consents to the examination of the records, the IRS may give the summoned third-party a certificate to that effect.924 A summoned third-party who, upon receipt of such certificate or court order, discloses the records, is protected against any liability to any customer or other person for making such disclosures.925 10. If a taxpayer commences an action in federal district court to quash a summons, the IRS usually will rely on an affidavit to the effect that the summons was properly issued for a legitimate purpose, and will ask the court for an enforcement order. If granted, the order generally provides the IRS with access to the records sought. If a taxpayer (or his or her agent, nominee or representative) commences an action to quash the summons, the period of limitations with respect to the taxpayer is suspended for the period during which the proceeding (and any appeals) regarding the enforcement of the summons is pending.926 Only those persons identified in an IRS summons issued to a third-party have standing to file a petition to quash the summons.927 11. The taxpayer's right to notice in connection with a third-party summons does not apply where: a. the summons is served on a person with respect to whose tax liability the summons is issued, or any officer or employee of that person;928 53
b. the summons is issued to determine whether or not records of the business transactions or affairs of an identified person have been kept;929 c. the summons is issued solely to determine the identity of any person having a numbered account with a bank or other financial institution;930 d. the summons is issued in aid of the collection of a tax liability that has been assessed or a judgment rendered;931 e. the summons is issued by a criminal investigator of the IRS in connection with the investigation of an offense connected with the administration or enforcement of the internal revenue laws, and is served on a person who is not a third-party recordkeeper (as defined in §7603(b));932 f.
the summons is a John Doe summons, as described below, requiring court approval;933
g. the summons is issued under circumstances where a court determines there is reasonable cause to believe that the giving of notice may lead to attempts to conceal, destroy, or alter records relevant to the examination, to prevent the communication of information from other persons through intimidation, bribery or collusion, or to flee to avoid prosecution, testifying, or production of records;934 or h. the person entitled to notice waives the right. D.
John Doe Summons 1. A “John Doe” summons is one that does not specifically identify the taxpayer under investigation. In general, a John Doe summons is issued when an identifiable group of taxpayers appears to have improperly computed its income tax liability, but the identity of an individual taxpayer within that group is not known. 2. Neither Special Agents nor Revenue Agents are authorized to issue John Doe summonses.935 A request for pre-issuance approval of a John Doe summons is submitted to Area or Associate Area Counsel. If approved, Area or Associate Area Counsel will prepare a letter on behalf of Chief Counsel, to DOJ, containing the law and facts justifying court approval. This letter and proposed summons will be submitted by Associate Area Counsel to Associate Chief Counsel (Procedure & Administration) for its review and approval.936 3. Before a John Doe summons can be served, it must be approved for service by a district court in an ex parte proceeding held in the federal district court for the district where the person or group or class of persons to be summoned reside or can be found.937 A John Doe summons may only be issued if the IRS can establish that: a. the summons relates to the investigation of a particular person or ascertainable group or class of persons; 54
b. there is a reasonable basis for believing that the person or group or class of persons may fail or may have failed to comply with any provision of the tax law; and c. the information sought to be obtained from the examination of the records, and the identity of the persons with respect to whose liability the summons is issued, is not readily available from other sources.938 4. A John Doe Summons is exempt from third-party notice requirements per §7609(c) (3).939 E.
