irs enforcement and examination

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IRS EXAMINATION AND IRS EXAMINATION AND ENFORCEMENTENFORCEMENT

J. Eric ButlerWoolf, McClane, Bright, Allen & Carpenter, PLLC

900 S. Gay StreetKnoxville, TN 37902

(865) 215-1000ebutler@wmbac.com

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.

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The IRS Organizational ChartThe IRS Organizational Chart

CommissionerDouglasShulman

ExaminationDivision

CollectionDivision

CriminalInvestigation

Division

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How Policy Drives the IRS How Policy Drives the IRS MissionMission

A look at the history

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Annual Enforcement Results:Annual Enforcement Results:Where is the Service Focused?Where is the Service Focused?

$0.00

$5.00

$10.00

$15.00

$20.00

$25.00

$30.00

$35.00

2008 2009 2010

Collection Division

Examination Division

Appeals Office

Document Matching

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Staffing for Key Service PositionsStaffing for Key Service Positions

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

2008 2009 2010

Revenue Officers

Revenue Agents

Special Agents (CID)

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Examination of Individual Returns:Examination of Individual Returns:Type of AuditType of Audit

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

2008 2009 2010

Field Audits

Correspondence Audits

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Examination of Individual Returns:Examination of Individual Returns:The Audit LotteryThe Audit Lottery

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

2008 2009 2010

Income under $200,000

Income over $200,000

Income over $1 Million

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Examination of Business Returns:Examination of Business Returns:The Audit LotteryThe Audit Lottery

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

2008 2009 2010

Small corporations(assets under $10M)

Large corporations(assets over $10M)

Subchapter Scorporations

Partnership returns

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What is the Tax GapWhat is the Tax Gap

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.

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.

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The Tax Gap is the Driving Force for The Tax Gap is the Driving Force for Recent IRS InitiativesRecent IRS Initiatives

On August 2, 2007, then Commissioner Mark Everson published a report entitled Reducing the Federal Tax Gap: A Report on Improving Voluntary Compliance

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.

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).

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Tax Gap in 2001Tax Gap in 2001

Gross Tax Gap estimated to be between $312 to $353 Billion by IRSLess Enforced and Late Payments ($55 Billion)Equals Net Tax Gap of $257 – $298 Billion

The net tax gap is now estimated to be around $350 Billion annually.

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Underreporting Noncompliance is theLargest Component of the Tax Gap

$0

$50

$100

$150

$200

$250

$300

Nonfilers

Underreporting

Underpayment

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2001 Federal Tax Gap Study – Underreporting2001 Federal Tax Gap Study – Underreporting(In Billions of Dollars)(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)

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IRS Examination DivisionIRS Examination Division

You Lost the Audit Lottery – Now What?

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Selecting a return for auditSelecting a return for audit::

Income Matching: The IRS compares information returns to amounts reported on your return (Forms W-2, Forms 1099, etc.).

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.

Random Audits: The IRS establishes special programs in various industries to see what a particular industry is doing with certain items.

Informants: Former spouses, former partners, former employees, etc. are all great sources of information for unreported income or erroneous deductions.

Related Audits: Entities or individuals associated with a taxpayer currently under audit.

Referrals: Courts (typically divorce cases) or administrative agencies recommend a taxpayer for audit.

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The Correspondence AuditThe Correspondence Audit

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.

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.

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.

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.

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The Field Audit:The Field Audit:((Initial Contact Letter)Initial Contact Letter)

The Group Manager in the local IRS Office (Knoxville or Johnson City) will assign a Revenue Agent to the audit.

Assigned Revenue Agent will send an initial contact letter to the taxpayer setting initial date and time for the first meeting.

The letter is usually accompanied by an Information Document Request (IDR).

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Examination Overview by Taxpayer Examination Overview by Taxpayer Advocate Nina OlsenAdvocate Nina Olsen

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The Eggshell AuditThe Eggshell Audit

Is the Revenue Agent conducting a “disguised” civil audit that is in reality a criminal investigation?

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.

How to recognize a potential “eggshell” audit: (cash business, unreported income, poor record keeping, requests for bank statements, unexplained delays or absences).

