IRS Audits - Part 4 Examining Process

[ Home ] [ Services ] [ FAQ ] [ Site Map ] [ Contact Us ]

IRS Audits

Chapter 19. Liability Determination

Section 1. Campus Examination Operations (Cont. 5)

4.19.1  Campus Examination Operations (Cont. 5)

4.19.1.6 
Discretionary Programs

4.19.1.6.32 
Gambling Issues (Income and Losses) - General

4.19.1.6.32.2 
Evaluating Gambling Issue Responses

4.19.1.6.32.2.3  (10-01-2004)
Replies – General Processing

  1. Use the following table when processing replies.

    Processing Taxpayer Replies to Letter 566 and Subsequent Letters
    If And Then
    The taxpayer replies to L566, L525, L692 or the 90 day letter with information to support gambling losses You are able to determine that he is entitled to the entire deduction Close the case "no change.."
    The taxpayer replies to L566 or L525 with information to support gambling losses You are able to verify that the taxpayer is entitled to part of the amount claimed Issue L 525 or L692 with Form 4549 and an appropriate explanation.
    The taxpayer replies to L566 or L525 with information to support gambling losses You are able to determine that the taxpayer is not entitled to any part of the deduction Issue L 525 or L692 with F4549 and an appropriate explanation.
    The taxpayer replies to L566, L525 or L692 with information to support gambling losses You are able to determine that the line 27 amount belongs on another line Issue L 525 with F4549 and an appropriate explanation.
    The taxpayer replies to the 90 Day letter with information to support gambling losses You are able to verify that the taxpayer is entitled to part of the amount claimed Issue L 555 with a revised F 4549 and an appropriate explanation to the taxpayer.
    The taxpayer replies to the 90 Day letter with verification of his deduction You are able to determine that the taxpayer is not entitled to any part of the deduction Issue L555 with the latest F4549.
    The taxpayer replies to the 90 Day letter with verification of his deduction You are able to determine that the line 27 amount belongs on another line Issue L 555 with a revised Form 4549 and an appropriate explanation to the taxpayer. Do not increase the deficiency as shown on the 90 day letter.

4.19.1.6.32.2.4  (10-01-2004)
No Response Cases

  1. Take the following action if the taxpayer has not replied to the most recent letter by the normal purge date:

    Latest Letter Issued Rule broken Action
    566 206 Prepare L 525 & Form 4549 disallowing the gambling losses. Use standard explanation #9412.
    566 207 Prepare L 525 & F4549 disallowing the gambling losses and adding the unreported gambling winnings. Use standard explanations #1407 and #9412.
    525 or 692, and the F4549 reflects a deficiency 206 or 207 Follow normal procedures to have Statutory Notice issued based on the adjustments shown on F4549.
    525 or 692, and the F4549 reflects an overpayment 206 or 207 Close the case DC08.
    90 Day letter 206 or 207 Close the case DC10

4.19.1.6.32.3  (10-01-2004)
Special Gambling Closing Procedures

  1. When closing cases consideration must be given to the disposition of receipts to the taxpayers. Receipts will not be returned to the taxpayer as a matter of practice. All verification of losses must be retained with the case file. If the verification is not substantial, for example a statement from a casino, it can be retained in the closed case file. If the documentation would be difficult to file, retain the records in a retrievable method for a period of nine months.

  2. Provided the IRS and the Taxpayer agree as to the amount of the losses verified on the documentation, there is no reason to retain the receipts. If the taxpayer request the receipts be returned, contact the taxpayer by telephone to confirm his request. Explain that there is no longer a tax requirement to retain the receipts. If the taxpayer insists, the tickets must be stamped before they are returned.

  3. If the taxpayer does not address the disposition of unredeemed tickets, retain them for a period of nine months after the case closes.

  4. The DCI must also remain with the case file until the review is complete.

4.19.1.6.33  (01-01-2006)
Health Coverage Tax Credit

  1. Health Coverage Tax Credit (HCTC) is a fully refundable prepayment credit available to two distinct groups of taxpayers:

    1. Workers who have been displaced by foreign trade and who are eligible to receive Trade Adjustment Assistance (TAA) or Alternative Trade Adjustment Assistance (ATAA) benefits, and

    2. Pension recipients covered by the Pension Benefit Guaranty Corporation (PBGC).

    The term eligible individual in this text refers to a person meeting a) or b) above.