Summons for Computer Software 1. Section 7612 provides special limitations for summonses pertaining to computer software.940 In general, under these procedures, no summons may be issued for taxrelated computer software source codes unless: a. the IRS is unable to ascertain the correctness of any item on a return from the taxpayer's books and records or the computer software program and associated data; b. the IRS identifies with reasonable specificity the portion of the computer source code needed to verify the correctness of the item; and c. the IRS determines that the need for the source code outweighs the risk of unauthorized disclosure of trade secrets.941 2. The IRS is considered to have satisfied the first two requirements if it makes a formal specific request for such materials to both the taxpayer and the owner of the software that is not satisfied within 180 days.942 3. The limitation on the summons of tax-related computer software source codes does not apply if the summons is used in connection with an inquiry into any offense connected with the administration or enforcement of the internal revenue laws.943 The limitation does not apply to a summons of computer software source codes that were acquired or developed by the taxpayer or a related person primarily for internal use by the taxpayer or such person rather than for commercial distribution.944 The limitation also does not apply to a summons concerning communications between the owner of the tax-related computer software code and the taxpayer.945 Finally, the limitation does not apply if the source code must be provided or made available under another tax code provision.946 4. Any person summoned may contest the summons of computer source codes in any proceeding brought under §7604 to enforce the summons. The court must, at the request of any party, hold an evidentiary hearing to determine whether the summons requirements have been satisfied.947 In addition, any court enforcing a summons for
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software may issue any order necessary to protect trade secrets or prevent disclosure of other confidential information.948 5. In addition to protective orders, other safeguards exist to protect against improper disclosure by the IRS of trade secrets and other confidential information when software has come into the possession or control of the IRS during the examination of a taxpayer. These safeguards include the following: a. computer software or source code may be examined only in connection with the examination of the taxpayer's return, an administrative appeal by the taxpayer to the Appeals office, a judicial proceeding (including appeals), and any inquiry into any offense connected with the administration or enforcement of the internal revenue laws; b. the IRS must provide the taxpayer and the software owner with a written list of the names of all individuals who will analyze or otherwise have access to the software; c. the software must be maintained in a secure area or place and, in the case of computer software source code, may not be removed from the owner's place of business without the owner's consent or a court order; d. the software may not be decompiled or disassembled; e. the software or source code may not be copied except as necessary to perform the specific examination, and the IRS must number all copies and provide written certification that no other copies have been or will be made; f.
at the conclusion of the examination and related court proceedings, the software and all copies must be accounted for and returned to the owner and permanently deleted from any hard drives;
g. if an individual who is not an officer or employee of the United States examines the software, the individual must enter into a written agreement with the IRS that the individual will not: i. disclose the software to anyone other than the IRS authorized agents and employees; and ii. will not participate, for two years, in the development of software that is intended for a similar purpose. h. computer software or source code that is obtained by the IRS in the course of the examination of the taxpayer's return will be treated as return information for the purposes of §6103.949 6. Finally, any person who willfully divulges or makes known to another person software that has been obtained for the purpose of examining a taxpayer's return, in violation of 56
§7612 will be subject to imprisonment not to exceed five years or a fine not to exceed $5,000, or both, if convicted, and may also be liable for the costs of his or her prosecution.950 F.
Summons Enforcement 1. Overview a. A summons is not self-enforcing. Thus, if the summoned taxpayer (or thirdparty) ignores the summons or otherwise fails to comply, the IRS must bring a proceeding to enforce the summons in the appropriate federal district court.951 b. The government commences an enforcement proceeding by filing a petition in federal district court in the district where the taxpayer or person summoned resides or can be found.952 To avoid enforcement, a taxpayer must show the existence of procedural defects, an improper purpose, or bad faith in the issuance of the summons.953
Note: A federal district court may issue an order requiring a summoned person to appear and show cause why a summons should not be enforced on the basis of the government's ex parte showing.954 The order of a federal district court in an enforcement hearing or contempt proceeding is final and appealable. It becomes final and enforceable 14 days after it is entered unless stayed.955 2. Powell Requirements a. The IRS's summons power is subject to the substantive and procedural limitations set forth in United States v. Powell,956 which requires the IRS to establish a prima facie case that: i. the examination to which the summons relates is for legitimate law enforcement purposes; ii. the summons seeks information that may be relevant; iii. the IRS does not already possess the information; and iv. the IRS has complied with the administrative steps mandated under the Code. This prima facie showing is generally made through the affidavit of the IRS Agent seeking enforcement. Once the IRS satisfies these requirements, the burden shifts to the taxpayer to rebut the IRS's allegations or present an affirmative defense.957 b. As noted, the IRS may use the summons power to investigate tax crimes so long as the case has not been referred to the Department of Justice for criminal investigation or prosecution.958 57
