IRS Audits - Part 4 Examining Process

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

IRS Audits

Chapter 23. Employment Tax

Section 10. Report Writing Guide for Employment Tax Examinations

4.23.10  Report Writing Guide for Employment Tax Examinations

4.23.10.1  (02-01-2003)
Overview

  1. This Section provides instructions for preparation of examination reports covering employment tax examinations. It also discusses certain related procedures that are necessary both to have an efficient report writing system and to reduce examination time applied to a case.

  2. Section 10 applies to all employment tax examinations whether conducted by field or office techniques.

  3. The examiner's report is the record of his/her findings and recommendations regarding the investigation of a taxpayer's liability for tax. It is the document from which reviewers may determine whether the examiner has properly developed the case and has correctly applied the law, regulations, etc., to the facts in the particular case. Also, it may become the evidence on which the Government relies in a court case. Since the taxpayer ordinarily receives a copy of the report, it serves as a formal presentation to the taxpayer of the findings and recommendations of the examiner.

  4. Preparation of an examination report is a very important part of the examiner's duties. The examination report should be clear, concise, and to the point. All adjustments must be properly explained and supported by appropriate references to the applicable laws, regulations, court decisions, rulings, etc., on which the examiner based his/her findings.

  5. Under no circumstances should a change report of employment tax adjustments be incorporated into an audit report covering income tax adjustments.

  6. Additional guidelines can be found in IRM 4.10.8, Reporting Writing.

4.23.10.2  (02-01-2003)
Scope

  1. The Report Writing Guide for Employment Tax Examinations is for all examining officers (revenue agents, revenue officer examiners, and tax compliance officers) who conduct examinations of employment tax returns.

4.23.10.2.1  (02-01-2003)
Purpose

  1. The objective of this material is to provide you with the necessary tools to:

    1. Minimize time-consuming research for instructions on preparing reports;

    2. Minimize the number of cases returned by reviewers for correction of errors;

    3. Ensure the use of correct forms; and

    4. Promote uniformity.

     

4.23.10.2.2  (02-01-2003)
Manner of Presentation

  1. This Guide is designed to be flexible enough to permit some latitude in presenting findings and at the same time establish consistency. The Guide will demonstrate how to effectively write your report.

  2. The line by line instructions for completing the various forms will explain, in depth, a variety of situations that may not be specifically illustrated.

4.23.10.3  (02-01-2003)
Disclosure

  1. Revenue agents, revenue officer examiners, and tax compliance officers should consider the disclosure provisions of the Manual when preparing agreed and unagreed case reports.

4.23.10.4  (02-01-2003)
Survey of Employment Tax Return Before Assignment

  1. An employment tax case selected for examination is considered as surveyed before assignment when it is disposed of without communication with taxpayers or their representatives and before assignment to an examiner.

  2. Group managers should survey returns before assignment if no examination is warranted, or if the number of returns assigned to the group exceeds the number which can be examined and processed within the examination cycles. This authority extends to employment tax referrals under IRC section 6020(b).

  3. A stamp, approximately 3” X 1” in size, will be procured locally and will be imprinted on each return surveyed. The form of the stamp should be as follows:

    CLOSED SURVEY BEFORE ASSIGNMENT
    ___________  ___
    Group Manager Signature  Date

4.23.10.5  (02-01-2003)
Survey of Employment Tax Return After Assignment

  1. A case will be closed "Survey After Assignment" if after analyzing the employment tax return and without contacting the taxpayer or representative or reviewing any records, the examiner believes that an examination of the return would result in no material change in tax liability.

  2. Examiners are required in cases closed by "Survey After Assignment," to stamp the return as indicated in (5) below. Group managers are required to approve any return closed "Survey After Assignment " by signing the face of the return under the examiner's signature. When an examiner surveying a return after assignment considers it necessary to explain the survey action, he/she should use Form 2503 (Survey after Assignment-Excise or Employment Tax).

  3. In the case where a return is received from another area and the other area only made the initial contact with the taxpayer (without commencement of the examination and/or inspection of the books and records), the receiving area may apply the survey after assignment procedures if the return does not warrant examination. Letter 1024(DO/lN/SC) can be used to notify the taxpayer.

