|
Presented by
for all IRS tax issues, problems and emergencies. of interest to taxpayers and consultants Testimony by Alvin S. Brown before the House Ways and Means Committee
States Offer
in Compromise
Innocent
Spouse Relief
IRS Collection
|
Ten Most Important Things to Know About IRS Tax AuditsFor Urgent Help Call (888) 712-7690. Attorney-Client Privilege protects this communication. Located near Northern Virginia? Call now to schedule a free-of-charge walk-in. Internal Revenue Code Section 7602 authorizes the Secretary or a delegate to examine books and records and to take testimony under oath. Your return may be examined for a variety of reasons, and the examination may take place in any one of several ways. After the examination, if any changes to your tax are proposed, you can either agree with those changes and pay any additional tax you may owe, or you can disagree with the changes and appeal the decision.
If you want to avoid an IRS audit, you should know the situations that the IRS targets for examination. The IRS focuses on high-risk areas of non-compliance. IRS Abusive Scheme Groups have been established and the use of Fraud Specialists have increased. To identify and address promoter activity, an IRS Promoter Lead Development Center has been created. The Center systematically monitors the Internet to identify promoters of abusive activities and develops cases for injunctive investigations. For example, the IRS effort will generally focus first on tax shelter promoters and then on participants in these various schemes. The following are some of the IRS targets: Offshore credit card users. It is not illegal to have an offshore credit card. However, the IRS thinks there is a reasonable basis for believing that some people are using offshore credit cards to evade paying U.S. taxes. Credit cards provide easy access to offshore funds and accounts in tax haven countries that allow income to be hidden. U.S. citizens must pay tax on their worldwide income. This is one of the largest “red flag” issues targeted by the IRS. An offshore credit card guarantees and IRS audit. High-risk, high-income taxpayers. High-income returns are often more complex and, generally, upper income taxpayers have resources to engage in pass-through entities such as partnerships, trusts and corporations. The IRS utilizes a combination of filters to identify high-risk, high-income returns. The returns selected for examination will be those most likely to have unreported income or structured transactions. A structured transaction is one with limited economic benefit and whose primary purpose is to reduce or eliminate a tax liability. Structured transactions are generally done through one or more pass-through returns, such as Forms 1065 or 1120-S. The pass-through returns create paper losses that flow back to individual income tax returns offsetting income from other sources. Do not think that just because you are a low income or middle income taxpayer that you will not get audited if you are involved with another high risk “red flag” issue such as an offshore tax shelter. Abusive schemes and promoter investigations. The IRS places a top priority on pursuing promoters of abusive schemes, shelters. IRS makes it a high priority to combat abusive schemes and scams. The IRS will always audit abusive tax promotions. In auditing these transactions, the IRS assumes that investors who participate have a fraudulent intent by participating in the scams. You have a high risk in these audits if your are not represented by an experienced and qualified tax attorney. Scams targeted by the IRS include: Schemes, reducing a person’s tax liability by claiming inflated expenses, false deductions, unallowable credits or excessive exemptions. Frivolous return arguments, telling taxpayers compliance is voluntary or the U.S. Constitution does not provide for tax collection. The IRS will try to turn an innocent belief into tax fraud. There are too many people who are misled into frivolous argument. If someone is trying to convince you that there is a tax “loophole” – please check that argument with a tax attorney. The IRS can easily twist a well-intentioned belief into a perception of tax fraud. Promotion of slavery reparation claims, scams that claim compensation for people who have ancestors who were slaves. Abusive shelters and trusts, investments established for the purpose of hiding income from taxation. Any plan to hide income will be treated as willful tax fraud. Employment tax schemes, employee leasing, paying in cash and filing false payroll tax returns. Never lie in a tax return unless you want to go to jail. Your signature in a tax return is an affidavit. A false statement in a tax return can be treated as tax fraud under IRC 7204. Non-filers. The “willful failure to file tax returns” can be treated as a felony and a non-filer can be sent to jail for 5 years. The good news is that the voluntary filing of a tax return will eliminate the “felony” risk. IRC 7203. The IRS focuses on the most egregious and high-risk segments of the population. The non-filer strategy identifies the most egregious non-filers. However, even for low income and middle income taxpayers, you have a criminal risk under IRC 7203 unless you voluntarily file a tax return. Always file your tax returns. If you have an unfilled tax return, you will always get a 25% non-filing penalty and a 20% underpayment penalty. Giving the IRS 45% in penalties plus interest for not filing is just plain stupid. If you are missing information, you can still file a tax return if you disclose the numbers you are estimating. In short, you can file a tax return that is incomplete or with estimates as long as you make a disclosure