IRS Audits - Part 4 Examining Process

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IRS Audits

4.1.9  International Features

4.1.9.1  (05-19-1999)
Overview/International Returns

  1. This chapter discusses features unique to returns with international issues.

  2. The Chief, Classification Section is responsible for classifying all returns with international characteristics manually at the service center before sending them to the areas.

  3. An international examiner will classify all returns with international characteristics. Refer to the Law Enforcement Manual for international characteristics.

  4. The jurisdiction for the field examination of entities filing Form 1120F and individuals claiming the foreign earned income exclusion (Form 2555 or Form 2555EZ) is the area office (AO) where the taxpayer maintains the principal books and reports.

    1. The Director, Compliance will maintain jurisdiction overall Form 1120F returns and Form 1040 returns (with Form 2555 or Form 2555EZ) if the taxpayer keeps the principal books and records outside the United States.

    2. The Philadelphia Service Center (PSC) will transfer these returns to the appropriate service center.

    3. The Chief, Classification Section will ensure that an international examiner screens and/or classifies these returns before transmission to the areas.

     

  5. Effective January 1, 1985, the Tax Reform Act of 1984 replaces the existing Domestic International Sales Corporation (DISC) with the Foreign Sales Corporation (FSC).

    1. The FSC is a taxable foreign corporation that files Form 1120–FSC (U.S. Income Tax Return of a Foreign Sales Corporation) at the PSC.

    2. The PSC will transfer Form 1120–FSC returns to the appropriate service center for screening and/or classification an international classifier.

    3. A small DISC may still exist as an Interest Charge-Domestic International Sales Corporation (IC-DISC). Generally, this domestic corporation will be non-taxable and file Form 1120–IC-DISC.

     

4.1.9.2  (05-19-1999)
Identification of Returns

  1. Individuals responsible for the classification of returns will do the following:

    1. Identify returns they select for possible examination or those they will associate with returns already under examination as "International."

    2. Ensure that the Form 3210 (Document Transmittal) sent to the Area PSP Support Manager states that the returns were selected for "International," and includes special instructions. For example, Form 1120-DISC should be associated with the related return of another area or a return that is part of a national or area coordinated examination.

    3. Assign the applicable project code from the list below to returns selected before sending them to the area.

     

4.1.9.2.1  (05-19-1999)
Project Codes

  1. Project code 090 — returns selected before transmitting them to the area

  2. Project code 091 — all tax haven returns

  3. Project code 155 — returns with responses to the foreign bank account question

  4. Project code 155 — returns if both project codes 091 and 155 are applicable. Instructions in the Law Enforcement Manual apply to this international feature.

  5. Project code 162 — Forms 1120F and 1040 (with Form 2555). Project Code 162 takes precedence over the project codes identified in (2), (3), and (4) above.

4.1.9.3  (05-19-1999)
Corporation, FSC, IC-DISC, Individual, Partnership, Fiduciary Returns

  1. With the exceptions stated in (3) below, there are no mandatory requirements for selecting corporate, IC-DISC, FSC, individual, partnership, and fiduciary returns showing foreign business transactions or interest in a and foreign bank, securities, and other financial accounts.

  2. When screening returns, classifiers will consider the objectives of the International Enforcement Program, and carefully scrutinize returns showing foreign business transactions and foreign financial accounts. When foreign business activity appears to be substantial, they should select the return for examination.

  3. Instructions for selecting returns identified during classification as reporting Subpart F income (IRC 951 to 964, inclusive) appear in the Law Enforcement Manual.

4.1.9.4  (05-19-1999)
International Related Forms

  1. Reserved

4.1.9.4.1  (05-19-1999)
Form 3520 Internal Processing

  1. Form 3520 (Creation of, or Transfers to, Certain Foreign Trusts) is filed at the PSC. A copy is forwarded to the Classification Section at the service center where the related tax return will be filed.

