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IRS Audit Initiatives Innocent Spouse Appeal Rights Expanded Information Reporting Problems Circumvented
Editor: Mark
H. Ely, J.D., CPA
Editors note: Mr. Ely is former chair of the AICPA Tax Divisions Relations with the IRS Committee. Messrs. Taylor, Turner and Parker are members of the IRS Practice and Procedures Committee.
The IRS realizes that the old way of conducting its audits will be changed forever once it fully realizes two new endeavorsthe National Research Program (NRP) and the Small Business/Self-Employed Division (SBSE) audit reengineering project. The NRP replaces the notorious Taxpayer Compliance Measurement Program (TCPM). To meet the demands of these new compliance methods, both practitioners and the Service will have to be ready to make changes.
Reengineering the Audit Process The IRS had recognized that rapid improvements in work practices in the private sector were far ahead of its methods of auditing returns. In 2001, it began an ambitious examination reengineering project to completely rethink, redesign and modernize how it conducts audits. This was not only a good idea, but also a necessity; the IRS had not undertaken such a course of action since the early 1950s, when it established the current procedures. To evaluate the projects concepts, it initiated a pilot program in October 2002 in New York. Although the pilot was supposed to be completed in March 2003, it is still ongoing. When it is completed, the Service will analyze the results and make adjustments before the SBSE rolls it out nationally. The overhaul. With the help of Booz Allen Hamilton, the strategy and technology global consulting firm, the IRS initially analyzed the leading practices of over 200 organizations from the public and private sectors and determined that it needed to redesign four areas:
It also discovered that the following processes required improvement:
This analysis led to key concepts that the IRS will incorporate into the new audit process: 1. Return classification: This will be coordinated at the national level; by the time a case is assigned to an examiner, the audit issues will already have been designated by the classification function (CF). 2. Examination scope: The CF will designate specifically the issues the examiner will have to audit. 3. Manager involvement: Managers will be proactive, getting involved at the front-end, rather than reacting to problems as they unfold or at the conclusion of the audit. A group manager will approve audit plans and any changes in an examinations scope. The manager and examiner will also determine the time that will be needed to conduct an examination and will project a completion date. This will be discussed with the taxpayer and/or representative at an audit engagement meeting. 4. Workpapers and templates: Workpaper formats and approaches to specific audit items will be standardized to ensure consistency in examinations. 5. Audit engagement meeting: This will be the initial meeting between a taxpayer and/or a representative and an auditor (and, in some cases, a group manager). The purpose is to reach agreement on how the audit will be conducted, and to discuss the (1) examination issues, (2) time frames for responding to information document requests (IDRs), (3) projected completion date, (4) black out dates when the practitioner and/or the taxpayer will be unable to meet and/or furnish information (e.g., vacations, year-end closings and busy season) and (5) materiality of items to be examined.
Projects Effects What does the SBSE examination reengineering project mean for practitioners and taxpayers? Because examiners will focus more on specific issues, taxpayers and/or their representatives will have to be prepared to provide appropriate documentation as the examination progresses. Because the examinations scope is set and controlled nationally, the auditor should not be able to adjust either the scope or the materiality of items to be examined without a managers approval. The representative and/or taxpayer will also have to meet their obligations to the auditor for IDR response times, etc. If a problem develops during the examination that cannot be resolved with an examiner, a manager should be brought in at once. If the issue cannot be handled with the manager, it can be elevated to the Office of Appeals under Fast Track Mediation with a group managers approval, while the rest of the examination continues with the agent. Importantly, taxpayers do not lose their appeal rights under the reengineering projects provisions: the bottom line for both practitioners and the SBSE is more cooperation and coordination from both parties, which promotes success, reduces audit time, ensures fairness and encourages taxpayer compliance (IR News Release 2001-68 (8/2/01)).