  2. HCTC is computed on Form 8885 and

    1. Is equal to 65% of the premiums paid by an eligible individual for qualifying health insurance covering that person and any qualifying family members.

    2. Eligibility is determined on a month-by-month basis. An eligible coverage month is any month that a person is deemed to be an eligible individual by either a state workforce agency or the PBGC

    3. December 2002 is the first month that HCTC became available.

     

  3. Advance HCTC became available in 2003.

    1. The HCTC Processing Center forwards payment of 100% of the cost of health insurance coverage for a person enrolled in the advance payment option directly to the insurer or health care provider.

      • Department of Treasury pays 65% of the premiums (TC 971 AC 171)

      • The eligible individual reimburses the HCTC Processing Center 35% (TC 971 AC 170)

       

    2. Advance HCTC payments are reported on Form 1099-H and Form 8885, line 6

    Refer to Publication 502 and the following web site below for more in-depth information concerning this credit. http:// win.web.irs.gov/hctc.htm

4.19.1.6.33.1  (01-01-2006)
The HCTC Test Program – Project Code 505

  1. Procedures for the program are dependent on whether other issues are classified and whether the credit has been posted to the taxpayer’s account.

    Returns are classified for HCTC and related issues such as Medical and Dental Expenses on Schedule A, Self-employed Health Insurance Deduction (SEHID), and Archer Medical Savings Account (MSA) Deduction

    1. Refer to:

      i) Publication 502, Medical and Dental Expenses
      ii) Publication 535, Business Expenses
      iii) Publication 969, Medical Savings Accounts (MSAs)
      iv) IRM 4.19.1.6.23 for information about related medical issues

       

    2. Consult your manager concerning any large, unusual or questionable items not previously classified on the return.

    ..

  2. Unallowable 89

    1. See 3.12.3.69.2.6

    2. Unallowable 89 will be coded if HCTC claimed was equal to or greater than $10,000 and was not disallowed during return processing for any of the following:

      1) a tax year prior to 2002
      2) taxpayers age 66 or older
      3) Form 8885 not attached
      4) the taxpayer did not check any boxes on Form 8885

       

    3. See IRM 4.19.1.6.18 for unallowable procedures.

     

  3. Returns are categorized as "Processed" claims if HCTC is posted to the account. TXMOD of a processed claim should include transaction code (TC) 766 in an amount equal to the HCTC claimed on Form 8885.

    1. Beginning with processing year 2004, TC 766 should include credit reference number (CRN) 250

    2. Consult the work leader if HCTC was adjusted in some other manner (example: TC 291, TC 806, TC 766 with CRN 336).

     

  4. Returns are worked as "Unprocessed" claims if the credit is not posted to the account.

    Exception:

    If HCTC is posted to the account and the erroneous amount is frozen or was offset to another tax year and/or to Debtor Master File (DMF), then follow the instructions for Unprocessed claims until case closure. When closing the case, follow the procedures for Processed claims, however send a certified claim disallowance letter unless "no changing" the return or the taxpayer signs the waiver.

     

  5. The HCTC Program Office provides a database of eligible individuals with processed claims selected for examination. The database is located on the Austin Examination web site. Access the HCTC Eligibility Database to determine:

    1. The eligible coverage months, and

    2. Whether potential eligibility was based on TAA/ATAA or PBGC benefits.


    See your work leader if the eligible individual is not in the database.

4.19.1.6.33.2  (01-01-2006)
HCTC Taxpayer Initial Contact

  1. Consider any health insurance records filed with the return, HCTC Eligibility Database information, and IDRS account prior to contacting the taxpayer

  2. If HCTC is the only issue, and the total credit is clearly unallowable, do not send inquiry letter, issue appropriate disallowance letter.

    Pre-refund Claims – Source Code 30 Post-refund Claims – Source Code 06

    • Send Letter 566D (HCTC)

    • Send Letter 566 (HCTC)

    • Include Form 886-HCTC and any other Forms 886 applicable for classified issues

    • Include Form 886-HCTC (see Exhibit A) and any other Forms 886 applicable for classified issues

    • Update to status 10

    • Update to status 10

    • Suspend the case for 45 days

    • Suspend the case for 30 days

    • Follow general claims procedures in IRM 4.19.1.7.5 through to case closure

    • Follow instructions for disallowing all examined issues under Responses~ Processed Claims if the taxpayer does not respond

     

