Accuracy - IRS Audit - Audit Techniques Guide | irstaxattorney.com



Accuracy-Related Penalties: Up Introduction Accuracy Related Penalty Negligence of Rules Substantial Understatement Valuation Misstatement Fraud Penalty Reasonnable Cause Annoucement 2002-2 Policy Statements Audit Techniques	Audit Techniques Guide Chapter 10: Audit Techniques – Development of Potential Penalty Issues for Tax Shelter Cases Objective In developing a penalty, the examiner needs to determine what efforts the taxpayer made to determine the correctness of the return position. The examiner’s objective is to determine accountability for the return position, and determine whether the paper trail corroborates the taxpayer’s position. Of course, every effort should be made to apply penalties in a fair and consistent manner. Penalties should not be applied as "bargaining chips" or because the taxpayer was uncooperative during the examination. Inquiries relating to accuracy-related penalty Examiners should obtain information and documentation relating to the following: Does the taxpayer have an underpayment of tax? What was the amount shown on the return? Did the taxpayer file a qualified amended return? Are there any amounts assessed before the return was filed that were not shown on the return, such as termination assessment under IRC § 6861 or a jeopardy assessment under IRC § 6861? Are there any rebates? Was the taxpayer negligent? Did the taxpayer make a reasonable attempt to comply with the Federal tax laws? Is the return position reasonably based on one or more authorities? What type of authority? Does the taxpayer have contemporaneous documentation to demonstrate consideration of authorities? Did the taxpayer disclose the return position on Form 8275? Did the taxpayer disclose a reportable transaction on Form 8886? Did the taxpayer keep adequate books and records? Can the taxpayer substantiate the items properly? Is the transaction one which would appear to a reasonable person “too good to be true”? Does the taxpayer have an approval process to enter into a transaction of the size or dollar amount involved? Did the taxpayer comply with this approval process? Obtain copies of approval documents. Compare documents to similar approval documents of like size company or taxpayer transactions for the same time period. Who was responsible for the decision to take the reporting position? Did the taxpayer obtain advice from outside counsel or other tax professional? From whom? What is the relationship, if any, between the outside counsel and the promoter? Did the promoter refer the taxpayer to outside counsel? Did the taxpayer’s inside counsel review or comment on the tax aspects of the transaction? Did the taxpayer obtain the views of tax professionals other than the promoter, the promoter’s agent or persons otherwise having a financial interest in the promotion? After the transaction began, what did the taxpayer do to monitor its progress? Did the taxpayer have a “checksheet” or evaluation process in place to see that the various steps in the transaction were accomplished? Did the taxpayer obtain an appraisal or other valuation? Are there in-house, tax advisor and/or consultant memoranda questioning the proposed return position? Did the taxpayer disregard a rule or regulation? Did the taxpayer carelessly, recklessly or intentionally disregard a revenue ruling or a notice (other than a notice of proposed rulemaking)? Does the taxpayer’s position which is contrary to a revenue ruling or notice have a 1 in 3 likelihood of being sustained on the merits? Did the taxpayer disclose the position that is contrary to a revenue ruling or notice on Form 8275? Is the transaction reportable? Did the taxpayer carelessly, recklessly or intentionally disregard a regulation? Is the taxpayer taking the position that a regulation is invalid? Does the position represent a good faith challenge to a regulation? Did the taxpayer disclose the position that is contrary to a regulation on Form 8275-R? Did the taxpayer disclose the position that the regulation is invalid on Form 8275-R? Did the taxpayer disclose a reportable transaction on Form 8886? Is the Service’s position which is believed to be contrary to the taxpayer’s position a longstanding position or very recent position? In what manner was the Service’s position disseminated? What evidence is there in the return preparation workpapers that the taxpayer knew about the existence of a contrary position? Is there a substantial understatement? What is the correct income tax liability? What is the tax reported by the taxpayer? Is the taxpayer entitled to a reduction in the amount of the understatement under IRC § 6662(d)(2)(B)? Is the amount of the understatement $5,000 ($10,000 for a corporation) or 10% of the tax required to be shown on the return? Is the transaction a tax shelter? Is the transaction a plan or arrangement? Is a significant purpose of the transaction to avoid or evade Federal income tax? Is there a legitimate business purpose other than tax savings? To what extent was the taxpayer influenced by tax benefits as opposed to investment potential? Why did the taxpayer enter into the