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Dealing With The IRS
The IRS also compares tax returns against information returns, such as wage, interest and dividend statements filed on Forms W-2 and 1099. If there is a mismatch, the IRS sends the taxpayer a notice. See §7522. Finally, some tax returns are selected for examination (audit), on the basis of factors such as mismatching with information returns and questionable deductions or refunds, or random sampling. The IRS is authorized to examine any return. See §7602. However, taxpayers cannot be subjected to unnecessary examination or investigations, and only one inspection of a taxpayer’s books of account can be made for each tax year unless the taxpayer requests otherwise or unless the IRS, after investigation, notifies the taxpayer in writing that an additional inspection is necessary, §7605(b). In addition, the IRS cannot not use financial status or economic reality examination techniques to determine the existence of unreported income of any taxpayer unless it has a reasonable indication that there is a likelihood of such unreported income. §7602(e). When a return is selected for examination, the IRS chooses the time and method, which must be reasonable under the circumstances. §7605(a). Examinations may be office examinations, which generally take place in the IRS’s office, or field examinations, which are conducted at the taxpayer’s home or place of business, or some other location. Reg. §301.7605-1. Before conducting an in-person interview or examination, the IRS must provide the taxpayer with an explanation of the audit process and the taxpayer’s rights. §7521(b). The taxpayer has the right to be represented by an attorney, certified public accountant, enrolled agent, enrolled actuary, or any other person permitted to represent the taxpayer before the IRS who is not disbarred or suspended from practice before the IRS and who has a written power of attorney executed by the taxpayer, §7521(c). If, after a taxpayer’s return has been audited, it is determined that adjustments are required, the District Office ordinarily sends the taxpayer a preliminary letter, called a “notice of proposed disallowance,” and a copy of the examining agent’s report. Because the preliminary letter gives the taxpayer 30 days to submit his written protest, the preliminary letter is referred to as a “30-day letter”, Reg. §601.105(d). Examination, Deficiencies and AssessmentOptions When Adjustments Are ProposedA taxpayer who receives a 30-day letter can pursue an administrative appeal by protesting the proposed action and requesting an Appeals Office conference, Reg. §601.103(c).
PRACTICE TIP: If the taxpayer does not respond within 30 days, and thus receives a 90-day letter, in lieu of filing a petition in Tax Court, the taxpayer may belatedly file a request for Appeals Office consideration and submit a protest. In these undocketed cases referred to as “90-day” cases the Appeals Office has the discretion to accept the case if there are extenuating circumstances present. Reg. §601.106(b Alternatively, the taxpayer can accept the findings and sign a waiver of restrictions on assessment, which will allow the IRS to collect the deficiency without issuing a 90-day letter. Finally, the taxpayer can do nothing, and the IRS will send a notice of deficiency (90-day letter), Reg. §601.105(d). Examination, Deficiencies, and AssessmentIRS Summons Power and Third-Party SummonsesThe IRS is authorized to summon a taxpayer (or other person required to perform an act required under the Code), or any officer or employee of the taxpayer (or other person), or any person having possession, custody, or care of books of account containing entries relating to the taxpayer’s (or other person’s) business, or any other person it deems proper, to appear before the IRS at a time and place named in the summons. It is also authorized to require the taxpayer or any other person subject to summons to produce such books, papers, records, or other data. §7602(a)(2). However, the IRS generally may not contact any person other than the taxpayer with respect to the determination or collection of the tax liability of such taxpayer without providing reasonable notice in advance to the taxpayer that contacts with persons other than the taxpayer may be made. §§7602(c), 7609. The taxpayer has the right to bring a proceeding to quash the summons. §7609(c). The IRS can apply to federal district court for enforcement if the taxpayer or other person does not comply. §7604. Examination, Deficiencies, and AssessmentAppeals ProcedureA taxpayer who receives a 30-day letter can pursue an administrative appeal by protesting the proposed action and requesting an Appeals Office conference. Reg. §601.103(c). In many cases, the protest can be oral. For example, no written protest is required for most office interview and correspondence cases, or for field