  4. Procedures for the survey of claims are found in IRM 4.23.13.

  5. A stamp, approximately 3” X 1” in size, will be imprinted on each return surveyed. The form of the stamp should be as follows:

    CLOSED SURVEY AFTER ASSIGNMENT
    ___________ ___
    Examiner Date
    ___________  ___
    Approved Group Manager  Date

4.23.10.6  (02-01-2003)
Notification Letters in No-Change or No-Liability Cases

  1. In every examined no-change employment tax case not involving a claim for refund in which the taxpayer or representative was contacted, the taxpayer will be notified by Letter 590 (SC/DO/lN) that the liability reported has been accepted without change. If a complimentary no-change letter is deemed appropriate in a particular case, a specially composed typewritten letter will be prepared in lieu of Letter 590. The manager must approve all nonstandard letters. The Letter 590 is generally sent to the taxpayer by the area support staff.

  2. When a Letter 590 is sent, the form number and date of the letter will be noted on the tax return by the use of an appropriate stamp, e.g., "Letter 590 sent…......" . A copy Letter 590 will be retained in the case file

  3. Occasionally, it is necessary to send a Letter 590 to a taxpayer who has elected to take credit on a subsequent return of an overpayment discovered by an examiner (see IRM 4.23.8.6.3 and IRM 4.23.8.6.4). In such a case a footnote to that effect should be inserted on the bottom of the no-change notification letter.

  4. In all cases where the taxpayer has erroneously treated workers as independent contractors, and where relief is provided by Section 530 resulting in no adjustments for this issue, a special notification letter will be provided to the employer to inform all affected workers of the determination, so as not to deprive the workers of any state or other regulatory agency benefits afforded to an employee. (See Exhibit 4.23.8–3)

    1. Document the Form 4318–A to alert future examiners of your conclusion.

    2. Close case as a Change/No Change. (See IRM 4.23.10.10 for worker notification.)

     

  5. A no-change examination report will be furnished to the taxpayer in all no-change cases on Form 4666. A copy should also be sent to the representative, if applicable.

  6. Refer to IRM 4.23.10.12.4 for special employment tax report writing procedures relating to no-change examination cases.

4.23.10.7  (02-01-2003)
Notification Letters in Agreed Cases

  1. In agreed employment tax cases, the examiner will prepare and furnish the taxpayer with a copy of the report at the conclusion of the examination. If the additional tax was not paid, the examiner will indicate the last day for an interest-free adjustment on the letter. When such a report clears Technical Support, the taxpayer is so notified by the form letter as prescribed below:

    1. Additional tax or overassessment—Letter 1002(DO).

    2. Delinquent tax—Letter 1002(DO).

     

  2. A copy of the audit report will not be sent to the taxpayer with Letter 1002. The Letter 1002 is mailed by the Support Staff.

  3. The original report (Form 4666, 4667 or 4668) will be stamped "L–1002 mailed—." by the Support Staff.

4.23.10.8  (02-01-2003)
30–Day Letters

  1. Since employment tax cases do not require the issuance of a Notice of Determination (except for Section 7436 cases), the 30-day letter will be issued in employment tax cases to advise taxpayers of all unagreed proposed adjustments to their tax liabilities and of conclusions reached in no-change cases involving the disallowance in full of claims for refund. 30–day letters are not issued on cases accepted for Fast Track resolution.

  2. A copy of the examination report and agreement Form 2504 (Agreement to Assessment and Collection of Additional Tax and Acceptance of Overassessment–Excise or Employment Tax) and/or Form 2504–WC (for worker classification and section 530 issues) will accompany the 30–day letter. In delinquency cases do not send the "Substitute for Return" with the 30–day letter.

  3. 30–day letters are designed for specific types of cases. These letters advise taxpayers of appeal rights. Available letters are listed below:

    1. Letter 950 (DO)—For all unagreed employment tax cases, except those involving claim disallowances or reconsideration of disallowed claims. Separate 30–day letters should be issued when both section IRC 7436 and non-section 7436 issues are present. One Letter 950 should indicate the IRC section 7436 issues and the other Letter 950 will contain the non-section 7436 issues.

    2. Letter 569 (SC/DO)—For claim disallowance cases.

    3. Letter 953 (DO)—For reconsideration of disallowed claims, no modification of prior determination warranted.

     

  4. Publication 3498, "The Examination Process" , will accompany each of the letters listed in (3) above when they are used for unagreed employment tax cases.

  5. 30–day letters will be sent by ordinary mail, except when in the judgment of the Area Director or LMSB Program Manager the use of certified mail is deemed advisable. If certified mail is used, return receipts will be requested.