statement attached to the tax return. You can also file an amended tax return when information becomes available to you. You do not have to make payments with your tax return if you do not have the money to pay your tax debt – you should still file the tax return to eliminate the 25% non-filing penalty. See a qualified and experienced tax attorney in these circumstances because you may qualify to get your tax debt eliminated in an Offer in Compromise. Trusts and then identifying participants in an effort to evade taxes. Forming an offshore trust is the quickest way to be selected for an IRS audit. Do not even think of an offshore trust in the absence of a provable business purpose. You can expect that the IRS will assume that you sent property offshore to willfully evade your tax liability. Unreported income. The “willful failure to pay tax” can be treated as a felony and the failure to pay can be treated as a felony under IRC 7201 and 7203. However, if tax returns are filed, your tax liability can be reduced (and eliminated in some cases) in an Offer in Compromise. Any effort to deal with your tax liability will eliminate the felony risk. Unreported income represents the largest component of the tax gap.Unreported Income Discriminate Index Formula (DIF)The IRS has developed a new tool for identifying returns with a high probability of unreported income. A DIF is a mathematical technique used to score income tax returns as to examination potential. These formulas were developed based on available NRP data. Each return measured under DIF receives a DIF score. Generally, the higher the score, the greater the audit potential. The highest scored returns are made available to Examination upon request. DIF mathematical formulas are kept confidential by the IRS.All individual returns are computer scored under the DIF System. Corporation returns having no balance sheet or assets under $10,000,000 are computer scored under the DIF System. The IRS programs the DIF with high error rate items such as home office expense deductions, foreign bank accounts, persons with un-filed tax returns, etc. ll individual returns have traditionally been assigned a DIF score rating the probability of inaccurate information on the return. The new UI DIF score rates the probability of income being omitted from the return. The IRS has customarily used indirect examination methods to identify unreported income but until now has had no systemic method for selecting the returns at highest risk for unreported income. UI DIF gives the IRS the ability to systemically identify returns at high risk for unreported income and beginning this fall all returns will receive a UI DIF score in addition to the traditional DIF score. The National Research Program National Research Program (NRP) examinations, measure reporting compliance and identify compliance issues. NRP will enable the IRS to improve the examination selection process. NRP is very different from its predecessor, the Taxpayer Compliance Measurement Program (TCMP). NRP no longer relies heavily on time-intensive, “line-by-line” audits for establishing a baseline measure of reporting compliance. The IRS has not conducted updated research on the distribution of errors on returns for more than 13 years, a period when the economy and the tax law have changed dramatically. Without the information that will be gathered through NRP, the IRS will have less ability to direct examinations and other compliance activities with accuracy and precision. Other IRS Targeted Examination Programs – the annual “Dirty Dozen.” This list is updated every year. The IRS is primarily looking for tax fraud in this targeted list of the “dirty dozen.” Telephone Excise Tax Refund Abuses: Early filings show some individual taxpayers have requested large and apparently improper amounts for the special telephone tax refund. In some cases, taxpayers appear to be requesting a refund of the entire amount of their phone bills, rather than just the three-percent tax on long-distance and bundled service to which they are entitled. Some tax preparers are helping their clients file apparently improper requests. The IRS is investigating potential abuses in this area and will take prompt action against taxpayers who claim improper refund amounts and against the return preparers who help them. Abusive Roth IRAs: Taxpayers should be wary of advisers who encourage them to shift under-valued property to Roth Individual Retirement Arrangements (IRAs). In one variation, a promoter has the taxpayer move under-valued common stock into a Roth IRA, circumventing the annual maximum contribution limit and allowing otherwise taxable income to go untaxed. Phishing is a technique used by identity thieves to acquire personal financial data in order to gain access to the financial accounts of unsuspecting consumers, run up charges on their credit cards or apply for loans in their names. These Internet-based criminals pose as representatives of a financial institution –– or sometimes the IRS itself –– and send out fictitious e-mail correspondence in an attempt to trick consumers into disclosing private information. A typical e-mail notifies a taxpayer of an outstanding refund and urges the taxpayer to click on a hyperlink and visit an official-looking Web site. The Web site then solicits a social security and credit card number. It is important to note the IRS does not use e-mail to initiate contact with taxpayers about issues related to their accounts. If a taxpayer has any doubt whether a contact from the IRS is authentic, the taxpayer should call 1-800-829-1040 to confirm it. Disguised Corporate Ownership: Domestic shell corporations and other entities are being formed and operated in