Protecting taxpayer rights under the National Research Program.
In August 2002, at the invitation of the IRS, NSA participated in two "train the trainer" sessions. Dr. William Stevenson, PA, chair of the NSA Federal Taxation Committee, and Beanna Whitlock, EA, chair of the NSA Education Committee, ably represented NSA at the training geared to key IRS staff involved with NRP audits. Following is the essence of Bill Stevenson's presentation.
The practitioner community's greatest concern and the main reason for its involvement in the National Research Program (NRP) training module is the perceived possibility that the NRP will compromise and violate taxpayers' rights. The practitioner's job is to protect taxpayer rights and it is the IRS' responsibility to respect taxpayer rights. In fact, Publication 1, Your Rights as a Taxpayer, states: "IRS employees will explain and protect your rights as a taxpayer throughout your contact with us."
It is the duty of taxpayer representatives to protect the rights of taxpayers with warm zeal. What level of effort is expected of IRS employees? Should the IRS go beyond providing Publication 1 and Publication 556, Examination of Returns, Appeal Rights, etc?
Some of the threatened taxpayer rights that we'd like to discuss are:
* Right to representation.
* Right to know why the Service is auditing the taxpayer.
* Protection against financial status or economic reality audits.
* Right to have examination conducted at taxpayer's (and IRS') convenience.
* Right to exclude IRS agents from the private areas of a business and to say "no" to an internal inspection of a taxpayer's residence.
Right to Representation
The Conference Committee Report to the IRS Restructuring and Reform Act of 1998 states: "The Committee believes that taxpayers should be fully informed of their rights to representation in dealings with the IRS and that those rights should be respected." Publication 1 and the NRP draft audit letter inform the taxpayers of the right to be represented.
The practitioner community encourages the IRS, at first contact, whether by telephone or in person, to inform the taxpayer of the right to be represented. Furthermore, the low-income taxpayer should be told about the existence of Low Income Taxpayer Clinics. The result of the exchange should be included in the work papers. Should IRS employees question taxpayers to make certain that they understand their rights and that the IRS will not treat them harshly if they opt for representation?
Right to Know Why the Return Is Being Examined
The newly revised Publication 742, Why Your Return is Being Examined, informs the taxpayer that the return was selected at random for a compliance research examination. However, this statement is tucked away in the middle of the first paragraph. We encourage the Service to tell the taxpayer that the return was randomly selected for research purposes and that no assumptions have been made regarding the correctness of the information on the tax return. We don't understand why the IRS appears to disagree with this approach, as evidenced by a statement in Module E, page 8, which states: "We don't want to explain on the first contact by telephone the nature of the NRP examination, random nature of selection, etc."
Protection Against Financial Status or Economic Reality Examination Techniques
Section 7602(e), Limitation on examination on unreported income states: "The Secretary shall not use financial status or economic reality examination techniques to determine the existence of unreported income of any taxpayer unless the Secretary has a reasonable indication that there is a likelihood of such unreported income."
The practitioner community is concerned that, in an effort to satisfy NRP expectations in the area of income probes, over-zealous Revenue Agents may inadvertently violate the provisions of IRC 7602(e).
Right to Have Examination Conducted at Taxpayer's Convenience
It appears that the first battery of examinations is going to be rolled out at the end of 2002 and early 2003. The first quarter of the calendar year represents the highest energy and most stressful time for accountants and tax preparers. The professional community has to complete: W-2s and 1099s to mail to the taxpayers by January 31; most corporate returns are due March 15, and the lion's share of the personal and partnership returns face an April 15 deadline. While we understand the need for the IRS to dispense its workflow evenly throughout the year, accountants have no such luxury. We simply ask for understanding during this very stressful period.
Right to Exclude IRS Agents from Private Areas of a Business and a Residence
In the landmark case, GM Leasing Corp v. United States (429 U. S. 338 97 S. Ct. 619 (1997), "...a search of private property without proper consent is unreasonable unless it has been authorized by a valid search warrant."
GM is a case holding that the Fourth Amendment applies to warrantless intrusions that violate the privacy interests of a taxpayer. In that case, government agents actually entered the taxpayer's private office without consent to effectively conduct a search, clearly violating the Fourth Amendment.
Taxpayer representatives are trained to resist obtrusions of IRS agents into businesses and homes. The area of flexibility for the IRS is in the non-private business areas. For example, the IRS has access to public areas such as waiting rooms, show rooms, retail shopping areas and so forth. In many cases, however, IRS presence at a taxpayer's business is disruptive to the business operations since customers and employees fear the IRS.
