Internal Revenue Service Manual – Guidelines For IRS Agents
The Internal Revenue Manual (IRM) contains the official compilation of all internal management documents of the Internal Revenue Service. If tax professionals study the IRM, they will be able to understand the working procedures of the IRS. In the third part of a three-part series, this article focuses on the IRM’s procedures for dealing with tax return examinations. The first article (Tax Practice, Sept. 18,2000) focused on the IRM’s treatment of taxpayers who are unable to pay their taxes, and the second article (Tax Practice, Sept. 25,2000) focused on the IRM’s treatment of taxpayers who haven’t filed their taxes.
IRM 4.2 Examination of Returns Handbook
The procedures for dealing with taxpayers who have returns that are being examined are contained in the Examination of Returns Handbook, IRM 4.2. The handbook provides the basic procedures, guidelines, and requirements for revenue agents and tax auditors when they are conducting income tax examinations.
Internal Revenue Code section 7602 provides any authorized IRS officer or employee the authority to examine any books, records, papers or any other data that may be relevant or material, and to take the testimony of the person concerned under oath that is relevant to the inquiry. The IRS can issue an administrative summons to any person with possession, custody, or control of records. Although IRC section 7602 is powerful, it has some limitations, including constitutional limitations under the Fourth and Fifth amendments, a requirement of reasonable time and place for examination as provided under IRC section 7605(a), a restriction of unnecessary examinations under IRC section 7605(b), and a requirement for relevant questions when information is compelled by administrative summons.
Responsibilities of Examiners
IRS examiners are responsible for determining the correct tax liability as prescribed by the IRC. Examiners are expected to identify the applicable law, correctly interpret its meaning in light of congressional intent, and correctly apply the law based on the facts and circumstances of the case in a fair and impartial manner.
Examiners also must ensure that all taxpayers’ rights are observed, and they must know about the rights provided by the Taxpayer Bill of Rights 1 and 2, the IRS Restructuring and Reform Act of 1998, and IRS policies. Examiners are expected to assist taxpayers in solving any tax problems identified during an examination, even if the problems are not associated with the examination. Examinations may make referrals to the Taxpayer Advocate when it is appropriate and to Collection personnel if taxpayers have questions about current or past collection actions.
IRS policy prohibits examiners from examining a tax return if a relationship impairs impartiality. A conflict of interest exists if an examiners personal relationships or private interests (usually of a financial or economic nature) conflict, or raise a reasonable question of conflict, with the examiners public duties and responsibilities. (IRM 18.104.22.168.3) Examiners must avoid any situation that creates a conflict of interest or creates a reasonable question of a conflict of interest with their official duties. If an examiner is assigned a tax return for examination that might create a real or apparent conflict of interest, he or she must notify the group manager. IRS Policy Statement P-4-5 also prohibits examiners from examining a tax return if they have examined a return for the same taxpayer for one of the three preceding tax periods unless there has been an intervening examination by a different examiner. (IRM 22.214.171.124)
The first step in the examination process is to identify potential issues on the return. An in-depth, precontact analysis includes reviewing the return to identify large, unusual, or questionable items (LUQs) that will be examined for a correct determination of the tax liability. The definition of an LUQ depends on the examiner’s perception of the return as a whole and is the separate items that make up the return. Some of the factors that are considered when identifying the LUQs include: the comparative size of the item, the absolute size of the item, the inherent character of the item, evidence of the intent to mislead, beneficial effect of the manner in which an item is reported, its relationship to other items, wipsaw issues (such as the transaction benefits one party and harms the other), automatic adjustments, and missing items. (IRM 126.96.36.199.1)
IRS auditing is a gathering of evidence to evaluate the accuracy of a tax return. Some potential evidence includes the taxpayer’s testimony, the taxpayer’s books and records, the examiners observations, and documents obtained from third parties. (IRM 4.2.3) Each examiner determines the appropriate amount of evidence and establishes the proper depth of examination. To gather evidence, examiners will interview taxpayers, tour business sites, inspect residences, examine the taxpayer’s records, and reconcile bank records. Examiners will pursue an examination until a reasonable determination of the correct tax liability can be made.
Examiners Draw Their Conclusions
After all the facts have been gathered from interviewing the taxpayer, examining the records and supporting documents, and interviewing third parties, the examiner will use his or her professional judgment to arrive at a conclusion. Examiners are expected to arrive at a definite conclusion by a balanced and impartial evaluation of the evidence. Examiners have authority to recommend disposition of all identified issues, and any issues raised by the taxpayers. Once examiners reach their conclusions, the findings are communicated to the taxpayer, face-to-face, by explaining proposed adjustments and the authority for the examiners positions. The examiner will request the taxpayer’s position on any unagreed issues and seek payment of additional tax for any agreed issues.
Taxpayer’s Response to Examination Report
Preliminary (30 day) letters provide taxpayers with a copy of the examination report and advise them of their appeals rights when they do not agree with the results of the examination. The taxpayer may respond by requesting an appeal. For any case in which the total amount of proposed additional tax, additions to tax and penalties, proposed overassesment, or claimed refund, credit, or abatement for any tax period does not exceed $25,000 a request for an appeal is made using small case procedures. Those procedures requires a written request asking for Appeals consideration, indicating the changes the taxpayer does not agree with and his or her reasons for disagreement. A case with a deficiency exceeding $25,000 requires a formal written protest. If the taxpayer submits a formal written protest, the Service will determine whether the protest is adequate, the examination should be developed further, or the examiners report should be modified.
Request and protests will be returned to the taxpayer if they are incomplete, and additional time will be granted to perfect the documents needed. The case will be returned to the examiner for further development if the request or protest contains information warranting consideration. Examination group managers, at their discretion, may discuss disputed issues with taxpayers in an attempt to resolve the issues and obtain agreements. If an agreement cannot be reached, the cases are forwarded to the IRS Office of Appeals for settlement negotiations.