certain states for the purpose of disguising the ownership of the business or financial activity. Once formed, these anonymous entities can be, and are being, used to facilitate underreporting of income, non-filing of tax returns, listed transactions, money laundering, financial crimes and possibly terrorist financing. The IRS is working with state authorities to identify these entities and to bring their owners into compliance. Zero Wages: In this scam, a Form 4852 (Substitute Form W-2) or a “corrected” Form 1099 showing zero or little income is submitted with a federal tax return. The taxpayer may include a statement rebutting wages and taxes reported by the payer to the IRS. An explanation on the Form 4852 may cite statutory language behind Internal Revenue Code sections 3401 and 3121 or may include some reference to the paying company refusing to issue a corrected Form W-2 for fear of IRS retaliation. Return Preparer Fraud: Dishonest return preparers can cause many headaches for taxpayers who fall victim to their schemes. Such preparers make their money by skimming a portion of their clients’ refunds and charging inflated fees for return preparation services. They attract new clients by promising large refunds. Some preparers promote filing fraudulent claims for refunds on items such as fuel tax credits to recover taxes paid in prior years. Taxpayers should choose carefully when hiring a tax preparer. As the old saying goes, “If it sounds too good to be true, it probably is.” Remember that no matter who prepares the return, the taxpayer is ultimately responsible for its accuracy. Since 2002, the courts have issued injunctions ordering dozens of individuals to cease preparing returns, and the Department of Justice has filed complaints against dozens of others. During fiscal year 2006, 109 tax return preparers were convicted of tax crimes and sentenced to an average of 18 months in prison. American Indian Employment Credit: Taxpayers submit returns and claims reducing taxable income by substantial amounts citing an American Indian employment or treaty credit. Although there is an Indian Employment Credit available for businesses that employ Native Americans or their spouses, there is no provision for its use by employees. In a somewhat similar scam, unscrupulous promoters have informed Native Americans that they are not subject to federal income taxation. The promoters solicit individual Indians to file Form W-8 BEN seeking relief from all withholding of federal taxation. A recent “phishing” variation has promoters using false IRS letterheads to solicit personal financial information that they claim the IRS needs in order to process their "non-tax" status. Trust Misuse: For years unscrupulous promoters have urged taxpayers to transfer assets into trusts. They promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes. However, some trusts do not deliver the promised tax benefits. As with other arrangements, taxpayers should seek the advice of a trusted professional before entering into a trust. Structured Entity Credits: Promoters of this newly identified scheme are setting up partnerships to own and sell state conservation easement credits, federal rehabilitation credits and other credits. The purported credits are the only assets owned by the partnership and once the credits are fully used, an investor receives a K-1 indicating the initial investment is a total loss, which is then deducted on the investor’s individual tax return. Forming such an entity is not a viable business purpose. In other words, the investments are not valid, and the losses are not deductible. Abuse of Charitable Organizations and Deductions: The IRS continues to observe the use of tax-exempt organizations to improperly shield income or assets from taxation. This can occur when a taxpayer moves assets or income to a tax-exempt supporting organization or donor-advised fund but maintains control over the assets or income. Contributions of non-cash assets continue to be an area of abuse, especially with regard to overvaluation of contributed property. In addition, the IRS is noticing the return of private tuition payments being disguised as charitable contributions to religious organizations. Form 843 Tax Abatement: This scam rests on faulty interpretation of the Internal Revenue Code. It involves the filer requesting abatement of previously assessed tax using Form 843. Many using this scam have not previously filed tax returns and the tax they are trying to have abated has been assessed by the IRS through the Substitute for Return Program. The filer uses the Form 843 to list reasons for the request. Often, one of the reasons is: "Failed to properly compute and/or calculate IRC Sec 83-Property Transferred in Connection with Performance of Service." Frivolous Arguments: Promoters have been known to make the following outlandish claims: the Sixteenth Amendment concerning congressional power to lay and collect income taxes was never ratified; wages are not income; filing a return and paying taxes are merely voluntary; and being required to file Form 1040 violates the Fifth Amendment right against self-incrimination or the Fourth Amendment right to privacy. Don’t believe these or other similar claims. These arguments are false and have been thrown out of court. While taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the law. 2. IRS, employees, grantees and contractors cannot be discriminatory. Director, Office of Equal Opportunity Program Any person who believes that he/she has been discriminated against on the basis of race, color, sex, national origin, disability, reprisal or age, in programs or activities conducted (e.g., VITA, Taxpayer Assistance Centers) by the Department of Treasury - IRS may submit a written complaint to: Director, External Civil Rights Unit 3. You have a right to know why you were selected for an examination. Section 3503 of the IRS Restructuring and Reform Act of 1998 (RRA 98) requires the publication of the general criteria and procedures for selecting taxpayers for examination. As a matter of policy, if a taxpayer under examination requests the specific reason for his/her examination, the IRS examiner is required to provide the taxpayer with a response that is as accurate as possible, without revealing restricted use information. Preparation for an examination is more focused with insight into the reasons that provoked the examination. 