•
For the most part, courts have required the IRS to meet only a minimal showing of relevance in determining whether a summons should be enforced.959 A greater degree of relevance may be required, however, where the summons is issued to a third-party.960
3. Discovery and Hearing a. A taxpayer may be able to challenge the government's summons through discovery and an evidentiary hearing, but only in limited circumstances.961 b. Additionally, a taxpayer challenging the enforcement of a summons may examine an IRS agent only when he can point to specific facts or circumstances plausibly raising an inference of bad faith. Although circumstantial evidence may support a plausible inference, mere conjecture or a bare assertion of an improper purpose is not sufficient.962 4. Contempt a. A summoned party cannot be held in contempt for the mere failure to appear at a summons enforcement hearing. Generally, courts will only hold a party in contempt for a substantial failure to comply, or for not making a good faith effort to comply, with an order enforcing a summons.963 Comment: Contempt proceedings may be civil or criminal, or both. A defendant may be purged of civil contempt by complying with the court order, but punishment for criminal contempt is usually not conditional. Use of civil or criminal contempt depends on whether the purpose is to compel compliance with, or punish disobedience of, a court order enforcing a summons. b. A civil contempt proceeding may be commenced by a motion requesting that the person summoned be adjudged in contempt. The recalcitrant party may then be committed to jail until he or she complies with the court order, although resort to this remedy is extremely rare. c. A criminal contempt proceeding can be undertaken only on notice given by the judge in open court in the presence of the defendant, by an order to show cause, or by an order of arrest, unless the contempt was committed in the presence of the court. The notice must state essential facts which constitute criminal contempt and describe the criminal contempt as such. For criminal contempt, the government must prove beyond a reasonable doubt that the defendant willfully failed to comply with a lawful court order and show that summoned records are presently within the defendant's power and control.964 5. Privileges and Other Defenses to Summons To avoid compliance with a summons, taxpayers and other summoned persons may assert a privilege. The most commonly asserted privileges are:
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a. the Fifth Amendment privilege against self-incrimination; b. the attorney-client privilege (which, as noted above, was extended in limited form by §7525 to include, for example, accountant-client communications); and c. the work product doctrine. 6. Designated Summons A designated summons is a special type of summons that is available to the IRS in order to extend unilaterally the period of limitations on assessments for large corporations examined under the Coordinated Industry Case Program. The IRS may issue a designated summons to any such corporation 60 days before the period of limitations is scheduled to expire. The period of limitations is then tolled until there is compliance with the designated summons. In addition, the IRS can issue a related summons to a party who has information relative to the corporation that is the subject of the designated summons.965 Note: On September 17, 2015, the IRS announced major restructuring of the LB&I division. As part of the reorganization, the IRS is phasing out the Coordinated Industry Case (CIC) Program continuous audit regime and moving to a risk-based approach. The IRS is announcing the changes periodically and modifying the changes as needed. Review Questions Which of the following rights does a person summoned by the IRS not have? A) The right to be accompanied, represented, and advised by counsel or other designated representative. B) The right to be accompanied by, and to consult with, his accountant during any part of the interview that deals with technical matters. C) The right to have his representatives appear in lieu of him on the appearance date set forth in the summons. D) The right to have a translator provided by the government or furnished by the summoned person if the summoned person cannot speak or understand English. Explanation A) is incorrect because it is a right of the summoned person. B) is incorrect because it is a right of the summoned person. C) is correct because a summoned person may not have his representative appear in lieu of him on the appearance date set forth in the summons. D) is incorrect because it is a right of the summoned person. 59
Q: What are the Powell requirements? A: The substantive and procedural limitations of the IRS’s summons powers as set forth in United States v. Powell. They require the IRS to establish a prima facie case that the examination to which the summons relates is for legitimate law enforcement purposes; the summons seeks information that may be relevant; the IRS does not already possess the information; and the IRS has complied with the administrative steps mandated under the Code. This prima facie showing is generally made through the affidavit of the IRS Agent seeking enforcement. Once the IRS satisfies these requirements, the burden shifts to the taxpayer to rebut the IRS's allegations or present an affirmative defense. The IRS may use the summons power to investigate tax crimes so long as the case has not been referred to the Department of Justice for criminal investigation or prosecution. For the most part, courts have required the IRS to meet only a minimal showing of relevance in determining whether a summons should be enforced. A greater degree of relevance may be required, however, where the summons is issued to a third-party.
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