Criteria for an IRS Audit

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If you’ve ever been audited by the IRS then you would probably agree that it is one of the most stressful ordeals of your life.  Some people worry themselves sick about their potential for audit before they even hear from the IRS.  It is useful to understand some of the IRS audit selection criteria so you can deal with the things that are within your control and not worry about the things that aren’t.

The IRS tends to use the terms “exam,” “examination,” and “audit” interchangeably.  These are all terms they use for the process of examining, clarifying, and correcting errors on one or more tax returns.  As you can imagine, the IRS does not have the resources to carefully pick through each line of each return.  Instead, the IRS picks out certain returns with a high likelihood of containing errors, and these are some of the selection methods:

  • Computer Scoring:  The IRS’ Discriminant Function System (DIF) is a computer program that flags returns based on a numeric score.  A return that has a higher likelihood of problems (such as unreported income) gets a higher score.  Then the high-scoring returns are reviewed by human eyeballs and some of them are selected for audit.
  • Information Matching:  The IRS compares payer reports (1099s, W-2s, etc.) and public records to what is claimed on the tax return and may select returns for audit based on discrepancies.
  • Related Examinations:  If you are affiliated with people or entities that were selected for audit, your chances of being audited may be higher because when the IRS finds problems with one return, they have found that others may be lurking near.
  • Informants:  Some returns are selected for audit based on anonymous tips or are the result of extensive investigation into tax evasion schemes.
  • Large Corporations:  And finally, some large corporations must submit to routine examinations (often yearly) simply because they generate huge profits and the stakes are too high for the IRS to miss anything.

If you do get selected, you should know that the vast majority of audits are completed without ever meeting face-to-face with the IRS.  Here are the different types of audits:

  1. Service Center Examinations (very simple, few issues, math error or something of that nature)
  2. Office & Correspondence Exams
  3. Field Examinations (Revenue Agent goes to your home or place of business to physically inspect your books)

http://www.irs.gov/uac/The-Examination-(Audit)-Process

 

Vengeful Audit Paranoia

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People who get audited often feel like they have been unfairly targeted by the IRS.  Many of our clients have felt this way.  When the tax audit notice comes, they immediately review their past dealings with the IRS, trying to figure out why they have been audited and what they did to upset the IRS.  Some of the more paranoid audit victims will go back and mentally review all their dealings with any branch of the government, assuming that they were selected in an act of revenge.  I suppose it is human nature that causes them to wonder and question why they, of all people, were selected for audit.

Bill Elliot is a high-profile example of this “vengeful audit paranoia.”  He was audited after appearing on FOX News earlier this month where he criticized ObamaCare and told the nation about his health insurance policy being cancelled.  He couldn’t afford the new premiums offered in the federal health insurance marketplace and needs insurance probably more than the average person given that he is battling cancer.

We can’t know for sure whether Mr. Elliot was targeted by the IRS.  We know some of their audit selection criteria, and there are probably others that we don’t know.  People are also audited at least in part based on chance.  I don’t know of any confirmed “vengeful audits,” but maybe that’s the next IRS scandal…

"This is George Miller with the IRS…"

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It sure was nice of the IRS to warn taxpayers of a “pervasive telephone scam” last week.  The scam artists apparently target recent immigrants, threaten jail time, and run credit card payments over the phone.  The IRS described a number of things to look out for, presumably so we all can  independently determine if the call we received is from a scammer or from an actual IRS representative.  The only problem is sometimes the thieves and the IRS agents share some of the same characteristics.  Let me show you what I mean.

  • Scammers use phony names and IRS badge numbers: Great, but how would we know if the name or badge number is fake?!  The IRS says that they often use common names.  But I know there are plenty of real IRS reps who have common names.  Plus, recent immigrants may not be fully aware what is or is not a common American name.  It might have been helpful if the IRS had given a sample ID number so that taxpayers could at least know if it was the correct number of digits.  Many of the representatives I speak with use 7-digit ID numbers (assuming I have been talking with the IRS for the past 8 years and not phone scammers).
  • Scammers may be able to recite the last 4 digits of the victim’s SSN: So can a real IRS rep.
  • Scammers spoof the IRS toll-free phone number on caller ID: When I have received calls from revenue officers, offer in compromise examiners, and appeals agents, it usually shows “Unknown” on caller ID, so this is good to know.
  • Scammers sometimes follow up the call with a bogus email: Real IRS agents never send emails, so this is actually a dead giveaway.
  • Scammers produce phony call center background noise: I have often heard phones ringing and low chatter that is characteristic of a call center when talking with the IRS, so I’m not sure how helpful this tip is.