MINIMIZING THE ADVERSARIAL NATURE OF NRP AUDITS
There are a variety of ways the Service and the practitioner community can work together to minimize conflict and maximize the potential for good will in the NRP audit process. This section is divided into four discussion areas:
* Understanding each other's jobs;
* Pre-audit contact;
* The audit; and
Understanding Each Other's Jobs
Several years ago, I polled a group of accountants to learn what they wanted most from their counterparts in the Internal Revenue Service. Almost everyone answered with one word: RESPECT.
In an attempt to broaden the perspective of our cousins in the Service as to our professional lives, the following are the elements of my practice. We believe we are typical of the NSA members.
My partner is a CPA and I am an Enrolled Agent. He is responsible for a total of 150 businesses that includes partnerships, S and C corporations, LLCs and exempt organizations. We also prepare about 600 to 650 personal tax returns during the filing season--half of them are finished during the last three weeks. We have another 75 to 100 on extension.
More than 25 percent of our personal tax clients owe money and add an additional $1.5 million to the United States Treasury. The amount of the refunds total a little more than a $1 million.
Our firm represents clients before New York City and New York State Departments of Taxation and Finance, the New York State Department of Labor, the Internal Revenue Service, and the United States Tax Court. Our clients come to us for estate planning, financial planning and investment advice. We also prepare tax returns for clients living in a variety of states throughout the United States and in foreign countries.
From the practitioner's perspective, the impact of an audit is disruptive and intrusive for a variety of reasons. Regardless of the circumstances around an audit notice, many of our clients perceive the notice as equivalent to an arrest warrant at worst and a search warrant at best. Receipt of an audit notice also casts doubt as to our credibility. Our clients come to us to avoid the possibility of having to deal with the taxing agencies. While they want the best tax deal possible, they also want to stay in compliance. Taxpayers who had their returns professionally prepared interpret the audit letter as a failure on the part of their accountant to correctly prepare their tax return, thereby exposing them to an investigation.
To a large degree, the Service is not auditing the taxpayer's tax return but rather it is challenging the decisions of the preparer. Therefore, Revenue Agents can expect that taxpayer representatives will battle for every issue with the goal being a no change audit." The IRS may be exposed to a little less emotional intensity from the representative if someone else prepared the tax return. Once the audit is over, if there are additional taxes due to the U.S. Treasury, additional taxes will probably be owed to the State and, possibly the City, as would be the case for New York City residents.
It is important that the Service understand that many small business taxpayers cannot afford to pay someone to maintain the type of records necessary to capture all of the detail that is required by law to prepare a tax return that is capable of withstanding the scrutiny inherent in an audit. Furthermore, the professional's workload during the waning weeks of filing season makes it difficult to chase down the taxpayer for that last bit of information needed to process the tax return. Quite often, practitioners sculpt reality and make reasonable efforts to estimate some expenses based on experience and prior years' tax returns. In an endeavor to minimize accounting fees, many small business clients visit the tax professional once a year when their personal tax returns are prepared.
Pre-audit contacts provide an excellent opportunity for the Revenue Agent and the representative to begin the process of building a respectful and constructive relationship. It should be made clear to the representative that the Revenue Agent is performing an NRP audit and must follow specific guidelines set forth by the NRP design team. However, it should also be made clear that every effort will be made, where possible, to minimize taxpayer burden. At this time, it is appropriate to discuss the scope of the audit, the items that have been classified and the documentation requirements. Sensitivity to the timing of the audit is in order as well.
Both parties should initiate a re-establishment of the attempt to build a positive relationship--hopefully. It might be useful, in some cases, if the Revenue Agent explained the special nature of the NRP audits and the onerous requirements of work paper documentation.
Schedule A. A few areas of controversy hiding in the Schedule A will be charitable contributions and miscellaneous deductions. Guidance should be provided to Revenue Agents about dealing with the charitable contributions other than cash or check. Most preparers accept oral testimony for the $500 or less line and will rarely have documentation of any kind. Also, the Service should come to terms with what will be acceptable documentation for the Form 8583, which is for gifts over $500. Is the Service going to accept blue-book amounts for donated cars? Lists of clothes will be offered with values determined by either the taxpayer or the representative. Will each amount be questioned?
If the miscellaneous deductions throw the taxpayer into Alternative Minimum Tax (AMT) territory, decisions need to be made as to the depth of inquiry. In many cases, a large percentage of the deductions claimed in this area will be disallowed only to result in a no change to the tax liability. As the AMT disappears, the regular tax increases by an equal amount. So, for statistical purposes only, the Service may be creating an unnecessary burden not only for the taxpayer but for itself as well.
Schedule D. Frankly, the fortuitous time to capture the best picture of Schedule D compliance has already passed. The second half of the 1990s generated spectacular stock market gains only to be squandered by the melt down that began in March 2000. Nevertheless, the IRS will have to address a few sticky areas if it is looking to achieve statistical viability. These areas include but are not limited to:
* Long- and short-term gains and losses from sales of mutual fund shares
* Cost basis of inherited securities
* Carry forward losses.
