IRS Audits - Part 4 Examining Process

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IRS Audits

Chapter 14. Statutory Notices of Deficiency

Section 1. Statutory Notices of Deficiency Issued by Area Offices

4.14.1  Statutory Notices of Deficiency Issued by Area Offices

4.14.1.1  (10-30-2004)
Overview

  1. When taxpayers disagree with a tax determination, taxpayers may petition the United States Tax Court (Tax Court) for a judicial determination of the tax liability after receiving a notice of deficiency, without prior payment of the tax at issue. The Tax Court provides a forum for disputing deficiencies asserted by the Internal Revenue Service. This section outlines procedures used by Technical Services' staff for preparing, reviewing, and issuing notices of deficiency under IRC section 6212.

4.14.1.2  (10-30-2004)
Notice of Deficiency Definition

  1. A notice of deficiency, also called a " statutory notice of deficiency" or "90-Day Letter," is the Commissioner's determination of a taxpayer's income, estate, gift or certain excise tax deficiencies sent to the taxpayer by certified or registered mail.

  2. The Commissioner is authorized to send this notice per IRC section 6212(a). The issuance of a statutory notice of deficiency begins the process. A taxpayer that does not agree with the adjustments may file a petition with the Tax Court within 90 days from the notice date (150 days if the notice is addressed to a person outside the United States). See Levy v. Commissioner, 76 T.C. 228 (1981). Generally, notices addressed to APO (signifying military mailing) addresses are considered outside the United States. See Brown v. Commissioner, 78 T.C. 215 (1982), acq. 1982–2 C.B. 1. See also 4.14.1.6.2.10, below.

4.14.1.3  (10-30-2004)
Criteria for Issuance

  1. A notice of deficiency may be issued when the:

    • expiration of the statute of limitations is imminent and no extension can be obtained,

    • taxpayer does not file a valid protest in response to a 30-day letter or fails to respond to a 30-day letter, or

    • taxpayer requests the issuance of the notice in order to petition the case to the Tax Court.

     

4.14.1.4  (10-30-2004)
When Issued

  1. If a 30-day letter (or equivalent) offering an Appeals hearing was issued to the taxpayer, a notice of deficiency will be issued within 60 days of receipt of the case in Technical Services. However, a notice will be issued earlier if the expiration of the statute of limitations is imminent and no assessment statute extension can be obtained.

  2. Examination Group Secretary will update ERCS to status 21, In-Transit to Technical Services, and forward case file to Technical Services for issuance of statutory notice of deficiency.

  3. If a case file that has been sent to Technical Services for preparation of a notice of deficiency is selected for sample EQMS/LQMS review, Case Processing will notify Technical Services of this fact and fax the sample selection sheet. Technical Services will affix the EQMS/LQMS sample selection sheet to the case file and follow guidelines in IRM 4.8.3, Examination Quality Measurement System (EQMS) or directions from LQMS site.

4.14.1.5  (10-30-2004)
Authority for Issuance - Servicewide Delegation Order 4-8

  1. Appeals Team Managers and Appeals Team Case Leaders (as to their respective cases); Large and Mid-Size Business (LMSB) Territory Managers; Small Business/Self-Employed (SB/SE) Field Directors: Accounts Management and Submission Processing; Campus Department Managers in SB/SE Compliance Services; SB/SE Compliance Field Territory Managers; SB/SE Technical Services Revenue Agent Reviewers GS-12 and Tax Compliance Officer Reviewers GS-09; Tax Exempt/Government Entities (TE/GE) Reviewers GS-12; Wage & Investment (W&I) Directors: Accounts Management, Field Compliance Services and Submission Processing; W&I Territory Managers can prepare, sign and send a notice of deficiency (Servicewide Delegation Order 4-8, formerly Delegation Order 77). See subsection 4.14.1.8 below, Signing and Dating the Notice of Deficiency, and also see subsection 4.14.1.24.4 below for authority to rescind notices of deficiency which have been issued.

4.14.1.6  (10-30-2004)
Preparing Notices of Deficiency

  1. The notice of deficiency is a legal determination that is presumptively correct. The notice of deficiency consists of:

    • a letter explaining the purpose of the notice, the amount of the deficiency and the taxpayer's options,

    • a waiver if the taxpayer should decide to agree to the additional tax liability,

    • a statement showing how the deficiency was computed, and

    • an explanation of the adjustments.