  2. During July of each year, the income tax return which relates to the prior year Form 3520 will be secured.

  3. When Forms 3520 are received in the service centers, they will be associated with copies of the related returns, prior to classification by an international examiner. The copies of Forms 3520 will remain with their related returns. Related returns to associate are:

    1. Person filing the return, identified by the TIN (of the filer) on Form 3520, line 1b

    2. Form 3520–A (Foreign Trust Owned by U.S. Persons) identified by TIN on Form 3520, Line 1b

    3. Form 706, if check box describing U.S. person filing return is identified as "Executor"

     

  4. Include a three-year Midwest Automated Classification System (MACS) run of the Form 3520 and for each related return. If the related return is already open, the copy of the Form 3520 will be forwarded for association. Upon receipt in the area, the related return will be referred to the International Enforcement Program.

  5. The potential liability for a gift tax, generation skipping transfer tax, or income tax should be considered when classifying the returns. Additionally, consider the penalty for failure to timely file the Form 3520 under IRC 6677. See Figure 4.1.9–1, Form 3520 Information.

     

    Figure 4.1.9-1
    If Form 3520 Then
    Line 10 is YES (the transfer is a completed gift or bequest) Form 706 and/or Form 709 should be filed and associated.
    Line 12 is NO (filer is not treated as owner of the assets)  
    Line 13 is NO (not treated as an exempt transfer) Associate Form 926 (Return by a U.S. Transferor of Property to a Foreign Corporation, Foreign Estate or Trust, or Foreign Partnership) with the Form 3520.
    Line 15 is NO (no election under IRC 057)  
    Line 16 is NO (no election under similar principles under IRC 367)  
  6. Check the Currency and Banking Retrieval System (CBRS) for the following documents and if filed, associate with the related returns.

    • TD F 90–22.1 Foreign Bank and Financial Accounts (FBAR)

    • Cash Transaction Report (CTR)

    • Suspicious Activity Report (SAR)

     

  7. A foreign trust without a U.S. owner which has effectively connected U.S. source income is filed currently on Form 1040NR—Fiduciary. This Form is processed on the Automated Non-Master File System (ANMF).

4.1.9.4.2  (05-19-1999)
Form 926

  1. Taxpayers must file Form 926 (Return by a U.S. Transferor of Property to a Foreign Corporation, Foreign Estate or Trust, or Foreign Partnership) on the day of the transfer and at the service center where they normally file their return.

  2. The excise tax per IRC 1491 does not apply if Federal income tax avoidance is not a principal purpose of the transfer.

  3. After processing, Forms 926 will be forwarded to the Chief, Classification Section, who will enter a Transaction Code (TC) 930 on the transferor’s account to secure the return when filed. If a transferor files Form 926 at a service center other than the one where the transferor normally files their return, the Chief, Classification Section in the receiving service center will forward Form 926 to the Chief, Classification Section at the transferor’s controlling service center.

  4. The transferor’s return and Form 926 will be associated before classification. An international examiner will classify all Forms 926.

  5. Due to their potential use in classifying Forms 706NR (Estates of Nonresidents) and Forms 1040NR filed by foreign trusts, copies of Forms 926 indicating that the transferee is either an Estate or Trust should be forwarded to the Director, Compliance at the following address:

    Internal Revenue Service
    Attn: Chief, Support and Services Branch OP IN D C 55
    950 L’Enfant Plaza South, S.W
    Washington, D.C. 20024

  6. When classifying Forms 926, the international examiner may generally accept as filed the following types of transfers.

    1. Forms 926 with a transferee that is an exempt organization [Reg. 1492–1(a)(1)]. A copy of the Commissioner’s determination letter must be attached.

    2. Transfer plans approved by the Commissioner [Reg. 1492–1(a)(2)]. A copy of the Commissioner’s approval letter must be attached.

     

  7. Returns selected for examination will be forwarded to the appropriate area office. Area offices should follow normal assignment, survey, and examination procedures.