I think this IRS warning is useful, but only by becoming familiar with the entire list of characteristics.  If you receive a call fitting one of the above descriptions, there may not be cause for concern (unless you are asked to provide credit card info).  But if you receive a call with many of the above characteristics, it is probably a phony IRS call and a scam.

Deceptive FTL Mailers

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If you have an IRS tax debt, chances are the government has filed a Federal Tax Lien (FTL) against you to protect its interests, especially if the debt is greater than $10,000.  The FTL becomes public information and any number of non-attorney tax relief companies begins sending advertisements.  Many of our clients have come to us with a sizeable stack of mailers, and I am rather disgusted by the way these bottom-feeders try to trick taxpayers into calling them.  Often these mailers are designed to look like official government otices.

Tax relief firms are normally successful in obtaining the following information from the public record:

  • name of taxpayer
  • address of taxpayer
  • lien type (i.e., Federal / State)
  • lien amount
  • lien filing date

The hope is that the taxpayer will recognize the information, see that it is accurate, and then call to get some kind of government-sponsored reduction of the liability.  At least that is what they would have you believe.

It is easy to identify a deceptive tax lien mailer if you know what to look for.  One of the “red flags” is repetition of information.  The sample mailer that I included in this post repeats a United States Code section three times.  The “personal ID number” is also repeated three times.  Phrases like “please read carefully” and “final notice” are also repeated to add urgency.  It is also common to see a phone number repeated two or three times, but often no address.  And finally, maybe the biggest red flag is an “estimated settlement amount.”  There is no way anyone could estimate what the IRS might settle a case for based on the limited information contained in a Federal Tax Lien.

Paying the IRS

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Since the IRS exists to collect taxes, one would think that the process of paying them would be simple, but it’s not.  Follow these tips so that you get proper credit for your payment:

  • Send a check or money order.  Don’t send cash.  It is never a good idea to send cash through the US Mail.  Lost checks can be canceled, but if cash gets stolen or lost then you have no paper trail.
  • Make your check payable to the United States Treasury, not the Internal Revenue Service.
  • The IRS also suggests that taxpayers use all digits when writing out the check amount.  For instance, include the dollars and cents place even if it is a whole number (i.e., $100.00).
  • Do not staple, clip, glue, tape, or otherwise affix your payment to any other papers (such as a letter or a payment voucher) sent with your payment.
  • Be sure the following information appears on your check: name, address, daytime phone number, primary Social Security number (i.e., the SSN belonging to the first listed taxpayer on the return), tax period and tax form (i.e., 2004/1040).
  • If you were sent a payment coupon then you should mail your payment to the address on the payment coupon.  If you do not have a payment coupon, check here to look up the correct address.

As nitpicky as all this seems, the IRS is pretty forgiving when you are sending them money. I always recommend that payments be made according to the above guidelines, but I also know for a fact that many of these components can be missing and the IRS will still cash the check.  For instance, the IRS will have no problem cashing a check made out to the IRS, even though technically they prefer that it be payable to the US Treasury.  Also, a check without a phone number is usually fine.  Even if you happen to send your payment to the wrong IRS address, believe me, the check is going to get cashed.  It may take a bit longer if the service has to re-route the check, but it will get cashed.

Finally, for taxpayers who don’t use banks, the best option is a money order or cashier’s check.  But if you’re a “strictly cash” kind of person, you may be able to pay your tax bill or installment agreement payment in cash at your local IRS office.  Availability of this option will vary from office to office.

IRS Appeals & Alternative Dispute Resolution

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If you have an IRS tax debt and are unable to achieve a satisfactory resolution with the office originally assigned to handle your matter, you may need to call on the IRS Appeals Office to take a second look.  Last time I wrote about the procedures and steps leading up to Appeals.  Today I will discuss some of the options available to taxpayers already in Appeals.