Most investors reinvest their mutual fund dividends. When shares are sold, the redemption includes the dividends from prior years, including the ones earned in the current year, thereby incurring long- and short-term gains or losses. Some, but not all, mutual fund families report the long- and short-term redemptions on their annual statements. In the heat of tax filing season, many preparers are inclined to report the sale in bulk, without regard to long- or short-term gains or losses. While the amounts are usually modest, Revenue Agents need guidance as to their flexibility in dealing with the situation.
The problem of determining basis on inherited securities can be problematic if "date of death" basis has not been made available to the preparer. Sophisticated tax preparers will make inquiries as to the existence of an estate tax return (Form 706) or other documentation. Some preparers will research the history of the stock price by going to the library or calling a broker. Others will simply make a good faith estimate. The direction preparers take is often related to the size of the fee the client is willing to pay.
A third area of potential controversy are the carry forward losses. In 2000 and 2001, many investors suffered huge losses after selling stock and wiped out their gains from prior years. Will the NRP auditor accept these prior year losses as reported? A disallowance of some carry forward losses may not have any impact on the taxpayer's tax liability for years to come, due to the current $3,000 limitation.
Schedule C. Schedule C examinations have the potential to yield the greatest number of adjustments. Knowing in advance that Schedule C is the arena which will generate the most conflict and consternation gives all of us an opportunity to develop strategies to minimize confrontation. We suggest that the Service sponsor a workshop for Revenue Agents and representatives. The workshop should be charged with coming up with ideas on how to deal with the problem inherent in examining small businesses in which reconstructed records (auto and entertainment) and oral testimony reign supreme.
Among the items that will be addressed in Schedule E examinations are:
* Travel to the property
Most deductions for travel to the property will be based on oral testimony. Also, how will the Revenue Agent handle travel expenses when there are multiple properties? Deductions for depreciation are not necessarily straightforward. When we inherit clients from other preparers, we often discover that land had not been considered; in some instances, we learn to our dismay that the wrong depreciation construct had been selected. While making adjustments to depreciation may be the valid statistical measure to take, even significant adjustments will not affect the current tax liability, due to passive loss limitations. Taxpayers with adjusted gross incomes over $150,000 get no benefit from Schedule E losses. In fact, many of them have suspended losses that will not be able to be used until such time as the property is sold. The IRS should make a decision prior to rolling out the audits as to how far the Revenue Agents need to go to correct errors in depreciation deductions.
Is the case agreed or unagreed? If the case is agreed, is it finished? Can the representative report the results with assurance that there will be no additional adjustments? How long will it take to receive an official report?
If the case is unagreed, where should the representative send the request for an appeal? Should it be sent to the Revenue Agent who will pass it along to Appeals, or should the protest be sent directly to the Appeals Office?
Is there another route that can be used to resolve the unaired issues? Is the manager going to be useful if he/she came from compliance as opposed to exam?
Although there are hundreds of issues that we could highlight, we chose to focus on just a few of them in the hope that the ideas presented will inspire others to continue the dialogue. Our primary message is that during the National Research Program audit process, the rights of taxpayers should not be compromised. We also hope that the IRS and the practitioner community will make every effort to minimize the adversarial nature of NRP audits.
RELATED ARTICLE: NSA audit registry and audit hotline
NSA is pleased to announce a new member benefit--The NSA Audit Registry and Audit Hotline. These programs are designed to assist and support NSA members who are involved in audit representation.
NSA members who register IRS notices of examination with the NSA Audit Registry are eligible to use the NSA Audit Hotline. This provides access to NSA member colleagues with exceptional credentials and years of taxpayer representation experience who have volunteered to serve as audit mentors. These volunteers specialize in taxpayer representation during the audit and appeal process. Some volunteers are admitted to practice before the United States Tax Court.
Why should you register an audit with NSA? Here are two reasons. First, the NSA Audit Hotline can help you navigate the audit and appeals process. Second, the data you provide NSA will provide ammunition for the Federal Taxation Committee's crusade to enhance and protect the rights of our members and their clients.
You can register IRS audits when your client receives an IRS notice of examination. To register an audit, log on to the members only section of the NSA website (www.nsacct.org) and download the registration form. Complete the form and fax it to NSA--Bernie Phillips--at (703) 549-2512. You may also register an IRS audit by calling NSA at 800-966-6679, ext. 1321. When you register an IRS audit, you will be given the opportunity to work with an NSA mentor. If you wish to become a mentor, and you meet the qualifications in the second paragraph, please contact Bernie Phillips.
START REGISTERING YOUR CLIENTS' IRS EXAMS TODAY!
William Stevenson is Chair of the Federal Taxation Committee for 2002-2003.
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|Publication:||The National Public Accountant|
|Date:||Nov 1, 2002|
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