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As Former IRS Agents and Managers we needed to follow guidelines and audit techniques for all IRS tax audits. Listed below are the methods and techniques that can or may be used on a IRS tax audit.
Methods for accumulating evidence include:
Such as analysis of Balance Sheet items to identify large, unusual, or questionable accounts.
Analytical tests use comparisons and relationships to isolate accounts and transactions that should be further examined or determine that further inquiry is not needed.
such as examining the taxpayer’s books and records to determine the content, accuracy, and substantiate items claimed on the tax return.
such as interviewing the taxpayer or third parties. Information from independent third parties can confirm or verify the accuracy of information presented by the taxpayer.
such as physically examining the taxpayer’s assets, e.g., inventory or securities.
IRS can or will conduct a tour of the taxpayer’s business to observe the taxpayer’s daily business operations.
IRS can or will trace transactions to determine if they are correctly recorded and summarized in the taxpayer’s books and records.
1.Will the examination technique provide the needed evidence?
2.Will the benefits derived from using a particular technique justify the associated costs to both the examiner and the taxpayer?
3. Are there less expensive alternatives that will provide the same evidence?
a. Conduct face to face interviews with the taxpayer and or the representative,
b. Make tours of Business Sites and Inspection of Residences,
c. Evaluation of the taxpayer’s internal control systems,
d. Examining the taxpayer’s books and tax records,
e. Analyzing Schedules M–1 and M–2,
f. Bank Record reconciliations,
g.Analysis balance sheets,
h. Testing of gross receipts or sales,
i. Testing of expenses: Cost of goods sold,
j. Testing Expenses: operating expenses.
IRS uses minimum income probes for individual business tax returns. They are a follows:
1. Financial Status Analysis.
Prepare a financial status analysis to estimate whether reported income is sufficient to support the taxpayer’s financial activities.
2. IRS Interview.
Conduct an interview with the taxpayer (or representative) to gain an understanding of the taxpayer’s financial history, identify sources of nontaxable funds, and establish the amount of currency the taxpayer has on hand.
IRS will consider possible bartering income as part of the minimum income probes.
3. IRS will usually take a tour of business .
Tour the business site and review of the Internet website to gain familiarity with the taxpayer’s operations and internal controls, and identify potential sources of unreported income.
However, a tour of the physical business site is not required for office audit cases but may be conducted if appropriate and with manager approval.
4. Internal Control.
IRS can and will evaluate internal controls to determine the reliability of the books and records (including electronic books and records), identify high risk issues, and determine the depth of the examination of income.
5.IRS will conduct a reconciliation of income.
Reconcile the income reported on the tax return to the taxpayer’s books and records.
An analysis of the IRP information in the file should also be completed to ensure all business and/or investment activities reflected on the IRP document are properly accounted for on the tax return.
6. IRS will do a Testing Gross Receipts.
Test the gross receipts by tying the original source documents to the books.
7. Bank Analysis – Prepare an analysis of the taxpayer’s personal and business bank and financial accounts (including investment accounts) to evaluate the accuracy of gross receipts reported on the tax return.
8. Business Ratios.
Prepare an analysis of business ratios to evaluate the reasonableness of the taxpayer’s business operations and identify issues needing a more thorough examination.
9. E-Commerce and/or Internet Use – Determine if there is Internet use and e-comm.
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