NRP In addition to the SBSE audit reengineering, the other closely watched project is the NRP. This project, which began in fall 2002, is an IRS effort to determine how taxpayers are meeting their tax filing, reporting and payment obligations. It was initiated as part of the Internal Revenue Service Restructuring and Reform Act of 1998, which mandated that the IRS find ways of delivering services to taxpayers at much higher levels than in the past. In setting strategic goals to meet its service objectives, the IRS identified top quality service to each taxpayer in every interaction as its first goal. To accomplish this, it had to find a way to measure taxpayer compliance. The programs initial steps aim at individual taxpayers; later on, the program will probably be expanded to cover various business taxes as well. Unlike the TCMP, which was a very intrusive and detailed audit that required taxpayers to substantiate every single item on a return, the NRP will select on a national basis, a statistically valid sample of approximately 50,000 returns at various levels. The Service will use internal data to verify return items, to the extent possible. Approximately 8,000 of the sampled returns will not require taxpayer contact, as they will most likely be verified by the IRSs internal data. Approximately 9,000 returns will require correspondence, rather than a meeting with an auditor; roughly 30,000 returns will result in face-to-face audits. However, these examinations will probably be significantly less intrusive than the TCMP audits, because many of the return items will be verified by the IRS internally. Only selected return items will have to be fully substantiated, with appropriate documentation. Finally, there will also be calibration audits, which will check about 2,000 returns nationwide on a line-by-line basis, but will not require substantiation for every item. The IRS will use the NRPs results to recalculate discriminant function formulas, which means that NRP examinations will have to be thorough; see Internal Revenue Manual (IRM) 4.22.4.4.1 (10/1/02)). Line items subject to examination will have to be fully verified. If there are de minimis adjustments, they will have to be reported internally, but will not be part of any Revenue Agents Report; see IRM 4.22.4.4.3De minimis adjustments (10/1/02)). Taxpayers audited as part of the NRP retain all their appeal rights; thus, they can appeal unagreed issues. At the NRPs conclusion, the IRS hopes to have current, reliable compliance data on filing, remitting payments and reporting, which will help it better use its resources to provide more efficient service to taxpayers in the most cost-effective manner possible. From Stephen R. Buschel, CPA, MBA, BDO Seidman, LLP, New York, NY
Administrative Appeal Rights in Innocent Spouse Cases Under Sec. 6013(d)(3), married taxpayers filing jointly are jointly and severally liable for tax. In certain circumstances, Sec. 6015 provides innocent spouse relief from liability on request, as well as various administrative appeal rights to the requesting spouse. In Rev. Proc. 2003-19, the IRS has now granted some of these rights to nonrequesting spouses whose spouses or former spouses sought innocent spouse relief from joint and several liability under Sec. 6015. Prior to Rev. Proc. 2003-19, the Service had given only the spouse requesting relief the right to file a written protest and receive an administrative conference with the IRSs Office of Appeals (Appeals) for a determination. The new procedure allows the nonrequesting spouse the right to file a written protest and have an Appeals conference on a decision that granted partial or full innocent spouse relief to the requesting spouse. In most cases, the nonrequesting spouse will protest a decision granting relief to the requesting spouse, but cannot appeal the decision to the Tax Court, under Rev. Proc. 2003-19. Sec. 6015(e)(1)(A) gives that right only to the requesting spouse. Thus, the nonrequesting spouse generally has no recourse once the Service makes a final innocent spouse determination.
General Procedures To apply for relief, a requesting spouse has to file Form 8857, Request for Innocent Spouse Relief, or submit a written statement to the IRS containing the same information required by Form 8857. When a taxpayer files such a request under Sec. 6015, the IRS will issue a preliminary determination letter based on the claims merits. If the determination grants full or partial relief to the requesting spouse, the Service will suspend processing of the claim for 45 days, pending an appeal by the nonrequesting spouse, and notify the requesting spouse that the nonrequesting spouse has the right to protest the preliminary determination. The IRS will notify both spouses simultaneously of a preliminary determination to grant full or partial relief. The nonrequesting spouse can file a written protest and seek an Appeals conference, by requesting it in writing within 30 calendar days of the mailing date of the preliminary determination notice. Such a request suspends further processing of the requesting spouses claim for relief pending the outcome. If only the nonrequesting spouse files a written protest asking for an Appeals conference, the Service will notify the requesting spouse of the nonrequesting spouses action. If the IRS proposes to change the preliminary determination after the Appeals conference with the nonrequesting spouse, the requesting spouse will be able to ask for an Appeals conference before a final determination. On the other hand, if only the requesting spouse files a written protest asking for an Appeals conference, the Service will notify the nonrequesting spouse of the requesting spouses protest and hold an Appeals conference with the requesting spouse. If Appeals proposes to increase the relief recommended, the nonrequesting spouse can request an Appeals conference. If both spouses file written protests asking for Appeals conferences, the IRS will notify each of the others request, and hold a separate Appeals conference with each spouse and permit both to submit information. At its discretion, the Service may decide to hold a joint Appeals conference to expedite a resolution and reach a final determination. Under these general procedures, both spouses can claim innocent spouse relief for the same return. Thus, each could be a requesting spouse and nonrequesting spouse under this process.