Once the controversy has advanced to the stage of appeals the IRS offers a variety of “alternative dispute resolution” options designed to keep the matter out of court.

The mission of Appeals is to resolve tax controversies, without litigation, on a basis that is fair and impartial to both the Government and the taxpayer, and in a manner that will enhance voluntary compliance and public confidence in the integrity and efficiency of the Service.

~ IRS Pub 4167

Fast Track Mediation (FTM)

  • Intended for Small Business/Self Employed taxpayers
  • Case remains in SB/SE
  • Parties must agree to FTM using Form 13369
  • Taxpayer meets with IRS representative and third party Appeals personnel
  • Solution normally reached within 40 days
  • Solution is not binding (i.e., parties are not obligated to accept the outcome)
  • Automated Collection Service (ACS) cases excluded

Fast Track Settlement (FTS)

  • Available to most other taxpayers (not just SB/SE)
  • Must complete application, Form 14017
  • Decision normally reached with 60-120 days
  • Taxpayer may withdraw at any time and retains all traditional appeal rights

Arbitration

  • For factual issues only (no legal issues)
  • Outcome is binding
  • Most collection issues excluded

In need of an OIC Appeal?

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Once in a while an Offer in Compromise (OIC) is accepted based only on the documents originally submitted, but this is extremely uncommon.  Normally the IRS will at least have some questions, and usually, they will have somewhat of a laundry list of questions and document requests.

Once the Offer Examiner has received all the information necessary to put together a complete analysis, she will send a “preliminary analysis letter.”  Most of the time the IRS will determine that the taxpayer is able to pay the tax liability in full and/or that acceptance of the offer is not “in the government’s best interest.”  Some of the language in this letter has a hint of finality to it and taxpayers tend to misjudge/misread it as a rejection letter.  But the offer can often be kept alive at this point by supplying additional information and by making the right arguments.

If taxpayer’s response does not convince the IRS to change its position, then the IRS will (after manager approval and independent review) submit a decision letter.  A decision letter could be any of the following:

  • Acceptance
  • Rejection (with OIC appeal rights)
  • Rejection with the option to increase
  • Return (no OIC appeal rights)

But even a rejection letter isn’t always the end of the road.  If there are legitimate issues, a taxpayer may want to file an appeal.  Filing an appeal puts the offer in front of an independent and fresh set of eyes.  The IRS Office of Appeals is “independent” in the sense that it is not connected with the office that decided to reject your OIC.  Don’t think that the Appeals Office is a completely independent government agency because it is not.

An Offer in Compromise must be filed on a specific form and within 30 days from the date of the rejection letter.  Taxpayers may substitute a letter instead of the appeal form, but the letter must contain all the same elements required by the form.  Once your appeal has been filed, be prepared to wait about the same length of time you waited for your OIC to be assigned.  Also, remember that the collection statute is tolled (extended) during the entirety of the appeals process just as it is during the OIC review.

July 22nd: Optional Work Day for IRS Employees

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Tax attorneys and other tax professionals plan their work days around their interactions with the IRS.  So, when the IRS is closed on a weekday, they take note.

Earlier this year the IRS had announced a series of planned nationwide furlough days to help with its “bottom line,” one of them to take place on Monday, July 22nd.  Then a couple days ago the acting IRS Commissioner, Daniel Werfel, announced by way of internal memorandum that the agency would no longer be forcing its employees to take that day off.  The furlough scheduled for July 22nd was lifted.  However, realizing that many IRS personnel have already made plans for a three-day weekend, Werfel is allowing anyone to still take the day off if they want.

So what does this mean for tax professionals who need to contact the IRS on July 22nd?  What can we expect?

In my years of working in the field of tax controversy, I have come to realize the impossibility of trying to predict too much when it comes to the IRS.  But my guess is that Monday is not going to be the best day to call them.  Given the opportunity to take a 3-day weekend with pay, what IRS employee would come in and work (besides may the overzealous brown noser or somebody too dim to realize he doesn’t have to be there)?!  I think the IRS is going to be severely understaffed, probably to the point that it would be no different than a furlough day from taxpayers’ point of view.  And those that do go in to work on the 22nd are going to be stressed and unhelpful.  It’s probably best to wait until Wednesday or Thursday if you need to call the IRS next week.