     

  2. Overassessment and "no-change" years should not be included in a notice of deficiency.

4.14.1.6.1  (10-30-2004)
Taxpayer Name

  1. The taxpayer's name and address appear throughout the notice of deficiency. It is extremely important that the taxpayer is correctly identified as even minor typographical errors in the name or address may affect the validity of a notice of deficiency. Taxpayers should be identified in the following manner:

  2. Use the name of the corporation as shown on the corporate seal. If unavailable, use the name shown on the tax return. In corporate reorganizations, include both the current and the former name.

  3. On a joint return where the same last name is used, the name will be stated as "John and Mary Doe."

  4. On a joint return where the last names are different, the names will be stated as "John Doe and Mary Smith."

  5. When the spouse remarries, the name is written "Mary Smith formerly known as Mary Doe."

  6. If one spouse has died since the joint return was filed, and

    1. a fiduciary relationship is unknown, the notice should reflect: "John Doe (Deceased) and Mary Doe" or "John Doe (Deceased) and Mary Doe, Surviving Spouse."

    2. a fiduciary relationship is known, the notice should reflect: "John Doe (Deceased) and Mary Doe, Richard Doe, Executor. "

    3. a fiduciary is required to give notice to the Service of the fiduciary relationship. Form 56, Notice Concerning Fiduciary Relationship, may be used for this purpose.

     

  7. If "also known as" or "AKA" is used, it should be included in the name.

  8. The name on the return, not the taxpayer's signature, is the name to be used in the notice.

4.14.1.6.2  (10-30-2004)
Taxpayer Address

  1. The mailing address should be the taxpayer's last known address.

4.14.1.6.2.1  (10-30-2004)
Last Known Address

  1. Revenue Procedure 2001–18, 2001–8 I.R.B. 708, defines this as the address on the most recently filed and properly processed tax return unless the taxpayer has clearly and concisely notified the IRS of a change of address or the Service may update the taxpayer's address of record by using United States Postal Service's (USPS) National Change of Address database (NCOA database) in accordance with Treas. Reg. § 301.6212-2 (effective January 29, 2001).

  2. If there is any doubt as to what the last known address is, additional original notices should be sent to each known address.

4.14.1.6.2.2  (10-30-2004)
Clear and Concise Notification

  1. A statement signed by the taxpayer informing the Service to change the address of record is considered clear and concise notification. The statement must also contain the taxpayer's full name, signature, old address, and social security number and/or employer identification number.

  2. Form 8822, Change of Address may be used to make the change.

  3. Correspondence sent by the Service that solicits or requires a response by the taxpayer, which is returned to the Service by the taxpayer with corrected taxpayer address information, constitutes clear and concise notification of a change of address (even if the taxpayer's signature is not on the correspondence).

  4. The following situations alone will not constitute clear and concise notification of a new address and, therefore, should not result in a change to a taxpayer's address of record. A new address reflected on the:

    • letterhead of taxpayer correspondence,

    • return envelope,

    • taxpayer's remittance form, or

    • Post Office notice (other than by means of United States Postal Service's (USPS) National Change of Address database (NCOA database).

      Note:

      Although the address of record should not be updated as a result of these new addresses, duplicate notices should be sent to these addresses.

       

     

4.14.1.6.2.3  (10-30-2004)
Elements of a New Address

  1. The following are elements of a new, complete address.

    • Number and street (or P.O. Box Number)

    • Apartment or suite number

    • City or town, state and zip code

     

  2. There should be no abbreviation in the taxpayer's address, except for the state; however, if the last known address as reflected on the last filed and properly processed tax return contains abbreviations, then that address containing abbreviations may be used. If notices are sent to foreign countries, the name of the country should not be abbreviated.

4.14.1.6.2.4  (10-30-2004)
New Addresses Secured by Telephone or Interview

  1. Address changes can only be made from an oral statement (i.e., telephone or walk-in contact) if for perfection or if concerning an open account or adjustment request from the taxpayer.

  2. Authentication of the caller's identity using the criteria in IRMs 21.1.3.2.3 and 21.1.3.2.4 is required before making changes to the taxpayer's address of record.

  3. Any request solely for an address change, other than for perfection or in connection with an open account or adjustment request, must be in writing.

4.14.1.6.2.5  (10-30-2004)
Establishing the "Last Known Address"

  1. The following steps should be taken to determine the taxpayer's "last known address" :

    1. Search IDRS for the most recently filed tax return and other information using appropriate CFOL and IDRS command codes including INOLES, SPARQ, IRPTRO, IROLE, IMFOLE, ENMODA.