4. You can be expected to be interviewed by the IRS Interviews provide to the IRS information about the taxpayer ’s financial history, business operations, and books and records. Interviews are used to obtain information needed to reach informed judgments about the scope/depth of an examination and the resolution of issues. Interviews are used to obtain leads, develop information, and establish evidence.
The “interview risk” is one of the reasons you need tax attorney representations. If the IRS examiner misstates what you say or twists what you say into a criminal admission, it is your word versus the word of the IRS. An attorney can prevent a communication issues as well as deal with the tax law technical issues. 5. The Examination An examination usually begins when you are notified that your return has been selected. The IRS will tell you which records you will need. The examination can proceed more easily if you gather your records before any interview. Any proposed changes to your return will be explained to you or your authorized representative. It is important that you understand the reasons for any proposed changes. You should not hesitate to ask about anything that is unclear to you. Recordings. You can make an audio recording of the examination interview. Your request to record the interview should be made in writing. You must notify the examiner 10 days in advance and bring your own recording equipment. The IRS also can record an interview. If the IRS initiates the recording, you must be notified 10 days in advance and you can get a copy of the recording at your expense. Transfers to another area. Generally, your return is examined in the area where you live. But if your return can be examined more quickly and conveniently in another area, such as where your books and records are located, you can ask to have the case transferred to that area. Repeat examinations. The IRS tries to avoid repeat examinations of the same items, but sometimes this happens. If your tax return was examined for the same items in either of the 2 previous years and no change was proposed to your tax liability, please you can prevent the examination. Examining books and Records. The IRS will examine your books and records. The examination of a taxpayer’s books and records serves two basic purposes: to analyze the likelihood that there are no material errors; and to determine that individual transactions are valid (allowable), have not been omitted, are recorded at the correct dollar value, are properly classified, and are recorded in the correct time period. If the taxpayer is under a record retention agreement with the Service, they must maintain magnetic tapes, disks, or other machine sensible data or media used for recording, consolidating, and summarizing accounting transactions and records within the taxpayer’s processing system. See Rev. Proc. 91–38 for further information on Record Retention Agreements. You need to be able to explain your accounting and record keeping system that may include explaining the flow of transactions or entries from the initial transaction, through all book entries and reconciliations to the tax return; or tracing specific income, expense, and, if applicable, balance sheet items through the accounting system (an accounting system includes all books of entry and all reconciliations); if applicable, tracing the flow of purchases and inventory through to Cost of Goods Sold.6. IRS MisconductThe IRS must follow the law written by Congress, they must follow IRS and Treasury Regulations, they are required to follow the IRS publications and their own Internal Revenue Manual. You cannot assume that the IRS follows the law or its own Internal Revenue Manual. If you have a problem with IRS error in following the law or its own rules, you can file a misconduct report with the Treasury Inspector General for Tax Administration (TIGTA). TIGTA was established under the IRS Restructuring and Reform Act of 1998 to provide independent oversight of IRS activities. Laws protect you from reprisals (any action taken against you because you filed this complaint). 7. Injured spouse exception When a joint return is filed and only one spouse owes past-due child and spousal support or a federal debt, the other spouse can be considered an injured spouse. An injured spouse can get a refund for his or her share of the overpayment that would otherwise be used to pay the past-due amount. You can get relief from joint and several liability on a joint return. Generally, joint and several liability applies to all joint returns. This means that both you and your spouse (or former spouse) are liable for any tax shown on a joint return plus any understatement of tax that may become due later. This is true even if a divorce decree states that a former spouse will be responsible for any amounts due on previously filed joint returns. In some cases, a spouse will be relieved of the tax, interest, and penalties on a joint tax return. Three types of relief are available.
