Caution about questions related to a specific ongoing audit or collection issue. Ask me afterward. Unless you deal with the IRS on a daily basis, I have found that most taxpayers and citizens don’t really understand how the IRS works. They just know it is bad when you have to deal with the IRS.
THIS IS AN OVERSIMPLIFICATION OF THE CHART THERE IS ALSO AN APPEALS BRANCH AND IRS CHIEF COUNSEL I WILL DISCUSS THE ROLE EACH OF THESE DIVISIONS CAN PLAY IN A TYPICAL TAXPAYER’S LIFE
DISCLAIMER - I AM GOING TO START THIS MORNING BY BORING YOU WITH STATISTICS EACH YEAR THE IRS PUBLISHES THE RESULTS OF ITS ENFORCEMENT AND EXAMINATION INITIATIVES FROM THE PRIOR YEAR IF ANYONE WANTS A COPY FOR SOME LIGHT NIGHTIME READING, PLEASE E-MAIL ME STATISTICS ARE IMPORTANT TO TAX PROFESSIONALS BECAUSE THEY TELL US WHERE THE IRS IS FOCUSING ITS ATTENTION. WHAT IS IMPORTANT TO THE GOVERNMENT RIGHT NOW? WHAT AREAS CAN MY CLIENT’S EXPECT TO RESULT IN CLOSER IRS SCRUTINY DURING THE YEAR.
NUMBERS ARE IN BILLIONS OF DOLLARS MOST IRS REVENUE COMES FROM THE EXAMINATION AND COLLECTION DIVISIONS. THUS, IT SHOULD BE NO SURPRISE THE SERVICE PLACES HUGE EMPHASIS ON IMPROVING THE ABILITY OF THE EXAMINATION AND COLLECTION DIVISIONS ABILITY TO INCREASE THEIR COLLECTION RATES. COLLECTION DIVISION IN 2010 = $29.10 BILLION EXAMINATION DIVISION IN 2010 = $16.90 BILLION APPEALS DIVISION IN 2010 = $4.90 BILLION DOCUMENT MATCHING PROGRAM = $4.9 BILLION ALL COMBINED = $57.60 BILLION IN ENFORCEMENT REVENUE IN 2010 (ABOVE WHAT IS SELF REPORTED AND VOLUNTARILY PAID)
HISTORICALLY THE SERVICE PLACED A HUGE EMPHASIS ON MONITORING VOLUNTARY COMPLIANCE. AS WE WILL SEE, THE EMPHASIS SEEMS TO BE SHIFTING TOWARD A MORE PROACTIVE IRS THAT WILL GO OUT AND FORCE COMPLIANCE. Revenue Officers in 2010 (Collection) = 6,042 (5,451 in 2009 – increased by 591 new ROs or about a 10% increase) Revenue Agents in 2010 (Examination) = 13,888 (12,958 in 2009 – increased by 930 new RAs or about 7% increase) Special Agents (CID) in 2010 = 2,780 (2,650 in 2009 – increased by 130 CID Agents or about 5% increase)
IRS IS STILL DOING MOST AUDITS BY CORRESPONDENCE CORRESPONDENCE AUDITS IN 2010 = 1,238,632 FIELD AUDITS IN 2010 = 342,762 A FIELD AUDIT IS WHERE THE REVENUE AGENT ACTUALLY COMES OUT AND AUDITS YOUR RETURN OR YOU COME TO THE IRS OFFICE WITH YOUR RECORDS
The one lottery you DON’T want to win!! PERCENTAGES ARE BASED ON RETURNS FILED PER INCOME CATEGORY FOR EXAMPLE: OF ALL INDIVIDUAL RETURNS FILED IN 2010 REPORTING INCOME OF $1 MILLION OR MORE, 8.36% OF THOSE RETURNS WERE AUDITED BY THE SERVICE. 2010 RETURNS REPORTING INCOME OVER $200,000 = 3.10% WERE AUDITED 2010 RETURNS REPORTING INCOME OF UNDER $200,000 = 1.04% WERE AUDITED THESE INCLUDE CORRESPONDENCE AND FIELD AUDITS COMBINED AS YOU CAN SEE, THE IRS AUDIT FOCUS HAS DRAMATICALLY TRENDED TOWARD HIGHER INCOME INDIVIDUALS SINCE 2008 WHILE AUDIT RATES FOR LESS AFFLUENT INDIVIDUALS HAS REMAINED CONSISTENT OVER TIME. As you can, see there was a major spike in the audit rate of individuals reporting over $1 Million in income on their return. As we will see later on, this is intentional by the Service as the Commissioner is pushing for more enforcement and review of high net worth individuals.