examination cases if the total amount of proposed additional tax is $2,500 or less for any taxable period. Reg. §601.105(d)(2). In addition, a written protest is optional in field examination cases if the total amount of proposed additional tax is more than $2,500 but less than $10,000. If the total amount exceeds $10,000, a written protest is required. Reg. §601.105(d)(2). PRACTICE TIP: A taxpayer can also request early referral of some issues from the examination or collection divisions to appeals. §7123(a); Rev. Proc. 99-28, 1999-2 C.B. 109. An Appeals Office conference is an informal meeting, usually consisting of the taxpayer’s representative (sometimes accompanied by the taxpayer) and an Appeals Officer. Reg. §601.106(c). Appeals conferences are usually held at the Regional Office for the taxpayer’s district. If the Appeals Officer and the taxpayer are able to agree on some or all the issues, the Appeals Officer prepares a memorandum and supporting statement, which is reviewed by an Appeals Supervisor. If the Appeals Supervisor refuses to accept the proposed settlement, the taxpayer has a right to confer with the Appeals Supervisor. If the settlement is approved in principle, the taxpayer is sent computations and a settlement agreement form, discussed in Section 20909. See Reg. §601.106. If the Appeals Officer and the taxpayer are not able to reach a settlement, the Appeals Officer prepares a memorandum and supporting statement that includes the taxpayer’s settlement offer, the Appeals Officer’s reasons for rejecting the offer, and the Appeals Officer’s settlement range. If the Appeals Supervisor approves the proposed rejection, the Appeals Office will prepare a statutory Notice of Deficiency, which must be approved by District Counsel before it is issued. See Reg. §601.106. Examination, Deficiencies, and AssessmentSettlementAn Appeals Officer may enter into a tentative settlement with a taxpayer; however, the Appeals Officer does not have final authority to settle a tax case. Instead, the proposed settlement must be approved by a reviewing officer before it becomes binding. A settlement may only be considered final when it is memorialized in a written settlement agreement and properly executed. See Reg. §601.106. Once an agreement is finalized, the IRS may use Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Over-assessment, Form 870-AD, Offer to Waive Restrictions on Assessment and Collection of Tax Deficiency, or Form 866, Agreement as to Final Determination of Tax Liability, to record the settlement. Form 870 has the effect of waiving restrictions on assessment, and also stops the running of interest. However, the taxpayer can still file a refund claim, and the IRS can raise non-agreed issues. In contrast, Form 870-AD also waives restrictions on assessment, and stops the running of interest, but the taxpayer cannot file a refund claim, and the IRS cannot make any additional assessments. A closing agreement on Form 866 (or Form 906, Closing Agreement on Final Determination Covering Specific Matters) is binding on both the IRS and the taxpayer, See §7121. If the taxpayer and the Appeals Officer are unable to agree on a settlement, the Appeals Officer will prepare a Notice of Deficiency, as discussed in Section 20931. Examination, Deficiencies, and AssessmentOptionsIf a Notice of Deficiency is issued, the taxpayer has the following options:
Problem Resolution and Taxpayer Assistance Orders (TAO)An additional alternative is to request a Taxpayer Assistance Order from the Office of the Taxpayer Advocate. Taxpayers can request taxpayer assistance orders not only if they receive an unfavorable determination, but when the IRS takes other actions relating to levies, collections, or discovery as well. The Taxpayer Advocate can issue Taxpayer Assistance Orders when it determines that the taxpayer is suffering or is about to suffer a significant hardship as a result of the manner in which the internal revenue laws are being administered by the IRS, §7811. COMPLIANCE TIP: A taxpayer requests assistance from the Taxpayer Advocate by filing Form 911, Application for Taxpayer Assistance Order, or in a written statement containing the information detailed in the regulations, Reg. §301.7811-1. OBSERVATION: For taxpayers subject to the jurisdiction of the Large and Mid-Size Business Division (LMSB) of the IRS, an opportunity is available to request an examination of specific issues relating to a tax return before the return is timely filed. The procedure establishes a framework within which the examined issues may be resolved and authorizes a finalization of the resolution by the execution of a LMSB Pre-Filing Agreement. Its purpose is to encourage the use of pre-filing examinations to resolve issues involving factual questions, but applies only to issues involving the application of well settled principles of law, Rev. Proc. 2001-22, 2001-1 C.B. 745. ProcedureThe