  6. After the 30-day letter has been mailed, the case will be placed in the 30-day suspense file pending further action by the taxpayer.

    1. If an agreement is received in response to the 30-day letter, assemble the case for closure (see IRM 4.23.10.20), and forward to the manager for review.

    2. If payment is received with the agreement, follow the procedures in IRM 4.23.11.3.

    3. If the taxpayer fails to file a protest, follow procedures in (9) and (10) below.

     

  7. When a taxpayer submits a protest in response to the 30-day leter and requests that the case be referred to the Appeals Office, the procedures in IRM 4.23.10.17.4, Review of Protests, should be followed. However, assessments prior to appeal may be granted if they are in the best interest of the government for non-section 7436 issues..

  8. If the taxpayer does not file a protest letter seeking review by Appeals, the proposed tax involving IRC section 7436 issues (worker reclassification/Section 530) may not be assessed. Instead, upon expiration of the 30-day period, the examiner mustsend the taxpayer a NDWC notice under the procedures in IRM 4.23.10.9. This suspends the statute of limitations for employment taxes dependent on the worker classification and section 530 determinations.

  9. If the taxpayer does not respond to proposed adjustments involving non-section 7436 issues, the case should be closed promptly after the 30-day period (including extensions) has expired as unagreed.

  10. When a taxpayer's case involves an issue which is recurring in nature, or for other reasons immediate consideration by Appeals Office is desired, the words "RECURRING ISSUE" should be annotated on Form 3198 in red.

4.23.10.9  (02-01-2003)
Special Procedures for Notices of Determination of Worker Classification or Section 530 Treatment

  1. Effective August 5,1997, section 1454 of the Taxpayer Relief Act of 1997, Public Law 105–34, created IRC section 7436 of the Internal Revenue Code. IRC section 7436 provides Tax Court review rights concerning certain employment tax determinations. As originally enacted, IRC section 7436 only applied to employment tax cases in which the Service determined that at least one worker should be reclassified as an employee and/or that the taxpayer was not entitled to relief under section 530 of the Revenue Act of 1978. The law requires that any employment tax that depends upon such determinations cannot be assessed unless the taxpayer has been given an opportunity to file a petition for Tax Court review of the Service's determinations on those two issues.

  2. Section 314(f) of the Community Renewal Tax Relief Act of 2000, effective January 22, 2000, amended IRC section 7436(a), to expand the subject matter jurisdiction of the Tax Court in employment status proceedings, retroactively to August 5, 1997. The amendment authorized the Tax Court to also determine the proper amount of employment tax and penalties (IRC sections 6651–6665) with respect to the determinations of worker status and section 530 treatment.

  3. SIRC section 7436(a) does not provide the Tax Court with authority to review any employment tax determinations other than the three listed in the statute. They are:

    1. Review the Service's determination that one or more individuals performing services for the taxpayer are employees;

    2. Review the Service's determination that the taxpayer is not entitled to treatment under section 530(a) of the Revenue Act of 1978 with respect to those individuals; and

    3. Determine the proper amount of employment tax under the above determinations.

     

  4. For purposes of providing taxpayers with notice of its determinations on worker classification and section 530 relief, the Service will utilize a "Notice of Determination of Worker Classification" (hereinafter referred to as "notice of determination" or " NDWC notice" ). The Notice of Determination has been officially designated as "Letter 3523" . See Notice 2002-5, (2002–3 IRB 320, January 22, 2002) and Publication 3953 for more information. A sample copy of a NDWC notice is included in this handbook as Exhibit 4.23.10–1.

  5. The examiner should prepare the Notice of Determination and attachments and forward the package to the Technical Support Office. Since the Notice of Determination is a statutory notice, Technical Support will review, sign and issue the Notice of Determination with attachments.

  6. In the future, the Notice of Determination may be revised, in response to statutory amendments, court opinions, and feedback from Service employees and the public. Thus, employees should examine Letter 3523 on the Form/Pubs/Products Repository page on the IRWeb (to verify that the version of the Notice of Determination that they wish to use is the current version. Service employees should NOT make changes to the language of the Notice of Determination as it appears on the Website.