CONSISTENT WITH ITS FOCUS ON HIGHER NET WORTH INDIVIDUALS, THE IRS CONTINUES TO FOCUS IS AUDITS OF ENTITIES ON THE LARGER CORPORATIONS SMALL CORPORATIONS (ASSETS UNDER $10M) = 0.94% IN 2010 LARGE CORPORATIONS (ASSETS OVER $10M) = 14.16% IN 2010 SUBCHAPTER S CORPORTIONS = 0.37% IN 2010 PARTNERSHIPS (FORMS 1065) = 0.36% IN 2010
IN THE LAST FEW YEARS, THERE HAS BEEN MUCH DISCUSSION ABOUT THE “TAX GAP”. THE IRS AND CONGRESS HAVE REALIZED THAT A LARGE AMOUNT OF TAX THAT SHOULD BE PAID EVERY YEAR IS NOT MAKING IT INTO THE GOVERNMENT COFFERS. THIS IS LARGELY DUE TO THE FACT THAT THE TRUE TAX LIABILITY OWED FOR A TAX YEAR IS NOT FINDING ITS WAY ONTO THE RETURN, WHETHER DUE TO MISTAKE OR THROUGH INTENTIONAL TAX FRAUD.
NOTE: PREVIOUS SLIDES SHOW STATISTICAL DATA FOR 2008 THROUGH 2010. REASON = IN 2007 THE IRS PUBLISHED A REPORT ON THE TAX GAP AND SET FORTH A ROADMAP CALLING FOR A SHIFT IN IRS POLICY TOWARD MORE ENFORCEMENT TO CLOSE THE TAX GAP. THE 2007 REPORT HAS BEEN USED BY THE SERVICE TO RETURN TO CONGRESS EVERY YEAR AND ASK FOR ADDITIONAL FUNDING TO CLOSE THE TAX GAP. IRS IS UNDER TREMENDOUS POLITICAL PRESSURE TO BRING IN AS MUCH REVENUE AS POSSIBLE TO FUND CONGRESSIONAL PROGRAMS AND REDUCE THE DEFICIT
These amounts are in billions of dollars and are based on the 2001 study by IRS. NONFILERS = THOSE WHO DON’T FILE RETURNS AND PAY TAX OWED UNDERPAYMENT = THOSE WHO FILE AND CORRECTLY REPORT BUT JUST CAN’T PAY WHAT THEY OWE THE IRS STUDY OF THE TAX GAP IN 2001 SHOWED THAT UNDERREPORTING (WHETHER BY MISTAKE OR INTENTIONAL FRAUD) IS THE BIGGEST COMPONENT OF THE TAX GAP. GUESS WHERE THE IRS IS GOING TO PLACE A LARGE PORTION OF ITS BUDGET IN THE NEXT FIVE YEARS?
Clearly, underreporting on individual income tax returns is the largest contributor to the tax gap. IRS HAS LEARNED THAT SMALL BUSINESS OWNERS AND SCHEDULE C FILERS (SOLE PROPRIETORS) ARE FAILING TO REPORT SOURCES OF INCOME (TYPICALLY CASH) OR ARE TAKING ERRONEOUS DEDUCTIONS.
IN THIS NEXT SEGMENT, I WANT TO INTRODUCE YOU TO THE IRS EXAMINATION DIVISION AND TALK ABOUT HOW THE IRS SELECTS RETURNS FOR AUDITS AND HOW THE SERVICE CONDUCTS THE AUDIT. THE IRS EXAM DIVISION USED TO HAVE AN “EDUCATION” MENTALITY – I.E., HELP EDUCATE TAXPAYERS UNDER AUDIT AND THEIR ACCOUNTANTS ON THE PROPER WAY TO REPORT ITEMS. NOW THE IRS AS A WHOLE, INCLUDING THE EXAM DIVISION, HAS TAKEN ON A PURELY ENFORCEMENT MENTALITY TO CLOSE THE TAX GAP
The DIF formula and calculation remain a deep dark secret.
I have clients who come see me often and tell me they called the IRS number on that letter but the person they talked to wouldn’t listen or they never got the same person twice.
This initial contact letter and the IDR are extremely valuable pieces of information. The IDR will contain requests for information or documents, which give us insight into why the return was audited and the direction the Revenue Agent plans to take the audit. We can also focus our fact gathering to the specific items on the IDR to better understand the client’s reporting position.
