Compliance checks defined.

In an effort to educate taxpayers as to how compliance checks, audits and examinations differ from one another, the IRS will print a new publication, Compliance Check, Audit, or Examination, focusing on the goals of these different procedures. Although these terms are not defined by the Internal Revenue Code, the Service has drawn a distinction between them, based on the agent's intent and the scope of the review.

The main difference between audits and compliance checks is their objective: an audit determines the taxpayer's correct tax liabilities, whereas a compliance check determines whether a taxpayer is satisfying its recordkeeping and information reporting requirements.

The publication refers to a compliance check as a "review." The objective of this review is to determine whether business owners are satisfying all of their recordkeeping and informational reporting requirements. Additionally, the taxpayers undergoing a compliance check may receive additional education regarding their recordkeeping and filing responsibilities (resulting in increased voluntary compliance), but will receive no additional protection against future audits or examinations. The publication specifically states that the compliance check is not designed to determine the taxpayer's tax liability for a particular period.

"Examinations" are defined as the fact-finding portion of audits, encompassing a systematic inspection of the taxpayers' books and records, as well as questioning the taxpayers about their books and records, or a combination of both.

Since compliance checks do not qulify as an audit, the IRS has taken the position that taxpayers who have been the subject of a compliance check receive no safe harbor protection under Section 530 of the Revenue Act of 1978. Thus, it is the Service's position that taxpayers who have experienced a compliance check do not have any resulting protection against employment tax liabilities and penalties associated with misclassified workers.

Conducting a Compliance Check

The IRS may conduct the following activities during a compliance check: * Review informational forms, such as Form 940, 941, W-2, 1099 or W-4. * Ask taxpayers whether they understand their filing requirements and whether they have any questions. * Request that taxpayers voluntarily file any missing information forms. The Service may either file substitute informational returns or initiate an audit for those taxpayers who do not voluntarily file these identified missing forms.

The publication specifically states that the IRS will not conduct the following activities during a compliance check: * Examine the taxpayers' books and records. * Ask questions regarding tax liabilities; e.g., the Service should not ask why an expense was treated in a certain manner or why a worker was classified as an independent contractor or an employee.

There are no penalties for taxpayers who refuse to cooperate with a compliance check, but the IRS has the option of opening a formal audit. Note that the option of auditing a taxpayer exists even if the taxpayer does cooperate with the Service's compliance check.

The IRS may subject a taxpayer to a compliance check as often as the facts and circumstances warrant.

It behooves practitioners to be aware of the distinction between a compliance check and an audit. In a compliance check, the focus should be on informational forms, not on books and records. Therefore, if the IRS asks for books and records, an audit report should be requested.