1. Page 57
Who is Being Audited?
Of the million 1040s audited (0.7%) 76.4% were correspondence exams, but the focus on business returns continues:
Gross Receipts - $100 - $200 K 2.2%
Gross Receipts - $200 K 1.9%
Schedule F – 0.4% (actually less than the general population)
Issue: Harder to find an individual who understands the issues of a business return
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2. Page 58
Who is Being Audited?
Of the million 1040s audited (0.7%) 76.4% were correspondence exams, but for non-business returns:
AGI $200K - $1M 1% (this is a 20% reduction from prior years)
AGI $1M – 5.8% (this is a 40% reduction from prior years)
The Winner (well kind off) smaller corporate returns (only a 10% reduction)
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3. Page 58-59
Who is Being Audited?
IRS has announced a special audit project on Farm returns
Will be conducted in Holtsville, NY (not exactly farm country), i.e. correspondence exams
Focus on problem issues –
Deposits and Supplies
Custom Hire
Fuel Expenses
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4. Dealing Successfully with Audits
Page
Dealing Successfully with Audits
The five step process of successfully dealing with an audit
Make sure the return is properly prepared.
Review the appointment letter and see if you can limit the scope of the audit.
Prepare and Research
The audit itself
Wrap it Up
Success
Wrap Up
Audit Day
Prepare & Research
Review Exam Ltr
Return Correctness
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5. Dealing Successfully with Audits
Page 60
Dealing Successfully with Audits
The five step process of successfully dealing with an audit
An audit should not be looked at as a process of climbing over an IRS fence but of a joint effort to determine the correctness of the return
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6. Dealing Successfully with Audits
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Dealing Successfully with Audits
The five step process of successfully dealing with an audit
Our job guide IRS through what was the process of preparing the return
Facts
Law
Documentation
The return itself
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7. Dealing Successfully with Audits
Page 60
Dealing Successfully with Audits
The five step process of successfully dealing with an audit
Prepare the return (perhaps again) to discern its level of correctness
If not your return, prepare return again
If your return, do it again, what happens during the heat of battle is oft times incorrect.
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8. Dealing Successfully with Audits
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Dealing Successfully with Audits
Audits almost always begin with the determination that something is wrong. How do we proceed from there: Every standard of practice requires the notification of the client but what if they decline.
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9. Dealing Successfully with Audits
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Dealing Successfully with Audits
What if the client says NO to disclosure, IRS gives limited guidance, but AICPA Statements on Standards for Tax Services says:
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10. Dealing Successfully with Audits
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Dealing Successfully with Audits
Now is the time wrap up Step 1:
Go to e-services and review the wage and income transcript to verify that it matches the return.
Does the return track with the records reviewed without the pressure of filing deadlines
Have there been law changes, court decisions, etc. that affect the return, i.e. the retroactive Medicare premium change
Are there elections that were missed on the return that can now be cured.
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11. Dealing Successfully with Audits
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Dealing Successfully with Audits
The five step process of successfully dealing with an audit
What can we do to limit the scope?
Demonstrate compliance
Provide summary data
Educate about the taxpayer
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12. Dealing Successfully with Audits
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Dealing Successfully with Audits
We have the appointment letter what do we do? Call the auditor to?
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13. Dealing Successfully with Audits
Page 63
Dealing Successfully with Audits
We have the appointment letter what do we do?
Call the auditor to?
Schedule the appointment based on:
The auditors schedule
Your schedule
A amenable compromise
Cautiously make the appointment considering all parties including your client.
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14. Dealing Successfully with Audits
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Dealing Successfully with Audits
We have the appointment letter what do we do?
Provide what information prior to exam?
Send the examiner everything you can.
Send them nothing
What information
The best solution is deal with the easy straight forward items to reduce time during an in person exam. These skills must be learned as the percentage of correspondence exams will increase.