transaction? Why did the taxpayer structure the transaction, adopt the accounting treatment or characterize the assets in the manner that the taxpayer used? To what extent did the taxpayer take steps to conceal the transaction (e.g., netting inside a partnership or grantor trust)? If the taxpayer is *not* a corporation, did he have substantial authority and a reasonable belief that the tax treatment of the item was more likely than not the proper treatment? *Substantial Authority:* What authority supports the taxpayer’s position? What authority contradicts the taxpayer’s position? Note that different authorities carry different weight, e.g., a regulation holds greater weight than a private letter ruling. Did the taxpayer request, and rely on, a private letter ruling or a determination letter? Does the taxpayer have contemporaneous documentation? *Reasonable Belief:* Did the taxpayer analyze the facts and authorities? Did the taxpayer reasonably conclude in good faith that there is a greater than 50 percent likelihood that the tax treatment of the item will be upheld if challenged by the Service? Did the taxpayer reasonably rely upon the opinion of a tax advisor? (See below for inquiries relating to reliance on a tax opinion.) Did the tax advisor unambiguously conclude that there is a greater than 50 percent likelihood that the tax treatment of the item will be upheld if challenged by the Service? Is there a valuation misstatement? What is the value of the property? What is the claimed value of the property? What is the adjusted basis of the property? What is the claimed adjusted basis of the property? Is the underpayment due to fraud? The examiner should coordinate closely with local Chief Counsel attorneys on cases involving potential fraud. What was the taxpayer’s intent? Did the taxpayer intend to evade tax? Was the underpayment due to inadvertence, reliance on incorrect advice, honest indifference, negligence or carelessness? Inquiries relating to Reasonable Cause & Good Faith What effort did the taxpayer make to assess the proper tax liability? Did the taxpayer rely on an erroneous information return? Is the information contained on the information return inconsistent with other information reported or otherwise furnished to the taxpayer or with the taxpayer’s knowledge of the transaction? Was the underpayment due to an isolated mathematical error? Is the taxpayer’s position one in which the Service would issue a private letter ruling or determination letter? If so, did the taxpayer request a private letter ruling or determination letter? What was the outcome of the private letter ruling or determination letter, e.g., favorable, adverse, withdrawal? Did the taxpayer abide by the private letter ruling or determination letter? Did the taxpayer attempt to conceal the transaction? If applicable, was the M-1 analysis misleading? Did the taxpayer net transactions or provide incorrect or misleading labels? Did the taxpayer provide the difference between financial statements and tax returns without concealment? Were there assurances or statements made to a third party that characterized the transaction differently for tax purposes? What is the sophistication of the taxpayer? What is the taxpayer’s background, business experience, sophistication and education? Was there an honest misunderstanding of fact or law that is reasonable in light of the facts? Does the taxpayer have a history of entering into sophisticated or complex tax related transactions? Did the taxpayer rely upon the advice of a tax advisor? See below for inquiries relating to tax advice. Are there other facts and circumstances that might apply that mitigate the taxpayer’s behavior or suggest that a penalty should be imposed? Did the taxpayer disclose under Announcement 2002-2, even though the taxpayer was not eligible to do so? While taxpayers cannot avoid penalty consideration under Announcement 2002-2, disclosure could be a mitigating factor. Has the taxpayer engaged in other listed transactions or is this the only listed transaction the taxpayer has attempted? Was the transaction listed after the taxpayer filed the return? Did the taxpayer notify the Service of the position after it was listed? Are there any meeting notes, board statements, etc., consistent with the taxpayer’s assertion of reasonable cause and good faith? If the transaction is related to another segment of the business, was the other unit consulted or informed? Were there assurances or statements made to third parties that characterized the transaction in a manner different from the characterization for tax purposes? Was the taxpayer’s participation in the transaction subject to a confidentiality agreement? Provide details. In the case of a corporation with a substantial understatement attributable to a tax shelter item: Can the corporation show legal justification? *Substantial Authority:* What authority supports the taxpayer’s position? What authority contradicts the taxpayer’s position? Note that different authorities carry different weight, e.g., a regulation holds greater weight than a private letter ruling. Did the taxpayer request, and rely on, a private