TAXPAYER ADVOCATE IS A SEPARATE DIVISION WITHIN THE IRS WHOSE MISSION IS TO ACT AS A LIASION BETWEEN TAXPAYERS AND THE IRS TO HELP NAVIGATE THE BUREAUCRACY.
Revenue Agents are trained to gather facts! They are taught to be polite and professional, and to gather data for use by the government in closing the tax gap and/or putting tax evaders in jail! Plain and simple! IN THIS NEW ENFORCEMENT ENVIRONMENT, YOU MUST BE MORE MINDFUL THAN EVER THAT THE REVENUE AGENTS NO LONGER ARE THERE TO EDUCATE YOU AND ASSIST YOU WITH ARRIVING AT THE CORRECT RESULT. THEY ARE THERE TO ENFORCE THE TAX LAWS AND PUSH COMPLIANCE!!! WITH A LIMITED BUDGET, THE IRS CAREFULLY CONSIDERS POTENTIAL CRIMINAL CASES FOR THEIR DETTERENCE VALUE TO THE GENERAL PUBLIC.
STATISTICS ARE FROM THE TRANSACTIONAL RECORDS ACCESS CLEARINGHOUSE (TRAC) AT SYRACUSE UNIVERSITY. OBTAINED EACH YEAR THROUGH FOIA REQUEST.
Questions 1 and 2: Section 7602 – authorizes Service to examine a taxpayer’s books and records to determine the correctness of any return and to take testimony; Section 7603 – gives Service the power to summons records in connection with an audit. Question 3: Section 6501 = generally 3 years to audit and assess additional tax Question 4: Section 6531 – general 6 year SOL for crimes involving “tax fraud”
Clients often come see me after they have attempted to represent themselves in the audit. Unfortunately, they learn the nice, sweet Revenue Agent gave them a final Examination Report that included a huge tax liability and additional penalties and interest. I typically get involved and learn the client ended up saying too much, which is referenced right there in the Examination Report in black and white!
I WANTED TO END THIS SEGMENT OF THE PROGRAM WITH SOME WISE ADVICE FROM DAVID LETTERMAN ON HOW TO DEAL WITH REVENUE AGENT IF YOUR RETURN GETS AUDITED
As the name implies, it is the collection arm of the IRS.
FOR THE LAST SEVERAL YEARS, THE IRS TAXPAYER ADVOCATE HAS LISTED THE IRS COLLECTION DIVISIONS LIEN FILING POLICIES AS ONE OF THE MAJOR CAUSES OF CONCERN FOR TAXPAYERS. THE IRS HAS YET TO TAKE ANY STEPS TO CHANGE ITS LIEN POLICY.
Financial statements (Forms 433)
I WANTED TO END THE PROGRAM TODAY BY LETTING YOU HEAR IN COMMISSIONER SHULMAN’S OWN WORDS WHERE THE IRS IS HEADED IN 2011 AND BEYOND!
IRS Enforcement and Examination
IRS EXAMINATION AND ENFORCEMENT J. Eric Butler Woolf, McClane, Bright, Allen & Carpenter, PLLC 900 S. Gay Street Knoxville, TN 37902 (865) 215-1000 [email_address] Circular 230 Notice: These materials are designed to provide general information. Although prepared by a professional, these materials should not be utilized as a substitute for professional legal advice in specific situations. If legal advice or other expert assistance is required, please consult with an attorney.
The IRS Organizational Chart Commissioner Douglas Shulman Examination Division Collection Division Criminal Investigation Division
How Policy Drives the IRS Mission A look at the history
Annual Enforcement Results: Where is the Service Focused?