4.19.1.6.33.3  (01-01-2006)
HCTC Responses

  1. Follow procedures in the table below to process replies.

    1. General

      If Then
      The eligible individual did not have qualifying coverage as of the first day of the eligible coverage month Do not allow premiums paid for anyone’s coverage for that month in HCTC computation.
      The eligible individual had other specified coverage as of the first day of an eligible coverage month Do not allow premiums paid for anyone’s coverage for that month in HCTC computation
      An otherwise qualified family member had other specified coverage as of the first day of an eligible coverage month Do not allow premiums paid to cover the family member for that month in the computation of HCTC.
      A family member did not have qualifying coverage as of the first day of an eligible coverage month Do not allow premiums paid to cover the family member for that month in the HCTC computation.
      The taxpayer is a non-custodial parent Do not allow premiums covering the child of divorced or separated parents in the computation of HCTC.
      Health insurance premiums were paid to cover a family member who was not claimed as a dependent Do not allow premiums paid for the non-qualifying member in the computation of HCTC unless the taxpayer is the custodial parent who has waived the right to claim the exemption over to the non-custodial parent on Form 8332 or a similar statement.
      Premiums covering ineligible months were used to compute the HCTC claimed Do not allow payments for ineligible coverage months in HCTC computation.
      Advance HCTC payments were not included on Form 8885 Re-compute allowable HCTC
      A Health Savings Account (HSA) or an Archer MSA distribution (Form 1099-MSA) was not included on Form 8885, Subtract the distribution from allowable premiums and re-compute the HCTC.
      The eligible individual was a PBGC recipient under age 55 as of the first day of an eligible coverage month Do not allow premiums paid for coverage for that month in the HCTC computation.
      The taxpayer requests a meeting with an Appeals officer Consult the manager. Appeal rights are generally not applicable to HCTC.
      Documentation is incomplete Disallow HCTC and any other unsubstantiated issues under examination.
      Verified payments for health insurance premiums are unallowable for HCTC but qualify as a Schedule A, Self-employed Health Insurance, HSA, or Archer MSA deduction Advise the taxpayer to file an amended return to claim the disallowed premiums as a deduction from income unless a double tax benefit was previously claimed.
      HCTC and other classified issues are fully substantiated Allow all issues and close the case.

      Note:

      Math verify Form 8885

       

    2. Processed Claims

     

    If Then
    Disallowing HCTC only

    • Send Letter 510 (HCTC) and Form 9465

    • Include Form 886-A explaining the reason for the adjustment

    • Include an explanation that we are not adjusting other examined issues if other issues were checked on Letter 566 (HCTC)

    • Include an interest computation schedule

    • Update to status 22

    • Suspend the case for 45 days

    • Follow instructions for disallowing HCTC under Case Closure~Processed Claims if no response is received.

    Note:

    HCTC is not subject to deficiency procedures.
    Allowing HCTC but disallowing other classified issues

    • Send Letter 525 with an examination report.

    • Include an explanation that we are not adjusting HCTC.

    • Follow normal deficiency procedures in IRM 4.19.1.4 through to case closure.
    Disallowing both HCTC and other classified issues

    • Send Letter 525 with an examination report.

    • Include Form 886-A explaining the HCTC adjustment and soliciting payment.

    • Follow normal deficiency procedures in IRM 4.19.1.4 through to case closure.

     

4.19.1.6.33.4  (01-01-2006)
Case Closure

  1. Follow procedures in the table below for case closure.

    Note:

    A completed data-gathering instrument (DGI) is required prior to case closure or transfer.

     

    1. Unprocessed Claims:

      Pre-refund Claims:
      If Then
      Allowing HCTC, Use credit reference number (CRN) 250 with the allowable amount in block 15 of Form 5344.
      Disallowing HCTC in whole or in part, Provide a detailed explanation on Letter 105C or 106C.

       

    2. Processed Claims:

     

    Post-refund Claims:
    If And Then
    Allowing HCTC Form 5344 does not include changes to tax, income, or other credits,

    • Use DC 02 in block 13 of Form 5344.

    • Input "no change" issue code 61065 in block 41.
    Disallowing HCTC TC 766 does not include a CRN,

    • Input CRN 767 with the unallowable amount and a minus sign (-) in block 15 of Form 5344.

    • Use disposal code (DC) 08 in block 13 unless assessing a deficiency.
    TC 766 includes CRN 250,

    • Input CRN 250 with the unallowable amount and a minus sign (-) in block 15 of Form 5344.