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15. Dealing Successfully with Audits
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Dealing Successfully with Audits
The five step process of successfully dealing with an audit – Tell them about the taxpayer The results were
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16. Dealing Successfully with Audits
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Dealing Successfully with Audits
Limit the scope or reducing the level of inquiry by precise statements
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17. Dealing Successfully with Audits
Page 63
Dealing Successfully with Audits
Limit the scope or reducing the level of inquiry by precise statements
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18. Page 65
Repetitive Audits
By policy IRS provides restrictions on “repetitive audits”
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19. Repetitive Audits IRM 4.10.2.13 Repetitive Examinations
Page 65
Repetitive Audits
IRM Repetitive Examinations
By definition business returns are “not eligible” of the repetitive audit procedures BUT:
Show IRS the compliance history of the taxpayer
The repeat of the same issues is not the best use of resources for the IRS
Present information that can allow the examiner to write the case up and close it.
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20. Economic Reality Audits
Page 66-67
Economic Reality Audits
An outcome of the bill of rights the economic reality audit is prohibited by IRC 7602(a) – UNLESS the IRS has a “reasonable indication” of such reported income Reality only slows the IRS down from their fishing attempts
Our task is to demonstrate to the IRS is that they are fishing in the wrong place(s)
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21. Economic Reality Audits
Page 67-68
Economic Reality Audits
By policy IRS provides restrictions on “repetitive audits” – but lacks clear definition
Indirect methods of examination
Bank deposits method
Cash transaction method
Net worth method
Percentage of mark-up method
Unit and volume method
When this information is based on circumstantial evidence or unidentified sources
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22. Economic Reality Audits
Page 68-69
Economic Reality Audits
By policy IRS provides restrictions on “repetitive audits” – IN PRATICE
IRC 7602(e) does not prevent IRS from requesting bank records from those who derive a substantial part of their income from sole proprietorships
IRS can also use these techniques when 1099 reporting has indicated that there has been “significant” amounts of unreported income
When confronted with these issues discuss up front with examiner what will be required to prove the correct amount
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23. Prior and Subsequent Years Returns
Page 68
Prior and Subsequent Years Returns
In February of 2009 TIGTA reported in
that:
That while IRS policy indicates that an exam is to cover ALL open periods they frequently are not doing so.
38% of sample cases in the review by TIGTA never request the prior and subsequent years
21% of sample cases during the primary year exam indicated that non-exam year returns should be examined but were not
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24. Prior and Subsequent Years Returns
Page 68
Prior and Subsequent Years Returns
TIGTA has recommended –
Ensure group managers emphasize open year return review
Ensure that workpapers reflect justification of action
Require the use of MULTI-YEAR lead sheets during examination.
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25. Prior and Subsequent Years Returns
Page 68-69
Prior and Subsequent Years Returns
IRS Response - IRS management agreed with TIGTA recommendations. Management will reemphasize the requirements for consideration of prior and/or subsequent year returns by ensuring appropriate content is included in the Fiscal Year 2009 Examination All Managers’ Outcome – It has become VERY difficult to escape the multi-year write up if any issues are discovered in year of focus, i.e. just plan on it if you got issues.
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26. Prior and Subsequent Years Returns
Page 69-70
Prior and Subsequent Years Returns
Issues of renewed emphasis on prior and subsequent year returns Obtaining a successful resolution of the exam year can assist the practitioner in limiting the scope of additional inquiry Practice Pointer – Knowing that IRS has refocused its efforts on open non-exam years means we MUST manage our client’s expectations regarding the same
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27. Dealing Successfully with Audits
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Dealing Successfully with Audits
The five step process of successfully dealing with an audit
Research is important – There are many free tax research sites available i.e. legalbitstream.com or do a google search
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28. Page 71
Research
Auditors have not the depth of experience and many of the resources that you and I enjoy – give them a reason to accept your story. Provide copies of court cases or rulings that support your position – Frequently you will discover these items make their way into the work papers when making a FOIA request.
