Dealing with Internal Revenue Service Income Tax Audits
Chaffin, Royce E., Busby, George, The National Public Accountant
The first of a 3-part series
Section 6001 of the Internal Revenue Code requires every person liable for federal tax or its collection to keep records sufficient to determine income and to render statements, file returns, and comply with rules and regulations issued by the Internal Revenue Service (IRS). These returns are sometimes audited (or examined, in the language of the Service) to verify compliance. These audits may be by correspondence from the Service Center processing the return or from a District Office where the taxpayer resides or conducts business. A district office audit may be an office visit where the taxpayer goes to an IRS facility or a field audit held at the place of business. Other than disagreements over the technical application of the tax rules, most of these audits are handled without incident so long as established procedures are followed. This paper discusses these procedures and what may generally be expected in dealing with the IRS audits.
AUDITS OF TAX RETURNS
Although the IRS checks virtually all tax returns for obvious errors, relatively few returns are actually audited. The IRS attempts to select tax returns for audit that have the highest probability of error. Income tax returns least likely to be audited are those in which all or substantially all of the income was subject to withholding and the taxpayer elected not to itemize. The likelihood of an audit may be increased when the taxpayer requests a ruling or a determination letter or files a claim for refund or the IRS discovered a substantial deficiency on audit of a prior year's return. Audits may also be anticipated when the IRS discovers discrepancies between the return and related information returns or the return was prepared by a return preparer who has a history of preparer violations or misconduct.
Most returns subjected to IRS audits are selected by a computer program called Discriminant Function System (DIF). Various components of a return are assigned points, with greater deviation from "norm" being assigned greater points. These factors are based, in part, on the Taxpayer Compliance Measurement Program and, in part, on statistical results of prior examinations.
Those returns with the higher DIF scores are pulled for a special classifications review. Usually, experienced employees will gather, on a temporary basis, at the regional Service Center to review the selected returns. Those that are deemed to have a high potential for adjustments - either for or against the taxpayer - are routed to the appropriate district office.
The purpose of a tax return audit is to determine the taxpayer's substantially correct tax liability. Examinations of records will be at a sufficient depth to fully develop relevant facts concerning issues. The examiner is to perform the work in a "fair and impartial manner." The examining officer is directed to raise issues only when they have merit, never arbitrarily or for trading purposes. At the same time, the examining officer won't hesitate to raise a meritorious issue.
Generally, where the taxpayer's books and records are located, or where the principal investigative work is to be performed will determine where an audit will be conducted. If the audit can be made more expeditiously and conveniently in another district, or a different office within a district, the taxpayer or representative may request that the case be transferred. The convenience of the Government is the principal consideration in approval.
If a non-business individual taxpayer has had an examination of the same issue in either of the two preceding years with nothing more than small changes, the examiner may, but is not required to, terminate the exam. Documentation may be required to prove the prior audits examined the same issue(s) being currently questioned.
The taxpayer may bring supporting witnesses to an audit and may be represented by an attorney, certified public accountant, or person enrolled to practice before the IRS. …