Examination of Individual Returns: Type of Audit
Examination of Individual Returns: The Audit Lottery
Examination of Business Returns: The Audit Lottery
What is the Tax Gap <ul><li>The tax gap is defined by the Service as the aggregate amount of true tax liability imposed by law for a given tax year that is not paid voluntarily and timely. </li></ul><ul><li>The true tax liability for any given taxpayer means the amount of tax that would be determined for the tax year in question if all relevant aspects of the tax law were correctly applied to all of the relevant facts of that taxpayer’s situation. </li></ul>
The Tax Gap is the Driving Force for Recent IRS Initiatives <ul><li>On August 2, 2007, then Commissioner Mark Everson published a report entitled Reducing the Federal Tax Gap: A Report on Improving Voluntary Compliance </li></ul><ul><li>The Administration’s FY 2008 Budget request included $11.1 billion for the IRS, a 4.7 percent increase over the budget enacted for FY 2007. </li></ul><ul><li>President Obama’s fiscal 2012 budget proposes a 9.4% increase in the IRS budget to $13.28 billion for 2012. He is proposing $460 million more for tax enforcement and the hiring of 5,100 new agents next year. ( See Wall Street Journal, Feb. 16, 2011). </li></ul>
Tax Gap in 2001 <ul><li>Gross Tax Gap estimated to be between $312 to $353 Billion by IRS </li></ul><ul><li>Less Enforced and Late Payments ($55 Billion) </li></ul><ul><li>Equals Net Tax Gap of $257 – $298 Billion </li></ul><ul><li>The net tax gap is now estimated to be around $350 Billion annually. </li></ul>
Underreporting Noncompliance is the Largest Component of the Tax Gap
2001 Federal Tax Gap Study – Underreporting (In Billions of Dollars) Underreporting ($250 to $292) Individual Income Tax ($150 to $187) Corporation Income Tax ($30) Employment Tax ($66 to $71) Estate and Excise Tax ($4)
IRS Examination Division You Lost the Audit Lottery – Now What?
Selecting a return for audit : <ul><li>Income Matching : The IRS compares information returns to amounts reported on your return (Forms W-2, Forms 1099, etc.). </li></ul><ul><li>Discriminate Function Analysis (DIF) : Computer score that is assigned to each element of income and deduction on the tax return. If selected based on a DIF score, return is reviewed by officer who will determine whether to send to the field for audit. </li></ul><ul><li>Random Audits : The IRS establishes special programs in various industries to see what a particular industry is doing with certain items. </li></ul><ul><li>Informants : Former spouses, former partners, former employees, etc. are all great sources of information for unreported income or erroneous deductions. </li></ul><ul><li>Related Audits : Entities or individuals associated with a taxpayer currently under audit. </li></ul><ul><li>Referrals : Courts (typically divorce cases) or administrative agencies recommend a taxpayer for audit. </li></ul>
The Correspondence Audit <ul><li>Read Carefully : Once you get your emotions in check, read the letter carefully. Yes, the Service does make mistakes. And yes, the language is impersonal, foreign and intimidating. But a slow, careful read may yield something plain and simple. Perhaps they overlooked a well-documented IRA deduction. Perhaps they questioned a mortgage-interest deduction you can clearly document. </li></ul><ul><li>Don’t Panic : It's natural to bow to the pressure and simply write the check. Even if you question the changes to the return, don’t immediately pick up the phone and call the number on the notice. </li></ul><ul><li>Do Some Research : There is a good chance you may have been right in the first place. Pull out your return and the source documents (the W-2s, the 1099s, the K-1s, etc.) and compare them to the audit letter. </li></ul><ul><li>Contact the Tax Advisor/Accountant : Ask your advisor to order account transcripts and wage and income transcripts from the IRS to see how these documents match up to your records. The IRS correspondence audit is based entirely on the information in the IRS file, as compared to your return. </li></ul>
The Field Audit: ( Initial Contact Letter) <ul><li>The Group Manager in the local IRS Office (Knoxville or Johnson City) will assign a Revenue Agent to the audit. </li></ul><ul><li>Assigned Revenue Agent will send an initial contact letter to the taxpayer setting initial date and time for the first meeting. </li></ul><ul><li>The letter is usually accompanied by an Information Document Request (IDR). </li></ul>
Examination Overview by Taxpayer Advocate Nina Olsen
The Eggshell Audit <ul><li>Is the Revenue Agent conducting a “disguised” civil audit that is in reality a criminal investigation? </li></ul><ul><li>The Internal Revenue Manual contains provisions allowing Revenue Agents (civil) to work (on a limited basis) with Special Agents (criminal) to investigate a taxpayer’s return. </li></ul><ul><li>How to recognize a potential “eggshell” audit: (cash business, unreported income, poor record keeping, requests for bank statements, unexplained delays or absences). </li></ul><ul><li>Do NOT try to talk your way out of a criminal prosecution! </li></ul>
