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IRS Policy Statement P-4-21. It states “The primary objective in selecting returns for examination is to promote the highest degree of voluntary compliance on the part of taxpayers.”
The plan that is used by the IRS is based on long range coverage planning, and objectives on the resources requested in the Congressional Budget. From this, there is an established plan where staff years are allocated to all area IRS offices using resource allocation and a prescribed methodology. Each Area Manager of the IRS is responsible for preparing an area response following instructions from the National Headquarters.
Staffing is based on the examination priorities that differs from office to office and region to region, front loaded programs set up before hand, historic examination rates adjusted to yield sure ended results and audits that match experience of the personnel. Each region is excepted to produce tax audits and money from tax audits. IRS is funded thru results.
Front Loaded programs are those tax audits that IRS DC headquarters has determined are very important and a considerable amount of time must be spent on these programs and activities. Each area has discussions within management as to what the programs should be for each region, district, and office.
Some of the programs are:
The National Office makes sure there is a balanced approach for audit return delivery and tax compliance. Resources and inventory and the size of personnel all go into this formula. The focus is blended into these areas:
The IRS will prepare a plan, which is classified. A National DIF score indicator is placed on all Federal Income tax returns that are filed. Each tax return has certain factors that contribute to its score such as Gross Income, Adjusted Gross Income and line item expense.
There are several classified secrets that go into the DIF score.
Each tax return is processed through the IRS computer line item by line item.
A DIF score label is placed on every tax return with its DIF number. A tax examiner or Revenue Agent manually eyeballs each and every tax return with a high DIF score.The examiner then determine which return has the highest probability of tax audit success.
The IRS will calculate the Area DIF cutoff score for each activity code, giving consideration to the selection rate. This is the lowest DIF score necessary to secure the number of returns required for audit. For example, if the return plan shows 225 returns for an activity code and the selection rate is 70%, the IRS will need to order 321 returns (225/70%).
The DIF Cut off Score is 500. The number of returns with DIF scores greater than 550 is 280, which is less than the number of returns required, so the lowest DIF score on an ordered return will be in the range of 500 to 550 and the DIF cutoff score is 500. This is the IRS example as found in the IRS IRM section 4.
Examination inventory is assigned to IRS offices based on ZIP codes, using the Look up Tables at Martinsburg Computing Center.
Certain ZIP code areas are identified as High Assault Risk Areas. There are special instructions the IRS has regarding these audits. These returns will be audited.
From year to year the IRS changes their programs to keep everyone honest. However, after years of experience, a trained eye can know what tax returns will be pulled for audit.
Being former IRS agents we know all the protocols, all the theories, all the settlement formulas and all the tax procedures the IRS will use for a IRS tax audit.
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Q . Does the IRS ever contact a taxpayer or the tax preparer via e-mail to initiate an audit?
A. The IRS does not contact an individual via e-mail for an initial appointment. Contact related to being selected for an audit will be made via telephone or mail only, due to disclosure requirements.
Q. Does filing an amended return affect the return selection process?
A. Filing an amended return does not affect the selection process of the original return. However, amended returns also go through a screening process and the amended return may be selected for audit.
Q. Why was my return selected for audit?
A. When returns are filed, they are compared against “norms” for similar returns. The “norms” are developed from audits of a statistically valid random sample of returns. These returns are selected as part of the National Research Program which the IRS conducts to update return selection information.
The return is next reviewed by an experienced auditor. At this point, the return may be accepted as filed, or if based on the auditor’s experience questionable items are noted, the agent will identify the items noted and the return is forwarded for assignment to an examining group.
Upon assignment to a group, the return is reviewed by the manager.
Items considered in assigning a case are: factors particular to the area such as issues pertaining to construction, farming, timber industry, etc. that have specific factors and rules that apply. Based on the review, the manager can accept the return or assign the return to an auditor.
The assigned auditor again reviews the return for questionable items and either accepts it as filed or contacts the taxpayer to schedule an appointment.
Q. Where will the audit be held?
A. It depends on the type of audit being conducted.
Audits by Mail/Correspondence Audit.
Some audits are conducted entirely by mail. If the audit is conducted by mail, you will receive a letter from the IRS asking for additional information about certain items shown on the tax return such as income, expenses, and itemized deductions.
In-Person Audits are audits conducted either at a local IRS office or at your business location.
Q. Can you request the audit be conducted at the IRS office instead of at your place of business?
A. If the audit has been scheduled to be conducted at your location, it will generally be conducted where the books and records are located. Requests to transfer the audit to another location, including an IRS office, will be considered but may not be granted. Treasury Regulation 301.7605-1(e), Time and place of audit, discusses the items considered when a request for a change in location is made.
Q. Can the audit be transferred to another IRS office?
A. You can request a transfer of an audit if you have moved. Several factors will be considered such as your current location, the location of the business and where the books and records are maintained.
If the audit is by correspondence, you can request a face-to-face audit because the books and records may be too voluminous to mail.
Q. How long should the records related to a business or other long-term asset be kept?
A. In the case of an asset, records related to the asset should generally be kept for as long as you have the asset plus three years. If the asset was exchanged, the basis for the new asset may include the exchanged asset so the records for both assets will need to be retained until the new asset is disposed plus three years from the file date of the tax return for the year of disposition.
Q. How long should payroll records be kept?
A. In general, payroll records should be kept for six years with a review of the file to see if any items relating to current employees should be retained with current records.
Q. After an auditor completes the audit, will the case be reviewed to ensure the audit results are correct?
A. All cases may be reviewed by the auditor’s manager either during the audit or upon completion. If errors are noted by the manager, the auditor will contact you to advise you about the proposed correction and what impact this may have on the amount of tax due.
Q. How far back can the IRS go to audit my return?
A. Generally, the IRS can include returns filed within the last three years in an audit. Additional years can be added if a substantial error is identified. Generally, if a substantial error is identified, the IRS will not go back more than the last six years.
The IRS tries to audit tax returns as soon as possible after they are filed. Accordingly most audits will be of returns filed within the last two years.
If an audit is for an older year, you may be requested to extend the statute of limitations for assessment of your tax return. The statute of limitations limits the time allowed to assess additional tax.
The statute of limitations is generally three years after a return is due or was filed, whichever is later. There is also a statute of limitations for making refunds.
If the audit is not resolved and the statute of limitations date is nearing, you may be asked to extend the statute of limitations date. This will allow you additional time to provide further documentation to support your position, request an appeal if you do not agree with the audit results, or to claim a tax refund or credit. It also allows the IRS time to complete the audit and provides time to process the audit results.
You do not have to agree to extend the statute of limitations date. However, if you do not agree, the examiner will be forced to make a determination based upon the information they currently have. Therefore, the examiner may not be able to consider additional adjustments, such as expenses, that could lower the amount of tax due.