Do NOT try to talk your way out of a criminal prosecution!

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IRS Criminal Referrals in 2009IRS Criminal Referrals in 2009(Eastern District of Tennessee)(Eastern District of Tennessee)

In 2009, CID moved forward with prosecuting 78.6% of all referrals and declined 21.4% of referrals for criminal tax violations.

The East. Dist. of TN ranked 8th nationwide in overall referrals recommended by CID for prosecution.

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

ReferralsProsecutedReferralsDeclined

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Common QuestionsCommon Questions::

Can the IRS force me to turn over documents? Can the IRS force me to appear and subject

myself to an interview? Can the IRS come view my business and

interview my employees? Is there some statute of limitations on auditing a

return? Is there some statute of limitations on a criminal

prosecution?

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Can lying to the Revenue Agent get Can lying to the Revenue Agent get me in trouble?me in trouble?

Furnishing a false and fraudulent statement to the Revenue Agent during the exam can lead to a criminal prosecution.

Signing any document containing a false or untrue statement during the exam can lead to a criminal prosecution.

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Why the Result of the Examination is Why the Result of the Examination is Vital to Your Case:Vital to Your Case:

1. Burden of proof – increases as you move to each level

2. Cost – involving an advisor earlier is better

3. Penalties4. Administrative Record5. Evidence to support

adjustments

EXAMINATION

IRS APPEALS OFFICE

30-DAY LETTER OR NOTICE OF DEFICIENCY

U.S. TAX COURT

U.S. DISTRICT COURT

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Recent Examination InitiativesRecent Examination Initiatives

Offshore accounts, unreported foreign source income, and cross border transactions

Payroll taxes – Employment Tax Audit Initiative begun in February 2010

Global High Wealth Industry Group within LMSB

Joint Audits with foreign countries Tax Preparer Compliance

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10 ways to annoy an IRS Agent10 ways to annoy an IRS Agent

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IRS Collection DivisionIRS Collection Division

You owe the IRS money or you have not filed returns – Now What?

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IRS Collection has Two Functions:IRS Collection has Two Functions:

Collection: Automated Collection System (ACS) and local Revenue Officers try to collect the maximum amount with the least effort.

Unfiled Returns: Solicit delinquent returns and recommend criminal prosecution for nonfilers.

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The 1998 IRS Restructuring and The 1998 IRS Restructuring and Reform Act:Reform Act:

Chief power of Collections is the power to seize property through levy if a tax liability is not voluntarily paid.

The 1998 Act implemented collection and appeals procedures for taxpayers dealing with the IRS Collection Division.

Collection Due Process (CDP) Hearing for lien and levy notices.

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The IRS Tax LienThe IRS Tax Lien

Gives the government security for the payment of tax liabilities.

Arises automatically and covers not only tax, but penalties and interest.

Blanket lien filed in county office with real property records to perfect the security interest.

IRS policy is to file a lien in cases with a balance over $5,000.

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IRS Tax Lien Policy and ProblemsIRS Tax Lien Policy and Problems

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Common Collections Questions:Common Collections Questions:

1. Is there a way to get the IRS to remove the tax lien?2. Can I work out some settlement with the IRS to

avoid levy?a) Installment Agreementsb) Offers in Compromisec) Currently Not Collectible

3. Will the IRS take my home?4. Can I get the lien removed from credit history?5. What if I sell property subject to the tax lien?

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Non-filersNon-filers

Is not filing a return a crime?o 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.

o 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.

o 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.

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Will the IRS find out I have not filed Will the IRS find out I have not filed my returns?my returns?

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Commissioner Shulman’s Congressional Commissioner Shulman’s Congressional Testimony on 2011 Filing SeasonTestimony on 2011 Filing Season

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Parting Thoughts - Surviving an Parting Thoughts - Surviving an Encounter with Exam or Collection:Encounter with Exam or Collection:

Your choice of advisor matters! It is never too early to ask for help! Don’t make your friends, employees, and others

witnesses for the government! Take action immediately! Remain proactive!