To be considered an injured spouse, you must have: filed a joint return, received income (such as wages, interest, etc.), made tax payments (such as federal income tax withheld from wages or estimated tax payments) or claimed a refundable credit (such as the earned income credit), and reported the income and tax payments on the joint return. 8. You have a right to appeal disagreements, both within the IRS and before the courts. If you disagree with the findings of an IRS examiner, you may request a meeting with the examiner’s supervisor. If you still do not reach an agreement, or if the examination or other adjustment was conducted through correspondence, the IRS will send you a report and/or letter that explains the proposed adjustments. The letter also tells you of your right to request a conference with an Appeals officer, as well as how to make your request for a conference. If you request an Appeals conference, be prepared to support your position. If there the IRS Office of Appeals the examiner’s manager or appeal their case administratively within the IRS, to the U.S. Tax Court, U.S. Claims Court or the local U.S. District Court. If there is no agreement at the closing conference with the examiner or the examiner’s manager, the taxpayer has 30 days to consider the proposed adjustments and their next course of action. If the taxpayer does not respond within 30 days, the IRS issues a statutory notice of deficiency, which gives the taxpayer 90 days to file a petition to the Tax Court. The Claims Court and District Court generally do not hear tax cases until after the tax is paid and administrative refund claims have been denied by the IRS. The tax does not have to be paid to appeal within the IRS or to the Tax Court. A case may be further appealed to the U.S. Court of Appeals or to the Supreme Court, if those courts accept the case. If your examination or other adjustment was conducted through a personal interview with an IRS employee, the employee will explain your appeal rights to you. The IRS has an appeals system for people who do not agree with the results of an examination of their tax returns or with other adjustments to their tax liability. Appeals conferences are informal meetings. Your conference may be face-to-face, or by telephone, or by correspondence. You may represent yourself at an Appeals conference; or, if you want, you may have an attorney, a certified public accountant, or an individual enrolled to practice before the IRS represent you. If you do not reach agreement with the Appeals or Settlement Officer, or you do not wish to appeal within the IRS, you may appeal certain actions through the courts.
You generally have 30 days from the date of the 30-day letter to tell the IRS whether you will accept or appeal the proposed changes. The letter will explain what steps you should take, depending on which action you choose. Be sure to follow the instructions carefully. Appeal Rights are explained later. 90-day letter. If you do not respond to the 30-day letter, or if you later do not reach an agreement with an Appeals Officer, the IRS will send you a 90-day letter, which is also known as a notice of deficiency. 9. Alternative Dispute Resolution Fast Track Settlement (Large & Mid-Size Division Taxpayers) Fast Track Settlement (Small Business and Self-Employed) Fast Track Mediation (Small Businesses, Self-Employed Taxpayers) 10. You have a right to be represented by an attorney You are at a serious disadvantage is you are not represented by an experienced IRS tax attorney. Without representation, you may say something that the IRS examiner can twist into a criminal admission. The IRS examiners are aggressive and could come to a determination that is unreasonable and inconsistent with the applicable facts. An experienced tax attorney will be able to handle the complex technical and interpretative issues that may arise and be an advocate on your behalf on any of the factual or legal issues that may arise during an examination. You have a “confidentiality privilege” with an attorney. In order to be properly defended, it is important to make sure your attorney is aware of all facts, issues, and problems surrounding the years for which you are being examined. The current IRS is very aggressive and their determinations may be based on erroneous applications of law. Perhaps the most important reason to use a tax attorney is to have ongoing counsel when the IRS is aggressive on trying to find tax fraud or is otherwise aggressive on the factual and legal issues. The tax law is very complicated and you need tax attorney representation specializing in IRS issues and problems.
| |||||||||||||||||||||||||||||||||||||
Mr. Alvin Brown is a Former Supervisory Manager and Tax Attorney-Advisor, Internal Revenue Service, Office of Chief Counsel, IRS National Office in Washington, DC.
|