letter ruling or a determination letter? Does the taxpayer have contemporaneous documentation? *Reasonable Belief:* Did the taxpayer analyze the facts and authorities? Did the taxpayer reasonably conclude in good faith that there is a greater than 50 percent likelihood that the tax treatment of the item will be upheld if challenged by the Service? Did the taxpayer reasonably rely upon the opinion of a tax advisor? (See below for inquiries relating to reliance on a tax opinion.) Did the tax advisor unambiguously conclude that there is a greater than 50 percent likelihood that the tax treatment of the item will be upheld if challenged by the Service? Did the corporation participate in a tax shelter lacking significant business purpose? Are the benefits claimed by the taxpayer unreasonable compared to the benefits? What were the risks to the taxpayer? Did the taxpayer have an out-of-pocket investment? Inquiries Relating to Reliance on Advice When a taxpayer claims reasonable reliance on the advice of a tax advisor, always obtain a copy of the opinion(s). If the taxpayer refuses to turn over the opinion(s) on privilege or other grounds, contact your subject matter technical advisors or local Chief Counsel Attorney. How did the taxpayer choose the tax advisor? Did they have a long standing relationship? Did a promoter or other person with a financial interest in the transaction refer the taxpayer to the advisor? Does the taxpayer have a regular tax advisor? If the taxpayer did not consult with its regular tax advisor, why not? Did the advisor prepare the return? Why did the taxpayer use a different person to prepare the return? How was the compensation for the outside advice determined (e.g., time based, a flat fee, a percentage of the tax savings, etc.)? Was there a compensation arrangement, such as a referral fee or fee sharing arrangement, between the author of the opinion and the person promoting, marketing or recommending the tax shelter? Did the taxpayer have knowledge of any fee arrangement between the advisor and a promoter? Obtain a copy of the invoice to identify the source of the opinion, number of hours or other method used to determine the fee and the date the work was done. What are the credentials of the tax advisor? Does the tax advisor have any special knowledge or expertise relating to the transaction or the underlying industry? Did the advisor do its own research? Was the advice in writing? In what format, e.g., opinion letter, offering materials, e-mail, etc.? Did the taxpayer discuss the opinion or advice with the author of the advice? If not, who explained the advice, e.g, in-house counsel? Are there any contemporaneous notes or minutes relating to these discussions? Is the advice dated? Are there contemporaneous documents that discuss the transaction or the advice? Is there an engagement letter defining the scope of the opinion or advice? Does the opinion or advice reflect the intent of the parties as outlined in the engagement letter? Obtain a copy of the engagement letter to determine any limitations or restrictions placed on the advice agreed to by the advisor and taxpayer. Does the opinion identify and ascertain the facts and determine which are relevant? What was the source of the documents used to ascertain the facts? Are the facts in the opinion supported by the documents provided to the advisor? Are pertinent facts assumed, and, if so, are the assumptions reasonable? For example, if the opinion depends on a valuation, has an independent confirmation of the valuation been made? Does the opinion relate the applicable law (including potentially applicable judicial doctrines such as the step transaction, business purpose, economic substance, substance over form, and sham doctrines) to the relevant facts? If the opinion is based upon hypothetical facts and assumptions, did the taxpayer seek independent advice based on individual circumstances? Was the opinion or advice marketed to several taxpayers? Were there additional marketing and/or offering materials? Obtain a copy of the marketing and/or offering materials. Did any of the materials contain disclaimers, disclosures or other warnings that would suggest the taxpayer should obtain outside advice based on individual circumstances? Does the opinion consider all material Federal tax issues? Is the opinion limited to one or more material Federal tax issue? Did the taxpayer seek independent legal advice on the feasibility of the transaction or merely rely upon a legal opinion provided by the outside vendor/promoter of the product at issue or an agent of that vendor/promoter? Did the taxpayer obtain an appraisal or a valuation? What kind of scrutiny did the taxpayer perform of the outside advice before it was adopted? Did the taxpayer have meetings or prepare analyses? Did the taxpayer actually follow the advice? Did the taxpayer enter into a transaction as described in the advice, or were there material differences between the transaction described in the advice and the transaction into which the taxpayer entered?

Audit Techniques Guide

Chapter 10: Audit Techniques – Development of Potential Penalty Issues for Tax Shelter Cases