    2. Search under the primary and secondary social security numbers.

    3. If wages are deducted on a business return or Schedule C, check for the most recently filed Form 941.

    4. Search the administrative file for " clear and concise" notification since the date of the last filed return.

    5. Scrutinize the power of attorney for a different address. Compare the signed dates found on the power of attorney to those found on the most current filed return.

    6. If there is any indication of an alternative address, send a duplicate notice to that address

     

4.14.1.6.2.6  (10-30-2004)
Fiduciary Relationship

  1. Form 56, Notice Concerning Fiduciary Relationship, is used by an individual to notify the Service of a fiduciary relationship. Other legal documents establishing fiduciary relationships can be substituted for the Form 56.

  2. The notice must be mailed to the fiduciary's mailing address as well as to the taxpayer's last known address.

  3. A joint deficiency notice when the fiduciary is unknown is addressed as:

    John Doe (Deceased) and Mary Doe
    John and Mary Doe's last known address(es)

     

  4. If the Service is apprised that a taxpayer is deceased prior to issuance of the notice, determine if a fiduciary exists. Do not assume the surviving spouse is the personal representative of the decedent.

4.14.1.6.2.7  (10-30-2004)
Divorced or Separated Taxpayers

  1. Duplicate joint notices are sent as follows:

    John Doe and Mary Smith, formerly Mary Doe
    John Doe's Last Known Address
     
    and
     
    John Doe and Mary Smith, formerly Mary Doe
    Mary Doe's Last Known Address

     

  2. Separate original notices will be sent to each spouse at their last known address. The notice letters and waivers will identify both spouses with only the address of the spouse to whom the notice is sent.

4.14.1.6.2.8  (10-30-2004)
Power of Attorney

  1. If a power of attorney address is the taxpayer's last known address, the notice should be addressed as follows:

    John Doe and Mary Doe
    c/o Power of Attorney's Name
    Power of Attorney Address

     

    Note:

    This subsection does not refer to the copy of the notice that is sent to the Power of Attorney. See 4.14.1.9.2 below, Power of Attorney, paragraph (3).

     

4.14.1.6.2.9  (10-30-2004)
Incarcerated Taxpayers

  1. If a taxpayer is incarcerated at the time the notice is mailed, duplicate original notices are sent to:

    1. The address on the taxpayer's last filed return, and

    2. The address where the taxpayer is incarcerated.

     

  2. The address on the Letter 531 (DO) should be where the taxpayer is incarcerated and should reference the prisoner locator number, if available. Information as to the prisoner locator number can be obtained for federal prison inmates from http://inmateloc.bop.gov/locatordocs/home.jsp

  3. Both notices should be sent certified/registered mail.

4.14.1.6.2.10  (10-30-2004)
APO Addresses

  1. APO addresses are considered to be outside the United States for purposes of mailing notices of deficiency. As such, deficiency notices must be mailed to such addresses by registered mail.

  2. The Military Postal Service (MPS) is a segment of the U.S. Postal Service (USPS) and provides postal service to members of the armed forces stationed outside the United States. The MPS consists of military post offices operated by each branch of the armed services and staffed by military personnel. Mail addressed to APO addresses are routed to gateway locations within the United States where APO mail is sorted and directed to the appropriate MPO. An APO address consists of a numerical code that identifies the location of an overseas MPO and the location of the United States gateway concentration point.

  3. In Brown v. Commissioner, 78 T.C. 215, 221, acq. 1982–2 C.B. 1, the Tax Court held that a notice of deficiency mailed to a New York APO address was mailed to an address outside the United States. Therefore, the taxpayer was entitled to 150 days after the notice of deficiency was mailed to file a petition with the tax court. Further, in Rogers v. Commissioner, 57 T.C. 711, 713 (1972), the Tax Court stated that, because postal regulations restrict the use of certified mail to domestic address, notices of deficiency sent to addresses outside the United States must be sent by registered mail.

  4. EXCEPTION: The Tax Court's specific holding in the Brown case is that "a notice of deficiency that bears an APO (or FPO) address is addressed outside the United States_if the military post office designated by the APO number is located outside the United States." See 78 T.C. at 225. As the court indicated, a few MPO's are located in Alaska and Hawaii, which would be considered inside the United States for purposes of the deficiency notice requirements. In 1991, the military overseas ZIP codes were aligned to reflect the location of the recipient post office and now have a standardized address format. Questions regarding APO/FPO ZIP codes should be addressed to the Military Postal Service Agency at 800-810-6098.