IRS Criminal Referrals in 2009 (Eastern District of Tennessee) <ul><li>In 2009, CID moved forward with prosecuting 78.6% of all referrals and declined 21.4% of referrals for criminal tax violations. </li></ul><ul><li>The East. Dist. of TN ranked 8 th nationwide in overall referrals recommended by CID for prosecution. </li></ul>
Common Questions : <ul><li>Can the IRS force me to turn over documents? </li></ul><ul><li>Can the IRS force me to appear and subject myself to an interview? </li></ul><ul><li>Can the IRS come view my business and interview my employees? </li></ul><ul><li>Is there some statute of limitations on auditing a return? </li></ul><ul><li>Is there some statute of limitations on a criminal prosecution? </li></ul>
Can lying to the Revenue Agent get me in trouble? <ul><li>Furnishing a false and fraudulent statement to the Revenue Agent during the exam can lead to a criminal prosecution. </li></ul><ul><li>Signing any document containing a false or untrue statement during the exam can lead to a criminal prosecution. </li></ul>
Why the Result of the Examination is Vital to Your Case: <ul><li>Burden of proof – increases as you move to each level </li></ul><ul><li>Cost – involving an advisor earlier is better </li></ul><ul><li>Penalties </li></ul><ul><li>Administrative Record </li></ul><ul><li>Evidence to support adjustments </li></ul>EXAMINATION IRS APPEALS OFFICE 30-DAY LETTER OR NOTICE OF DEFICIENCY U.S. TAX COURT U.S. DISTRICT COURT
Recent Examination Initiatives <ul><li>Offshore accounts, unreported foreign source income, and cross border transactions </li></ul><ul><li>Payroll taxes – Employment Tax Audit Initiative begun in February 2010 </li></ul><ul><li>Global High Wealth Industry Group within LMSB </li></ul><ul><li>Joint Audits with foreign countries </li></ul><ul><li>Tax Preparer Compliance </li></ul>
IRS Collection Division You owe the IRS money or you have not filed returns – Now What?
IRS Collection has Two Functions: <ul><li>Collection : Automated Collection System (ACS) and local Revenue Officers try to collect the maximum amount with the least effort. </li></ul><ul><li>Unfiled Returns : Solicit delinquent returns and recommend criminal prosecution for nonfilers. </li></ul>
The 1998 IRS Restructuring and Reform Act: <ul><li>Chief power of Collections is the power to seize property through levy if a tax liability is not voluntarily paid. </li></ul><ul><li>The 1998 Act implemented collection and appeals procedures for taxpayers dealing with the IRS Collection Division. </li></ul><ul><li>Collection Due Process (CDP) Hearing for lien and levy notices. </li></ul>
The IRS Tax Lien <ul><li>Gives the government security for the payment of tax liabilities. </li></ul><ul><li>Arises automatically and covers not only tax, but penalties and interest. </li></ul><ul><li>Blanket lien filed in county office with real property records to perfect the security interest. </li></ul><ul><li>IRS policy is to file a lien in cases with a balance over $5,000. </li></ul>
Common Collections Questions: <ul><li>Is there a way to get the IRS to remove the tax lien? </li></ul><ul><li>Can I work out some settlement with the IRS to avoid levy? </li></ul><ul><ul><ul><li>Installment Agreements </li></ul></ul></ul><ul><ul><ul><li>Offers in Compromise </li></ul></ul></ul><ul><ul><ul><li>Currently Not Collectible </li></ul></ul></ul><ul><li>Will the IRS take my home? </li></ul><ul><li>Can I get the lien removed from credit history? </li></ul><ul><li>What if I sell property subject to the tax lien? </li></ul>
Non-filers <ul><li>Is not filing a return a crime? </li></ul><ul><ul><li>Yes, the willful failure to file in and of itself is a crime. No affirmative act of evasion is required, only the intentional and deliberate act of nonfiling. </li></ul></ul><ul><ul><li>Nonfiling itself is a misdemeanor subject to imprisonment of no more than 1 year and a fine of $25,000 ($100,000 in the case of a corporation) per violation. </li></ul></ul><ul><ul><li>Can rise to the level of felony if conduct is geared toward willfully evading tax and concealing income. Punishable by 5 years and a $100,000 fine ($500,000 in the case of a corporation) per violation. </li></ul></ul>
Will the IRS find out I have not filed my returns?
Commissioner Shulman’s Congressional Testimony on 2011 Filing Season
Parting Thoughts - Surviving an Encounter with Exam or Collection: <ul><li>Your choice of advisor matters! </li></ul><ul><li>It is never too early to ask for help! </li></ul><ul><li>Don’t make your friends, employees, and others witnesses for the government! </li></ul><ul><li>Take action immediately! </li></ul><ul><li>Remain proactive! </li></ul>