IRS is authorized to assess all taxes, including taxes determined on a taxpayer’s return. §6201. Assessment is the procedure that establishes the taxpayer’s liability and permits the IRS to collect the tax. The simplest assessment procedure is the assessment of tax due as reported on an undisputed return. §6201(a)(1). After checking the return for accuracy, the IRS simply enters the admitted liability as an assessment. See §6213(b)(4). In other cases, the IRS generally cannot assess tax until it has asserted a deficiency against the taxpayer, as discussed in Section 20935. §§6212(b), 6213. However, the IRS can assess deficiencies arising from mathematical or clerical errors, as well as certain other deficiencies, without complying with the deficiency procedures. See §6213(b). In addition, the taxpayer can waive the restrictions on assessments by filing §6213(d). The taxpayer may do this by filing Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment, or another form or in a written notice. Reg. §301.6213-1(d). PRACTICE TIP: A taxpayer may choose to waive restrictions on only a part of the proposed deficiency and contest the balance in Tax Court. OBSERVATION: Assessments may be supplemented at any time within the period prescribed for assessment. Supplemental assessments may be made whenever any assessment is inaccurate or incomplete in any material respect. §6204. Statute of LimitationsNormally, a tax must be assessed within three years of the date the return was actually filed, whether or not the return was filed on time. §6501(a). An early return is considered filed on its due date for this purpose. §6501(b). At any time prior to the expiration of the three-year period, however, there may be an agreement in writing between the taxpayer and the IRS that the period for assessing the tax may be extended, in which case the tax may be assessed at any time before the expiration of the extended period. §6501(c)(4). In other cases, the IRS generally cannot assess tax until it has asserted a deficiency against the taxpayer, as discussed in Section 20935. §§6212(b), 6213. However, the IRS can assess deficiencies arising from mathematical or clerical errors, as well as certain other deficiencies, without complying with the deficiency procedures. See §6213(b). In addition, the taxpayer can waive the restrictions on assessments by filing §6213(d). The taxpayer may do this by filing Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment, or another form or in a written notice. Reg. §301.6213-1(d). COMPLIANCE TIP: Form 872, Consent to Extend the Time to Assess Tax, or another form in the Form 872 series, is used for this purpose. The general statute of limitations does not apply in the case of a false or fraudulent return, a willful attempt to evade tax, or a failure to file a return. Instead, these taxes can be assessed (or a proceeding can be begun without assessment) at any time. §6501(c). In addition, time for assessment is extended to six years after the return was filed if the taxpayer omits an amount exceeding 25 percent of the amount of gross income stated on the return. §6501(e). Finally, the time for assessing deficiencies attributable to credit carrybacks and carryovers is extended. See §6501(h), (i), (j). OBSERVATION: The sending of a 90-day letter suspends the running of the time for assessment until 60 days after the 90-day period, if no Tax Court petition is filed, or a final Tax Court decision, if a petition is filed. §6503(a). The running of the time for assessment is also suspended by:
Deficiency AssessmentsThe IRS asserts a deficiency when it determines that a taxpayer’s income, estate, or gift tax liability is greater than that stated on the return. The deficiency assessment procedure is the ordinary means to arrive at an assessment of tax liability. See §6212. The deficiency process begins with the IRS’s assertion that the tax is deficient through a statutory notice of deficiency (a “90-day letter”), which gives the taxpayer 90 days to file a petition to the Tax Court (150 days if the notice is addressed to a person outside the United States). If a timely petition is filed, formal recording of the assessment or collection of any amount cannot occur until the Tax Court’s decision is final. §6213(a). If the taxpayer chooses not to file a petition and not to respond with payment after the deficiency notice is sent and the time period runs out, the IRS is permitted to record the formal assessment and collect the deficiency. §6213(f). Summary AssessmentsThe IRS can assess a deficiency without following the normal deficiency assessments in the case of:
These are called summary assessments. In most cases, a taxpayer who has received a summary assessment must pay the deficiency before contesting liability. In addition, the taxpayer cannot petition the Tax Court for a redetermination of tax liability that has been summarily assessed. §6213(b). Instead, the taxpayer must file a refund suit in federal district court or the United States Court of Federal Claims. See §§6511, 7422. Jeopardy and Termination AssessmentsIf the IRS believes assessment or collection of a deficiency will be jeopardized by delay, it can immediately assess (in a jeopardy assessment) the deficiency, plus any interest and penalties, and demand payment. §6861(a). The IRS can also terminate a tax year and demand immediate payment of income taxes for the terminated year and the prior year (in a termination assessment) if it finds that a taxpayer plans to leave or remove his property from the United States quickly, conceal himself or his property in the United States, or do any other act that would prejudice the collection of the tax. §6851(a). A jeopardy assessment may be made before or after the mailing of a notice of deficiency as discussed in Section 20935. Reg. §301.6861-1(a). If a jeopardy assessment is made without notice, the IRS must provide formal notice of assessment as discussed in Section 20935 within 60 days after the assessment. §6861(b). Similarly, if a termination assessment is made, the IRS must provide formal notice of assessment for the tax owed for the full tax year within 60 days after the later of the due date for the taxpayer’s tax return for the tax year, or the date the taxpayer files the return. §6851(b). The IRS may abate the assessment if jeopardy is found not to exist or if the assessment if found to be excessive. §§6861(g), 6851(e); Reg. §301.6861-1. In addition, procedures are provided for administrative review and for stays of collection. §§7429, 6863. Request for Prompt AssessmentsA person filing an income tax return for a decedent or an estate, or a return for a dissolved or dissolving corporation, can request that the normal period for assessment be cut to 18 months. The request can be filed at any time not more than three years after the return is filed. §6501(d). COMPLIANCE TIP: A request for prompt assessment is filed on Form 4810, Request for Prompt Assessment Under Internal Revenue §6501(d). Special Rules for CashThe IRS can make a jeopardy assessment against a taxpayer who is in physical possession of cash (or cash equivalent) in excess of $10,000 and who does not claim ownership of the cash or identify it as belonging to another person whose identity can be readily ascertained. §6867(a). For purposes of the assessment, the entire amount of the cash is treated as income, taxed at the highest rate, and the possessor is treated as the owner. §6867(b). If the assessment is abated and replaced with an assessment against the true owner, the later assessment is treated as dating back to the date of the first assessment. §6867(c). Offers in CompromiseThe IRS is authorized to compromise any civil or criminal tax case after it has been assessed (but before it has been referred to the Department of Justice) because of doubt as to liability, doubt as to collectibility, or to promote effective tax administration. §7122; Reg. §301.7122-1(b). A compromise may promote effective tax administration when collection of the full liability will create economic hardship, or, regardless of the taxpayer’s financial circumstances, there may be such exceptional circumstances that collection of the full liability would be detrimental to voluntary compliance by taxpayers. In either case, however, such a compromise will not be accepted if it would undermine compliance by taxpayers with the tax laws. Reg. §301.7122-1(b)(3)(iii). The IRS cannot reject an offer in compromise from a low-income taxpayer solely on the basis of the amount of the offer. §7122(c)(3)(A). COMPLIANCE TIP: An offer in compromise is submitted on Form 656, Offer in Compromise. If the basis of the offer is doubt as to liability, the taxpayer must submit a written statement describing in detail why he does not believe he owes the liability. If collectibility is an issue, the taxpayer must submit IRS Form 433, Collection Information Statement. Offers in compromise should generally be accompanied by a remittance representing the amount of the compromise offer or a deposit if the offer provides for future installment payments. For any offer of compromise, the IRS may require an extension of the statute of limitations on assessment as a condition of accepting the offer, although the taxpayer must be informed of the right to refuse to extend or to limit the extension to particular issues or periods of time. Reg. §301.7122-1(i)(2). The IRS is prohibited from levying against the property or rights to property of a taxpayer who submits an offer to compromise, to collect the liability that is the subject of the offer, during the period the offer is pending, for 30 days immediately following the rejection of the offer, and for any period when a timely filed appeal from the rejection is being considered by Appeals. Reg. Section 301.7122-1(g)(1). See also Code Section 6331(k). Joint and Several Liability and Innocent Spouse RulesIn general, when married taxpayers file a joint return, they are jointly and severally liable for the liability with respect to the tax relating to the return. This means that the IRS can collect the entire amount of the tax (and any additions to tax) from either taxpayer. §6013(d)(3). However, an individual who has filed a joint return can seek relief as an innocent spouse if:
If all of the conditions are satisfied, the innocent spouse is relieved of liability for tax (including interest, penalties, and other amounts) to the extent the liability is attributable to such an understatement. §6015(b). All of the facts and circumstances are considered in determining whether it is inequitable to hold a spouse jointly and severally liable for an understatement. Reg. §1.6015-2(d). Information submitted by the non-requesting spouse, if any, will also be considered. Reg. §1.6015-6(b). If a requesting spouse had no knowledge or reason to know of only a portion of an erroneous item, the requesting spouse can be relieved of the liability attributable to that portion of the item if all other requirements are met with respect to that portion. Reg. §1.6015-2(e). An additional method of avoiding tax liability is available for innocent taxpayers filing a joint return who are either divorced, legally separated, or not living together. Under this alternative procedure, an innocent taxpayer may elect to be liable for only that portion of the deficiency allocable to the taxpayer (i.e., as if each spouse had filed a separate return for the relevant year). Relief under this provision is available only for unpaid liabilities resulting from understatements of liability. Refunds are not authorized. Reg. §1.6015-3(c)(1). An election to seek relief under this provision can be made within two years from the date collection activities begin by an individual who:
CAUTION: It has been suggested that eligible taxpayers may want to consider electing the proportional liability option immediately following divorce or separation even if there is no known deficiency at that time. However, final regulations provide that the IRS will not consider premature claims for relief made before the taxpayer receives a notification of an audit or a letter or notice indicating that there may be an outstanding liability with regard to the joint return. Reg. §1.6015-5(b)(5). Finally, taxpayers who cannot obtain relief through these two provisions can obtain innocent spouse relief if:
COMPLIANCE TIP: Taxpayers should use Form 8857, Request for Innocent Spouse Relief (and Separation of Liability, and Equitable Relief) to request relief from joint and several liability. CAUTION: Regulations clarify that equitable relief cannot be used to circumvent the rule that no refunds can be obtained under §6015(b). Thus, equitable relief is not available to refund liabilities already paid for which the spouse would otherwise qualify for relief under Code Section 6015(c). Reg. §1.6015-4(b). Transferee LiabilityThe IRS can assess and collect tax liabilities from persons other than the taxpayer under the general assessment and collection rules in the following circumstances:
Transferees for this purpose include donees, heirs, legatees, devisees, and distributees of all types. Code Section 6901(h). Thus, they include shareholders of dissolved corporations, assignees or donees of insolvent persons, successors to corporations, parties to reorganizations, and all other classes of distributees. Reg. Section 301.6901-1(b). In the case of estate taxes, they also include persons who are personally liable for any part of the tax under the rules on estate tax liens. The liabilities that can be assessed and collected can be either the amount of tax shown on a return or any deficiency or underpayment of tax. Code Section 6901(b). MitigationThe statute of limitations on assessments prevents the IRS from asserting a deficiency for a taxable year for which the three-year limitations period has run, and the statute of limitations on refunds prevents the taxpayer from asserting a refund of a closed year’s tax. However, the mitigation provisions (§§1311-1314) mitigate the effect of the limitations statutes in certain narrowly defined circumstances. In general, before there can be an adjustment of tax for a closed year, the following conditions must be met:
AbatementThe IRS is authorized to “abate” (i.e., to forgive, eliminate, reverse, or cancel) a tax (or interest or penalty) that has been incorrectly assessed if it is excessive in amount, is assessed after the expiration of the period of limitation, or is erroneously or illegally assessed. §6404(a). In addition, the IRS is authorized to abate small liabilities, or liabilities arising from errors in returns prepared by the IRS. §6404(c), (d).
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