4.1.9.5  (05-19-1999)
Foreign Information Documents

  1. Income tax treaties generally provide for the exchange of routine information relating to payments made to residents of the contracting countries (Foreign Information Documents). These documents reflect payments of dividends, interest, royalties, commissions, tax refunds, etc. PSC receives and stores documents from approximately 15 treaty countries in many formats.

  2. Foreign information documents showing individual taxpayers [Individual Master File (IMF)] as recipients are subject to processing under the Information Returns Program (IRP).

4.1.9.5.1  (05-19-1999)
Classification Procedures

  1. Foreign Information Return Program (FIRP) documents, which meet the selection criteria contained in the Law Enforcement Manual, will be processed as follows:

4.1.9.5.1.1  (05-19-1999)
Service Centers

  1. The PSP Support Manager, PSC in Service Centers will:

    1. Sort the FIRP documents

    2. Forward them to the payees’ service centers, Attention: Chief, Classification

    3. Forward FIRP documents with incomplete taxpayer information to the Director, Compliance, Attn: Chief, Tax Treaty for return to the submitting country.

     

  2. The Chief, Classification at each service center will:

    1. Receive FIRP documents for payees within that service center

    2. Perfect those documents without TINs

    3. Perform a cross-reference search for spouses’ TIN

    4. Forward FIRP documents (after TIN perfection) to the PSP Support Manager in the payees’ areas, or per other area instructions

     

4.1.9.5.1.2  (05-19-1999)
Area Offices

  1. The following procedures are required for area classification.

    If the FIRP documents relate to: Then the PSP Support Manager will:
    Cases in Status 06 or 08 Request the return from the service center.
    Cases in Status 10 or 12 Forward FIRP documents to the group manager.
    Coordinated Examination Program (CEP) cases—open Forward FIRP documents to the CEP manager.
    CEP cases—not open Forward FIRP documents to the district CEP Program Manager.
    Banks or insurance companies Forward FIRP documents to banking or insurance group manager.
    TE/GE returns Forward FIRP documents to Chief, TE/GE Commissioner.
    Survey cases Attach FIRP documents to the return.
  2. Personnel screening FIRP documents to decide whether to secure related returns, should consider the following factors:

    1. The impact Foreign Tax Credits (FTC) which may be available to the taxpayer

    2. The source and type of the foreign income

    3. The underlying asset and the method of acquisition

     

  3. The PSP Support Manager will place returns selected for examination into the appropriate program (Tax Auditor or Revenue Agent). If a return is surveyed, the FIRP document should be attached to the return.

  4. ALL PERSONNEL WILL CONSIDER THESE DOCUMENTS SENSITIVE UNDER THE EXCHANGE OF INFORMATION PROVISIONS OF THE VARIOUS TAX TREATIES AND WILL NOT MAKE THEM AVAILABLE EXCEPT FOR FEDERAL TAX ADMINISTRATION PURPOSES UNDER ANY DISCLOSURE PROVISIONS. ADDRESS ALL INQUIRIES CONCERNING THE DISCLOSURE OF THIS INFORMATION TO THE DIRECTOR, COMMUNICATIONS, NATIONAL HEADQUARTERS.

4.1.9.5.2  (05-19-1999)
Foreign Information Return Program (FIRP) Document Referrals to Collection

  1. FIRP Documents which meet the following criteria will be referred to service center Collection:

    1. FIRP Documents with TINs for which no TC 150 has posted on the taxpayer’s account.

    2. Undeliverable documents will not be sent to Collection.

    3. A cross reference on the Spouse’s TIN must be done before forwarding and FIRP document to Collection. All other research done on the FIRP document should be forwarded with the referral.

     

  2. FIRP documents forwarded to the controlling service centers, which are then determined to warrant referral to Collection, must be returned to the Chief, Classification, PSC. The Chief, Classification, PSC, will forward these returned documents to Collection, PSC.

  3. Forward all referrals of FIRP documents to the service center Collection on Form 3210. Itemize FIRP Documents on the Form 3210, and identify them as "Foreign Information Documents."