    • Use DC 08 in block 13 unless assessing a deficiency.
    HCTC is posted to the account in any other manner (see above),

    • Consult the work leader for the appropriate reversal code.

    • Use hold code 3 in block 7 of Form 5344 to prevent a notice.

    • Use DC 08 in block 13 unless assessing a deficiency.
    Some portion of the unallowable HCTC was offset to the Debtor Master File (TC 898) or another tax year (TC 826)

    • Complete Form 3465 instructing Special Handling to reverse the credit transfer

    • Use hold code 4 in block 7 of Form 5344 to hold the notice.

    • Issue Letter 105C or 106C
    The TP has fully repaid an erroneous refund (TY 2003 and subsequent)

    • Input TC 270 for $0.00 in block 12 of Form 5344

    • Input history items on TXMOD indicating the erroneous refund amount.
    Full payment of erroneous refund has not been received (TY2003 and subsequent) Follow Category D erroneous refund procedures (taxpayer error):

    • Use hold code 3 in block 7 of Form 5344 unless hold code 4 is required for a payment transfer.

    • Input TC 844 with the refund date using command code (cc) REQ77.

    • Input TC 470 with closing code 93 and posting delay code 1 using cc REQ77.

    • Complete From 12356 and attach a copy of the case file

    • Input history items on TXMOD indicating the erroneous refund amount After cc AMCLSE:

    • Attach a TXMOD print to the Form 12356 package and refer it to Accounting via Form 3210.

    • Open a status M control on TXMOD showing the referral

    • Close the TXMOD control on receipt of Form 3210 acknowledgement from Accounting.



    Refer to IRM 21.4.5.6 for additional information.
      A refund is frozen with TC 576 Issue Letter 105C or 106C.
    The tax year is 2002 and/or HCTC was claimed due to IRS error Consult your work leader or manager for instructions.

4.19.1.6.34  (10-01-2004)
Self-Employed Health Insurance Deduction

  1. A taxpayer may be able to deduct part or all of the amount paid for health insurance, if the taxpayer is one of the following:

    • A self-employed and has a net profit for the tax year from a Schedule C- EZ, or F

    • A shareholder owning more than 2% of the outstanding stock of an S Corporation (or is considered as owning more than 2% by reason of the attribution rules under IRC 318) with wages reported on Form W-2, or

    • A partner with net earnings from self-employment reported on line 15a of Schedule K-1 (TY 2003 Form 1065).

     

  2. For tax years prior to 2003, the employee-shareholder may claim 70% of the amount paid as an adjustment to income; the taxpayer may take the remaining 30% on Schedule A if they itemize. (See (4) below for reductions.)

  3. Beginning in 2003 and thereafter, employee-shareholder may claim 100% of the amount paid (See (4) below).

  4. In calculating the deductible amount, taxpayer should use the Self-Employed Health Insurance Worksheet in the Instructions to the 1040 which indicates the deduction is the lesser of a) the amount paid for health insurance coverage or b) net profit or earned income from the business under which the insurance plan is established, minus any deductions claimed on the 1040 for One-Half of the Self-employment Tax and contributions to Self-Employed SEP, SIMPLE, and Qualified Plans

  5. Taxpayers not receiving a W-2 may receive a 1099 for self-employed income. Generally, the taxpayer prepares a Schedule C to report this income but it may appear on the "Other Income" line. Ensure the taxpayer has reduced this income by any expenses applicable to the earning of this income to arrive at net income. Taxpayers who are in business as a self-employed writer, inventor, artist, etc. should report their income on Schedule C, and apply appropriate expenses to obtain net income.

  6. Earned income includes net earnings and gains from the sale, transfer, or licensing of property the taxpayer created. It does not include capital gain income. If the taxpayer was a more-than-2% shareholder in the S corporation under which the insurance plan is established, earned income is his wages from that corporation.

  7. Constructive ownership of stock under IRC 318 applies to taxpayer’s spouse, his children, grandchildren and parents.

  8. For purposes of the deduction, a two-percent-plus shareholder’s wages from the S corporation are treated as the shareholder’s earned income. No deduction is allowed in excess of an individual’s earned income derived from the trade or business with respect to which the plan providing the health insurance coverage is established.

  9. For employee-shareholders the health insurance premiums must be paid in the current year by the corporation and included in the wages (generally shown in box 14 of the W-2) of the employee-shareholder. The amount may include payments for insurance covering the taxpayer,