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29. Dealing Successfully with Audits
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Dealing Successfully with Audits
Remember there is a significant difference between preparation and exam. Preparation – Client completes organizer listing cell phone usage of $600 of which we make reasonable inquires in conjunction with disclosure of record keeping requirements of IRC 274D We have completed the engagement within the best practice requirements of our professional
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30. Dealing Successfully with Audits
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Dealing Successfully with Audits
Remember there is a significant difference between preparation and exam. Exam – The taxpayer now must demonstrate to the acceptance of the auditor that he has complied with the level of record keeping required of listed property if the taxpayer fails the expenses are not deemed to be allowable under IRC 162 as “normal, usual, or customary” – Ronald A Tash v. Comm., TC Memo
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31. Dealing Successfully with Audits
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Dealing Successfully with Audits
Reality – in exam the auditor will have the ability to yield judgment of what constitutes documentation – while there should not be unreasonable verification normally gets more difficult as you move through the process. Problem – Clients refuse, do not have records, decisions need to be made of how far do we pursue issues of insufficient documentation – understand the standards required of different types of expenses
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32. Dealing Successfully with Audits
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Dealing Successfully with Audits
By having a healthy respect for the actual condition of the return (reality) you are representing can go a long way to a better outcome and less expense for your client
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33. Dealing Successfully with Audits
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Dealing Successfully with Audits
The five step process of successfully dealing with an audit
Does the client attend the audit?
Never
Maybe
Yes
Only if they make me
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34. Dealing Successfully with Audits
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Dealing Successfully with Audits
The examination process can be found in the IRM (Internal Revenue Manual) Part 4 Chapter 10
Understand the agent’s playbook
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35. Dealing Successfully with Audits
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Dealing Successfully with Audits
The IRS is currently operating under an enormous amount of pressure, both time capital and money
By establishing credibility and believability you can lower the bar
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36. Dealing Successfully with Audits
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Dealing Successfully with Audits
The LUQ Large Unusual Questionable curiosity
Tax Return
Reduce or Eliminate the curiosity by explaining the Large, Unusual and Questionable
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37. Dealing Successfully with Audits
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Dealing Successfully with Audits
IRM (4) Methods for accumulating evidence
Analytical Tests – Comparisons and Relationships
Documentation – Books and Records
Inquiry – Interview of Taxpayer (or Rep)
Inspection – Take a look at the assets
Observation – Tour the business
Testing – Trace transactions/Conditions of the books
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38. Dealing Successfully with Audits
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Dealing Successfully with Audits
The analysis of the Examiner IRM – Risk Analysis (Retitled in 2016)
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39. Dealing Successfully with Audits
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Dealing Successfully with Audits
The Critical Concepts IRM The 80/20 Concept IRM – Mid-Audit Decision Point 50% rule
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40. Dealing Successfully with Audits
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Dealing Successfully with Audits
Some important concepts from an IRS perspective:
Correspondence is not an interview
Oral Testimony is a significant factor when documents are not available
Notify the taxpayer that appeals requires 365 days remaining in statute, i.e. expect an extension request.
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41. Dealing Successfully with Audits
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Dealing Successfully with Audits
Cohan v. Comm. - IRS has been working to reduce use of this rule
Was George M. Cohan born on the 4th of July
Nope – He was actually born on July 3rd, 1878.
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Chapter 2: Audits

42. Dealing Successfully with Audits
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Dealing Successfully with Audits
But the IRS says that the taxpayer MUST attend but the taxpayer or/and I do not want them to do so:
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43. Dealing Successfully with Audits
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Dealing Successfully with Audits
The auditor says he does not care and he will go around my power to FORCE the taxpayer to attend:
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44. Dealing Successfully with Audits
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Dealing Successfully with Audits
This is what they have IRM – Taxpayer’s presence Required?
May not be required without summons.
Representative must be clearly knowledgeable of the taxpayer.
Examiners must not be perceived as violating rights of representation.
The request is only voluntary.
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45. Dealing Successfully with Audits
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Dealing Successfully with Audits
The revenue agent is advised to not take extensive notes during the interview Abe’s practice advise
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46. Dealing Successfully with Audits
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Dealing Successfully with Audits
Do I let the IRS into the taxpayer’s place of business?
– Authorized to visit to establish facts that can only be verified by a direct visit
… However, consideration should be given to the cost effectiveness and practicality …
As the representative give consideration to the nature and character of the business, i.e. public versus private spaces.
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47. Dealing Successfully with Audits
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Dealing Successfully with Audits
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48. Dealing Successfully with Audits
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Dealing Successfully with Audits
The reason for the confusion of home office inspection trips:
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49. Dealing Successfully with Audits
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Dealing Successfully with Audits
Your ability to communicate what the taxpayer is all about will mean a lot.