4.23.10.9.1  (02-01-2003)
General Overview of Section 7436 Procedures

  1. In most cases, a taxpayer who is issued a Letter 3523, will have previously received a "30-day letter" , which the Service sends to taxpayers in unagreed examination cases. If the taxpayer does not respond to the 30-day letter by agreeing to the proposed adjustments or by filing a protest to Appeals, the taxpayer will receive a NDWC notice. If the taxpayer files a protest to Appeals and the IRC section 7436 issues are not settled agreed in Appeals, the taxpayer will be sent a NDWC notice. Tax Court proceedings seeking review of IRC section 7436 issues may not be started prior to the time the Service sends the NDWC notice.

  2. The issuance of a NDWC notice is the beginning of prospective litigation. Tax Court Rule 34(b)(8) requires that the petition shall have appended thereto a copy of the Notice of Determination plus so much of the accompanying statements as is material to the issues to which the error is assigned. Thus, if a case goes to the Tax Court the explanatory paragraphs become a part of the basic pleadings for the Commissioner. They set the pattern upon which the Government's case may be tried, and care must be exercised in the statement of grounds for the determination of the asserted liability.

  3. Enclosures with Notice of Determination —Every Notice of Determination (Letter 3523) should have the following enclosures:

    • Form 2504–WC (Agreement to Assessment and Collection of Additional Tax and Acceptance of Overassessment in Worker Classification cases),

    • Form 4666 (Summary of Employment Tax Examination),

    • Form 4667 (Examination Changes– Federal Unemployment Tax),

    • Form 4668 (Employment Tax Examination Changes Report),

    • Any schedules with explanations of the proposed assessment, and

    • Publication 3953 (Questions and Answers About Tax Court Proceedings for Determination of Employment Status Under IRC section 7436).

     

  4. Taxpayer Notification — Letter 3523 advises the taxpayers of the opportunity to seek Tax Court review and provides information on how to do so. Publication 3953, "Questions and Answers About Tax Court Proceedings for Determination of Employment Status Under IRC section 7436" , contains additional information and should always be sent to the taxpayer as an enclosure with the NDWC notice. The NDWC notice and Publication 3953 also advise taxpayers of the right to contact a Taxpayer Advocate.

  5. Names of Reclassified Workers— Table 1 of the Notice of Determination must be completed to identify the workers the Service has determined should be classified as employees. The Tax Court has indicated that a NDWC notice that does not contain the names of reclassified workers is flawed.

    1. Table 1 on page 2 of the Notice of Determination is used by examiners to list the reclassified workers' names and to mark (using an "x" or "✓" )the quarters for which the workers are being reclassified. Do not list dollar amounts in Table 1.

    2. If there is confusion among similarly named individuals, examiners should also indicate the social security number in the "name" column.

    3. If names are not available, examiners should provide the job description of the workers and make sure that an attachment to the Notice of Determination explains what steps were taken to obtain the names and why the names were unavailable.

     

  6. Amount of Tax — Table 2 of the Notice of Determination must include the Service's determination of the proper amount of employment tax, additions to tax, and/or penalties that arises from treating the workers listed in Table 1 as employees.

    1. The information about the proposed employment tax assessment must be moved from the attachments (Form 4667 and/or 4668) to Table 2 of the Notice of Determination.

    2. The amounts must be organized by type of employment tax (Old Age, Survivor, & Disability Insurance, Hospital Insurance, Income Tax Withholding, and FUTA) rather than by type of return and listed separately for each quarter.

    3. The total FUTA tax will be reported in the December 31 period.

    4. Copies of Forms 4666, 4667 and 4668 must be attached to the Notice of Determination to show the taxpayer which rates were used in calculating the employment taxes

     

  7. Form 2504–WC— A Form 2504–WC must be included as an attachment with Notice of Determination to provide taxpayers with an opportunity to agree to the proposed employment tax adjustment administratively. Form 2504–WC contains the statement that allows taxpayers to waive restrictions on assessments under IRC sections 7436(d) and 6213(a). Therefore, the taxpayers must be informed that Tax Court review is not available for agreed cases. It can only be sought if there is a controversy with respect to the proper amount of tax under the determinations of worker classification and/or section 530 issues, i.e., an unagreed case.

  8. Last Day to File a Tax Court Petition — On the front page of Letter 3523, the Service will provide the taxpayer with the date that represents the last day on which a timely Tax Court petition may be filed by the taxpayer. A taxpayer must file its petition with the Tax Court before the 91st day after the date the notice of determination was mailed by certified or registered mail. That means that the last day on which a timely Tax Court petition may be