  4. If the collection function determines that a substitute for return is required, they will forward the information to the PSP Support Manager on Form 3449 (Referral Report).

4.1.9.6  (05-19-1999)
Form 5074, Allocation of Individual Income Tax to Guam or Northern Mariana Islands

  1. Forms 1040 requiring a Form 5074 are filed at the PSC.

  2. These returns are processed, coded, and delivered to Examination as prompt examination returns.

  3. The Service Center Classification Section takes the following actions:

    1. Completes page 2 of Form 5074

    2. Forwards a copy of the completed Form 5074 to the Service Center Accounting Branch

    3. Classifies the return

     

4.1.9.7  (05-19-1999)
Director, Compliance Special Instructions

  1. Procedures, instructions, and information for the Identification and Selection of Returns are applicable to Director, Compliance returns except as provided hereinafter.

4.1.9.7.1  (05-19-1999)
DIF Returns

  1. The mathematical DIF formulas for individual returns with certain modifications are applicable to returns identified for Director, Compliance.

  2. No minimum cutoff scores are applicable to Director, Compliance individual DIF returns. All individual returns except Specials are maintained on the DIF computer inventory file.

  3. Returns with APO/FPO addresses are also selected under the DIF System. Military personnel stationed overseas or on ships generally file these returns. They fall under the jurisdiction of the Director, Compliance, Office of International/Area Operations OP:IN:D. Taxpayers should file all APO/FPO returns at PSC.

4.1.9.7.2  (05-19-1999)
Special Returns

  1. The same audit codes used for all individual returns apply when identifying individual returns as Special Returns. Many codes will not apply to Forms 1040NR, 1040PR, and 1040SS, since the criteria for identifying these special features will not be present on these returns.

4.1.9.7.3  (05-19-1999)
Computer Reports

  1. Computer reports for individual returns (1040–1, 1040–2, etc.) and corporate returns (1120–1, 1120–2, etc.) are generated for the Director, Compliance DOs 66 (Puerto Rico) and 98 (Washington, D.C.).

  2. Computer report 1040–2 contains the number of returns filed which have a Form 2555 or 2555EZ attached.

  3. The individual returns Post-of-Duty (POD) report 1040–1 is generated for AOs 66 and 98 by country or countries.

    1. Separate PODs are used for APO/FPO returns.

    2. All Forms 1040NR, except Specials, are assigned to AO 98 and POD 81.

    3. Various PODs within AO 66 will be assigned Forms 1040PR and 1040SS.

    4. POD 99 will be primarily assigned AO 66 returns and APO/FPO returns without valid ZIP Codes.

     

4.1.9.7.4  (05-19-1999)
Ordering Returns

  1. Submit all orders for returns to the PSC.

  2. On orders for individual returns for AO 98, specify if the orders are to include the related Forms 2555 or 2555EZ.

    1. Use indicator code F to order returns with Form 2555 or 2555EZ attached.

    2. Use indicator code G to order returns without Form 2555 or 2555EZ attached.

     

  3. Forms 1040NR, 1040PR, or 1040SS may be deleted from AO 98 or 66 return orders by excluding the applicable POD(s) to which these returns are assigned from the individual return order.

  4. Forms 1040NR, 1040PR or 1040SS may be separately ordered for Assistant Commissioner (International) by placing a POD Supplemental Order for individual returns.

  5. Forms 1040NR are delivered only when the indicator code is either blank or a "J."

  6. Forms 1040PR and 1040SS are delivered only when the indicator code is blank.

4.1.9.7.5  (05-19-1999)
Classification of Returns

  1. Tax Auditors from the Director, Compliance will classify the following returns:

    • Forms 1040 with Form 2555 or 2555EZ attached

    • Forms 1040 with foreign addresses

    • Forms 1040PR

    • Forms 1040SS

    • APO/FPO returns

     

  2. Revenue Agents from the Director, Compliance will classify Forms 1120F.

 
 

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