– Evaluation Methods and Tests – Be prepared to discuss the taxpayer’s internal controls
and – Reliable versus Unreliable Books and Records – Consider the value of reconstruction of them if deficient. But disclosure of fact is recommended
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50. Dealing Successfully with Audits
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Dealing Successfully with Audits
So if there are no records, everything was a guess and the return is a work of fiction, you:
Keep talking, story telling is a lost art.
Beg for forgiveness, IRS does have a heart
Prepare a new set and hope for the best
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51. Dealing Successfully with Audits
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Dealing Successfully with Audits
Consider preparation of something akin to M-1 when dealing with a 1040 return and present to the auditor – this can help enormously in focusing on the numbers and not on procedures.
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52. Dealing Successfully with Audits
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Dealing Successfully with Audits
The bank records – IRS continues to have a fixation with bank records in general Practice Pointer – Take the bank statements and reconcile them to return – Explaining ALL deviations of deposits that are not reported as gross income in some manner. Agents are being taught that bank account reconciliations are process critical as IRM
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53. Dealing Successfully with Audits
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Dealing Successfully with Audits
Have the bank account discussion with the client before the examination if possible: SEPARATE BANK ACCOUNTS ARE A MUST
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54. Dealing Successfully with Audits
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Dealing Successfully with Audits
The bank account analysis is not without risk to IRS, note the statement in
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55. Market Segment Specialization Program (MSSP) Guides
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Market Segment Specialization Program (MSSP) Guides
Much of this information has become dated as it has not be addressed by IRS in several years.
Exercise care in its usage, i.e. specific, old statistics and practices no longer prevalent in the industry discussed.
Most of this guidance is now labeled ATG (Audit Technique Guides) by IRS
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56. Dealing Successfully with Audits
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Dealing Successfully with Audits
Doing a search on will present the collection of ATG (Audit Technique Guides)
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57. Dealing Successfully with Audits
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Dealing Successfully with Audits
The conduct of the exam phase of an audit is the purest form of improvisation. We must interpret and react based on what is happening to help our taxpayer/client. This will be based on our experiences, skill and preparation
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58. Dealing Successfully with Audits
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Dealing Successfully with Audits
The five step process of successfully dealing with an audit Check the examiner’s work, i.e. go to your software and enter the adjustments. It is not unusual they got it wrong.
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59. Dealing Successfully with Audits
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Dealing Successfully with Audits
Its finally over what can we expect:
The RAR (Revenue Agent’s Report) also referred to as the 30 day letter, failure to respond or agree will bring:
The SND (Statutory Notice of Deficiency) or 90 day letter and with no action after the 90 day period has passed the tax is assessed.
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60. Dealing Successfully with Audits
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Dealing Successfully with Audits
Statute Extension - Careful:
Request to extend the statute – Form 872 which will be requested if less than 180 days are left prior to expiration (365 if appeals is requested).
Form 872A an open end statute agreement that should NEVER be signed.
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61. Page 106
Computer Records
To what extent can the IRS demand access to the taxpayer’s computer systems:
IRM (08/31/2002) - Can the IRS demand computer records? – Like all taxpayer records they can demand what they want it is up to the taxpayer whether they comply.
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62. Computer Records IRM 4.47.2.7 – Obtaining Computerized Data Page 106
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63. Page
Computer Records
It is the practitioner’s job to “limit the scope of the exam”
There is no specific directive or regulation regarding the “request” for the QB files
While common place to request electronic data it is within the agent’s and manager’s discretion to accept other forms of compliance
Agents are instructed to only look at data for the current year!

64. Dealing Successfully with Audits
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Dealing Successfully with Audits
Well it is all over and we represented our client well because we:
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65. Working on Audits
Representing a client in an exam is a primary part of many practices but some firms prefer not to do that kind of work:
By a show of hands:
We like audits it is a primary source of revenue after filing season.
We will not do audits.
The only audits we do are those of returns we filed.
Many of our audits after we investigate the issues reveal many errors that need to be addressed.
The Five Step process of exam looks like a process that can help our audit work.
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