Conclusion Under Rev. Proc. 2003-19, the nonrequesting spouse not only has the right to be notified of the requesting spouses claim for relief and to submit information for consideration in an IRS administrative determination, but he or she can also file a protest and receive an Appeals conference on an IRS determination. Rev. Proc. 2003-19 is effective for innocent spouse relief claims filed after March 31, 2003, and to earlier-filed claims for which the Service has not issued a preliminary determination as of April 1, 2003. From Frank Taylor, CPA, Howard, Wershbale & Co., Cleveland, OH
Common Pitfalls in Information Reporting Most tax advisers and their clients are aware of Sec. 6041s information reporting requirements for payments over $600 in any one tax year to unincorporated payees. Every trade or business (including a partnership or nonprofit organization) has to file information returns for certain payments made during the calendar year. Although the Service prefers to receive this information on magnetic media or electronically, neither is mandatory; paper is still acceptable, subject to certain limits. (Payments to medical and legal providers have different reporting requirements and are beyond this items scope.)
Form 1099-MISC Form 1099-MISC, Miscellaneous Income, is the most widely used information reporting form. A payee has to file the form for each person to whom it paid during the year at least $10 in gross royalty payments, or $600 for rents or services, in the course of its trade or business. Some items that require a Form 1099-MISC include: (1) real estate, equipment or pasture rentals; (2) royalties to authors; (3) prizes and awards not paid as part of services rendered; and (4) compensation (such as fees, commissions and awards) and golden parachute payments paid to nonemployees for services.
Potential Problems Form W-9: The most basic mistake a payer can make is failing to obtain from a payee Form W-9, Request for Taxpayer Identification Number and Certification. This form lists the payees entity classification and taxpayer identification number (TIN). Many accounts payable departments will not process payments without a completed W-9. TINs: The IRS matches TINs on Forms 1099-MISC to its database. Under Sec. 6721, it can assess a $50 penalty for a businesss failure to provide a correct TIN. Reasonable-cause penalty relief is available under Sec. 6724 if the mismatch was due to the payee, rather than the payer; a completed W-9 will provide reasonable cause in most cases. In the past, while the IRS was quick to waive penalties, it seems to be reversing that trend; in general, unless it receives supporting evidence for all information reporting penalty-waiver requests, it will not waive penalties. The current maximum penalty per calendar year for failure to include TINs is $100,000, under Secs. 6723 and 6724(d)(2)(C). Payment cards: A payment card transaction is one in which a cardholder-payer uses a payment card (as defined in Notice 2003-12, Section 4.03), to purchase goods or services, and a merchant agrees to accept the card as payment. Cardholder-payers are responsible for reporting information on payments for goods and services. However, they often have difficulty (1) determining whether purchases are subject to information reporting and (2) obtaining TINs from payees. The Service issued two proposed procedures on purchasing-card transactions. Notice 2003-13 would allow a qualified payment card agent (as defined in Notice 2003-13, Section 4.04) to solicit and collect the necessary entity status and merchant-payee TIN. Notice 2003-37 provides an optional procedure for payers and their agents to use in determining if payment-card transactions are reportable. It would allow cardholder-payers to rely on merchant category codes to classify payees as either service or goods providers, to determine whether payments are reportable. LLCs: Limited liability companies (LLCs) are partnerships for tax purposes and require information reporting. Such reporting is required for payments to the many hotels that are limited partnerships or LLCs.
Conclusion The Service has excellent publications on Form 1099-MISC and other information returns, containing de-tailed instructions and providing answers to almost any reporting question. Tax advisers can take advantage of this free resource easily online, at www.irs.gov/formspubs. From Tom Turner, CPA, Dooley and Vicars LLP CPAs, Richmond, VA, and Kenneth M. Parker, CPA, Parker & Associates, CPAs, PLLC, Jackson, MS |
