By Joe B. Marchbein, CPA
The IRS has expanded its use of correspondence examinations in lieu of field examinations of individual income tax returns. While this trend has allowed the Service to collect additional revenue more efficiently, it has also caused difficulties for some taxpayers and CPAs representing them. The IRS has had problems in timely and properly responding to letters providing requested information or disagreeing with proposed adjustments.
The problems were identified in a 2006 report by the Treasury Inspector General for Tax Administration (TIGTA) that documented a 170% increase in correspondence examinations for individual taxpayers with gross incomes or business receipts of at least $100,000 in fiscal years 2002 through 2005, while face-to-face examinations increased by 25% (Report 2006-30-105, July 25, 2006). TIGTA recently found improvements but said more were needed (Report 2011-30-016, Feb. 18, 2011). This article suggests ways CPA tax practitioners can help manage clients’ correspondence audits.
SELECTION OF RETURNS
The IRS typically compares returns against norms and selects some for correspondence examinations, which are handled at an IRS service center or campus. The IRS mails either (1) Letter 566 (CG), often termed an initial contact letter, advising the taxpayer that a return has been selected for examination and listing the items to be verified; or (2) a CP 2000 notice, which contains proposed adjustments based on information documents issued by third parties, such as Forms W-2, Wage and Tax Statement; 1099- MISC, Miscellaneous Income; and 1098, Mortgage Interest Statement. Some typical items for which the IRS requests verification include alimony, moving expenses, various itemized deductions, casualty losses, employee expenses, Schedule C receipts and expenses, foreign tax credits, earned income credits and education credits.
When the IRS receives correspondence, the file is assigned to an auditor. If there is no response from the taxpayer, the IRS issues a second notice, and if there is no reply, it issues a statutory notice of deficiency, known as a “90-day letter.”
RESPONDING TO NOTICES
A practitioner should advise a client in advance, usually by an explanatory paragraph in the tax engagement letter, to notify the practitioner if the client receives a notice from the IRS. If the CP 2000 notice is correct, the CPA should advise the taxpayer to sign the agreement sent with the letter and pay the deficiency. If the CPA responds to the IRS service center, he or she should submit the necessary documentation and explain whether an adjustment is appropriate.
If an assessment is incorrect or if a response is to be made to the initial contact letter, the practitioner should consider asking that the matter be transferred from an IRS service center to a local office, where it can be resolved by one auditor. Often in a correspondence audit, taxpayer correspondence is not assigned to the auditor who reviewed earlier documents. Correspondence from the IRS bears only the name of a supervisor. If the practitioner calls the supervisor, the IRS typically refers the call to whatever employee is available. Also, correspondence tends to not be reviewed for several months, resulting in the IRS’ sending letters advising the taxpayer that it needs additional time to review it. When the IRS finally issues reports, in some cases the proposed adjustments are incorrect because it has not properly considered and evaluated documents and substantiation furnished by the taxpayer or his or her representatives.
The IRS tends to not want to transfer cases because of the possibility of delay, and it is usually more economical for the agency to handle the matter by correspondence. However, Treas. Reg. § 301.7605-1(e)(1) provides that the IRS will consider written requests to change the examination venue. Many IRS service centers take the view that correspondence examinations will be transferred only in instances of hardship. If there are problems, the practitioner may want to contact the local office of the Taxpayer Advocate Service and request assistance in having the matter transferred to the local IRS office.
For most taxpayers, an examination is fraught with anxiety, which can only be compounded if correspondence explaining the taxpayer’s position or providing requested information or verification seems not to have been duly taken into account by the IRS. But these tips can at least help minimize frustration.
By Joe B. Marchbein, CPA, (email@example.com) with Jack P. Fitter, CPA, APC, in Chesterfield, Mo., and a member of the AICPA’s IRS Practice and Procedures Committee.
A version of this article appeared in The Tax Adviser, April 2011, page 276.