4.14.1.6.3  (10-30-2004)
Notice of Deficiency Letter

  1. Letter 531 (DO) is the notice letter used in income tax cases.

  2. The notice preparer should not date the notice of deficiency letter. The date will be added when the notice is issued.

  3. The notice must include the name, telephone number and the unique identifying number of the person to contact (if an actual name is used) regarding the notice. If the title "Notices Clerk" is used as the person to contact, no employee identification number is required.

    Note:

    The designated persons must clearly identify themselves using their name and employee identification number when answering a specific taxpayer inquiry.

     

  4. The "Last Day to File a Petition with the United States Tax Court" date should not be inserted by the notice preparer. The issuer of deficiency notices must enter this date.

  5. The deficiency amount should specify the amount of tax and penalty and should not include the interest amount.

  6. The deficiency notices must advise taxpayers of their right to contact the local office of the Taxpayer Advocate and provide the location and telephone number of the appropriate office. Enclose Notice 1214 for this purpose.

4.14.1.6.4  (10-30-2004)
Waiver Preparation

  1. Computer generated Form 4549 waiver or Form 4089 is included with the notice to allow the taxpayer to agree to the assessment of the proposed deficiency. The waiver should contain the following:

    1. Name and address of the taxpayer exactly as they appear on the Letter 531 (DO) or 902 (DO).

    2. Summary of the tax liability for each year with separately stated deficiencies and penalties. Each penalty should be listed separately by title and Code section. If space does not permit the separate listing of the individual penalties on the Form 4089, a summary total of the penalties can be placed on the Form 4089 (with a notation, SEE ATTACHED), with the details of the individual penalties reflected on the attachment to the waiver form.

     

4.14.1.6.5  (10-30-2004)
Computation Statement

  1. If Form 4089 is used as a waiver, then Form 4549–A or Form 5278, Statement of Income Tax Changes, should be used for all individual, corporate, and fiduciary income tax returns to reflect the list of adjustments and the proposed deficiency computation. The layout is similar to the Form 4549 and the instructions for completing Form 4549 are applicable.

  2. If Form 4549 is used as a waiver, it is not necessary to prepare a separate computation statement.

4.14.1.6.6  (10-30-2004)
Explanation of Adjustments

  1. Every adjustment must be explained as it serves to inform the taxpayer of the basis for the government's case, including statutory adjustments; e.g., adjustments to itemized deductions and exemptions based on limitations. Good judgment should be exercised to balance the taxpayer and government interests.

  2. The adjustments should be explained in the order in which they appear on the report.

  3. Use applicable standardized language as published in IRM 4.10.8, Report Writing (Exhibits 4.10.8-14 and 4.10.8-15), Exhibit 8.17.4-1 of IRM 8.17.4 or language previously approved by Area Counsel. The explanations can be modified to address specific facts of the case.

  4. Explanatory paragraphs should be concise. Voluminous details should be prepared as a separate exhibit or schedule. The explanation will include the reference to specific exhibits or schedules included with the explanation.

  5. Explanations should be complete. Alternative positions inconsistent with the primary position should be approved by Area Counsel as described in section 4.14.1.7.1 below. (See also section 4.14.1.13.5 below, Alternative to Civil Fraud Penalty.)

  6. Code sections should be quoted only to the extent needed for clarification. When Code sections are used, cite the exact Code language rather than paraphrasing.

    1. Proper statement:

    2. Improper statement:

     

    "Since it has not been established that your farm was operated with the intention of making a profit, the amounts deducted are not ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business"

     

    "You have not shown that such claimed deductions were connected with a business activity during your taxable year."

     

  7. References to Code subsections , regulations or decided court cases should not be used.

  8. For multiple years, reference explanations to the appropriate year.

  9. Net adjustments should be avoided since they are more difficult to understand and may present a question as to the actual amount at issue.

  10. Explanations should be objective in approach and neutral in tone. State "It has not been established" or "The claimed deduction is not allowable" rather than " You have not substantiated" or "You are not entitled to any deduction." Use "the amount of $1,000 is includible in gross income" rather than "you failed to report $1,000 " .

  11. Use the present tense in wording paragraphs rather than the past tense. This presents the Service's position as of the issuance date and does not affirm a prior decision.

  12. Use positive phrasing. State that the " allowable amount is" rather than the "disallowance is. "

  13. Qualifying phrases such as "based on the information in our files" should not be used as it implies the Service is using information unknown to and withheld from the taxpayer.

