Form 8275 disclosure may lead to additional scrutiny.

There has been a long-standing debate in the tax community as to whether attaching a For 8275, Disclosure Statement, to a return increases the chances of that return being audited. That debate has now apparently been resolved with the release of a revision to the Internal Revenue Manuel (IRM) dated July 24, 1995, which provides new internal processing instructions for individual returns with Forms 8275.

Discussion

Intuitively, many practitioners have believed that there was a direct correlation between attaching a disclosure statement and having a return selected for examination; the Service consistently denied there was any such connection. Rather, IRS officials have uniformly maintained that the first time a Form 8275 is looked at is only after a return has been identified under its computerized selection system.

All individual returns and most corporate returns are evaluated for audit potential under a computerized process called the discriminant function (DIF) system. The DIF system is a mathematical technique that allows the Service to measure certain items on a return to determine the possibility of adjustment if that return is examined. After a return is run through the DIF system, it is assigned a DIF score. The higher the DIF score, the greater the chance that the return will be manually screened for audit potential. Manual screening is the process by which the IRS makes a judgment decision whether to accept the return as filed or audit it. (Note that all income tax returns of corporations assets over $10 million rations with assets over $10 million are manually screened.)

In addition to the DIF selection process, certain returns, identified by the Service as "Specials," are given audit codes during the initial data inputting process in the Service Center. This early coding results in these returns automatically being pulled for manual screening. A return is classified as a Special if it contains one or more identifiable features listed in IRM 4118.1 (individuals), 4118.2 (corporations) or 4118.3 (S corporations).

Examples of individual Specials include returns with missing schedules or incomplete information, certain noncash charitable contributions issues on Form 8283, Noncash Charitable Contributions, and unallowable items on Schedule A. Corporate Specials include returns with partnership issues, international issues, Joint Committee cases, and returns of foreign-owned corporations. Returns of S corporations are considered Specials if they contain partnership issues, noncash charitable contributions or the low-income housing credit. Until this recent revision of the IRM, however, returns with Forms 8275 were not listed as Specials.

Form 8275

Although the IRM presently provides guidance only for individual returns with Forms 8275, it is safe to assume that similar procedures will be issued for C and S corporation Special returns. Under new IRM 4164.2, an individual return with a Form 8275 attached will be screened by the Service Center for the reason of the disclosure statement and the potential audit significance. As part of the screening, all items on the return will be considered. Returns selected as a result of this process will be forwarded to the district examination function.

Significance

It is important to note that the fact that a return is screened in the Service Center or referred to the district examination function does not necessarily mean that the return will be audited. There are many other factors considered before a return is actually selected. Moreover, due to the large number of Forms 8275 filed each year, it is unclear what the IRS intends to do with all the returns coded under this new procedure.