I have noticed that one of the consequences of the furlough days thus far has been a sharp increase in hold times when trying to call into the IRS.  People that don’t get through on a furlough Monday tend to call back on Tuesday, and then Wednesday, etc.  The calls pile up just like all their other work.  These days it is not unusual to wait 45-60 minutes before the IRS picks up you call.

Fixing the IRS: Where do we Start?

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It’s no secret that the IRS makes mistakes, sometimes serious mistakes.  It may have been secret before (at least for the average taxpaying citizen) regardless of the Treasury Inspector General for Tax Administration (TIGTA) reports that highlight the agency’s deficiencies.  But in recent months the IRS has been under intense media scrutiny, bringing these reports out into the open in mainstream media outlets.

The problems at the IRS are the result of:

  • ineffective training
  • weak leadership
  • poor judgment
  • inexperienced employees
  • an overly-complex tax code
  • simple human error
  • insufficient funding

This is by no means a comprehensive list.  And it’s easy to lump them all together and imagine one comprehensive solution.  There are some who think all the problems can be fixed by increasing funding to the IRS.  They see this as the root of all employee development, training, and managerial issues.  This is perhaps the primary argument of IRS sympathizers; however, I’m not so sure there is an all-in-one solution for cleaning up at the IRS.

To use a recent example, why don’t IRS Revenue Officers (RO) always follow legal guidelines when seizing taxpayer property to cover unpaid taxes?  This is probably the most serious collection action that the IRS can take.  And besides going to prison, this is what taxpayers fear more than anything.  So, why do they get it wrong sometimes?  We can probably rule out “complex tax code” because the procedures for seizure of property are clearly laid out in the Internal Revenue Manual (IRM) so an RO has only to follow the steps.  But any of the other listed reasons could realistically apply.

Although I think it is impossible to narrow it down to one root problem, it is clear that there is quite a bit of overlap.  For example, an inexperienced employee is more likely to make simple human errors and use poor judgment in his work.  And lack of/ineffective training is a symptom of poor leadership.  This overlap is a good thing when contemplating solutions because it means that addressing one issue will automatically improve another.  It also means that once we get started on the task of fixing the IRS, we’ll already be closer to our goal than we think.

How long should you keep your tax records?

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It’s now summertime, officially, and you still haven’t finished your spring cleaning. So, what tax records do you need to keep while catching up on your spring cleaning this summer? You need to give some thought before throwing out those old tax records.

What tax records should I keep?

This question requires an analysis of why you would need any of your tax records, other than shoe box filler of course. If you’re “lucky” enough to have your tax returns audited by the government, the burden of proof will be yours to substantiate the entries, deductions, and statements on your tax return. This is the primary reason for keeping your tax records. Therefore, the records you need to hang on to are the documents that you used, or should have used, to prepare your tax returns. This often includes, among other things, receipts, cancelled checks, bank statements, income statements, repair statements, mileage logs, withdrawal statements, and property transfer closing paperwork.

How long do I need to keep my tax records?

This is really a question of, how long is the government allowed to pester you for verification of the representations on your tax returns. If you file a federal income tax return, you will you need to keep your tax records for three years from the date the tax return was due, or the date the tax return was filed, whichever is later. However some states, such as California for example, may audit your records longer than the IRS can; so you will need to check your state’s rules to verify how much longer you need to keep your records depending on which state tax return(s) you file.

There are exceptions to the IRS’ three year rule that require you to keep records for longer than the three year period. These exceptions include when you don’t file a tax return, when you understate your income, or when you file a fraudulent return. Ironically, if you fall into one of these categories, you likely don’t have accurate records to begin with; so the government truly has you on the hook for a serious tax problem longer than taxpayers who keep accurate records. It’s also generally a good idea to keep tax returns and supporting documentation for the tax years when you acquire or transfer property that may be used to calculate gains or losses on a future tax return. And of course, there may be non-tax reasons to keep documentation accessible longer than the government’s need for evidence.

These days, converting files to an electronic format is pretty accessible to anyone with a scanner or near a print shop. So, if you’re not sure whether to dispose the document after the appropriate time has elapsed, at least scan and save the documentation to give you peace of mind. Lastly, when disposing of old tax records and supporting documents, be smart, securely shred the documents … your trash may be a thief’s treasure.