4.14.1.6.7  (10-30-2004)
"Duplicate" Notices Defined

  1. "Duplicate" notices, a term used throughout this text, means an originally signed Letter 531 (DO) that is sent by certified or registered mail. The "Duplicate" notice may reflect a different address for the taxpayer than the " Original" notice.

4.14.1.7  (10-30-2004)
Reviewing the Notice of Deficiency

  1. To insure the accuracy of a notice of deficiency meeting the criteria in section 4.14.1.7.1 below, the notice will be reviewed by both the designated technical person and Area Counsel.

  2. The designated technical person will review the:

    1. Merits of the adjustments underlying the proposed deficiency.

    2. Accuracy of the content of the letters and forms.

    3. Wording of the explanation of adjustments.

    4. Ensure that the amounts reflected on the notice of deficiency match with the amounts on the attachments.

     

4.14.1.7.1  (10-30-2004)
Mandatory Area Counsel Review Criteria

  1. The Area Director and Area Counsel may decide that Area Counsel will not to review any of the notices of deficiency before issuance. Otherwise, as outlined in the following paragraphs (2 through 19, immediately below), certain notices of deficiency must be reviewed prior to issuance. The authority to issue a notice of deficiency rests with those Service officials delegated the authority by Servicewide Delegation Order 4-8 (formerly Delegation Order 77). The role of Area Counsel in this procedure is to provide advice on whether a notice of deficiency should be issued, and if so, to make recommendations concerning the issues to be asserted and the wording of the determination.

  2. Fraud penalty

  3. Transferee liability

  4. Burden of Proof cases: e.g., exceptions to the statute of limitations due to mitigation, substantial omission of income, accumulated earnings tax, illegal bribes or kickbacks, etc.

  5. Substantial deficiencies (in excess of $100,000) involving indirect methods of determining unreported income, use of Bureau of Labor statistics, or information returns. Pre-issuance review of these notices of deficiency is required because Area Counsel is expected to make affirmative allegations of fact with regard to any issues for which the government has the burden of proof when answering a Tax Court petition.

  6. Notices where the deficiency plus penalty exceeds $250,000 without considering offsets

  7. Jeopardy and termination assessments

  8. Doubt as to proper party to which the notice should be sent

  9. Alternative positions

  10. Issues affecting related parties: parent and subsidiary corporations, corporate distributions, corporate reorganizations and similar issues or facts.

  11. High profile media attention cases where the appropriateness of conducting the examination may be questioned. Examples include cases where the taxpayer is famous or notorious, had a prior criminal case which was the subject of media attention, or any case involving politicians, congressional hearing witnesses, or allegations that the Service had examined the taxpayer for impermissible reasons.

  12. Difficult legal issues

  13. Department of Justice, Chief Counsel or Area Counsel recommendation to issue notice

  14. Complex international issues

  15. Unique, recurring or complex issues

  16. Coordinated issues

  17. Notices issued prior to June 15, 2005, where any of the tax periods included in the notice bear Project Code 127, Offshore Credit Card, case designation.

  18. Notices involving Munro calculations or notices involving oversheltered returns. See IRM 4.14.1.14.5, below.

  19. Any notice, regardless of amount, that the Area Director (or designee) believes warrants Area Counsel review.

4.14.1.7.2  (10-30-2004)
Area Counsel Review

  1. If Area Counsel suggests changes to the proposed notice, the following actions will be taken.

    1. Area Counsel will provide written directions and guidance on how to perfect the notice.

    2. Examination will consider Area Counsel's proposed changes and modify the notice as directed, if in agreement.

    3. Disagreements will be initially discussed between the Area Counsel attorney providing advice and the Technical Services Group Manager.

    4. An override of Area Counsel's advice must be done in writing by means of an Area Director memorandum outlining the reasons for not following Area Counsel's recommendations.

     

  2. All written communications to/from Area Counsel should be kept in the case file.

4.14.1.7.3  (10-30-2004)
Area Counsel Review Timeframes

  1. A notice of deficiency subject to mandatory review must be submitted within the following timeframes.

    1. To the designated technical person with at least 120 days remaining on the statute.

    2. To Area Counsel with at least 60 days remaining on the statute.

    3. Area Counsel will return cases to Examination within 45 days. The designated technical person will take follow-up actions on cases that have been pending in Area Counsel more than 45 days.

     

4.14.1.7.4  (10-30-2004)
Informal Advice From Area Counsel

  1. Other communications with Area Counsel are encouraged to informally resolve questions while notices are being prepared. Area Offices may seek informal advice for any case for which the office feels Area Counsel advice is warranted.