It's your worst nightmare....The Tax Audit. It may not be as bad as it seems. Competent representation can make all the difference.
The IRS examines (audits) tax returns to verify that the tax reported is correct. Selecting a return for examination does not always suggest that the taxpayer has either made an error or been dishonest. In fact, some examinations result in a refund to the taxpayer or acceptance of the return without change.
The overwhelming majority of taxpayers files returns and make payments timely and accurately. Taxpayers have a right to expect fair and efficient tax administration from the IRS, including verification that taxes are correctly reported and paid with enforcement actions against those who fail to comply voluntarily.
How Returns Are Selected for Examination
The IRS selects returns using a variety of methods, including:
* Potential participants in abusive tax avoidance transactions — Some returns are selected based on information obtained by the IRS through
efforts to identify promoters and participants of abusive tax avoidance transactions. Examples include information received from “John Doe” summonses issued to credit card companies and businesses and participant lists from promoters ordered by the courts to be turned over to the IRS.
* Computer Scoring — Some returns are selected for examination on the basis of computer scoring. Computer programs give each return numeric “scores”. The Discriminant Function System (DIF) score rates the potential for change, based on past IRS experience with similar returns. The Unreported Income DIF (UIDIF) score rates the return for the potential of unreported income. IRS personnel screen the highest-scoring returns, selecting some for audit and identifying the items on these returns that are most likely to need review.
* Large Corporations — The IRS examines many large corporate returns annually.
* Information Matching — Some returns are examined because payer reports, such as Forms W-2 from employers or Form 1099 interest statements from banks, do not match the income reported on the tax return.
* Related Examinations — Returns may be selected for audit when they involve issues or transactions with other taxpayers, such as business partners or investors, whose returns were selected for examination.
Other — Area offices may identify returns for examination in connection with local compliance projects. These projects require higher level management approval and deal with areas such as local compliance initiatives, return preparers or specific market segments.
An examination may be conducted by mail or through an in-person interview and review of the taxpayer's records. The interview may be at an IRS office (office audit) or at the taxpayer's home, place of business, or accountant's office (field audit). Taxpayers may make audio recordings of interviews, provided they give the IRS advance notice. If the time, place, or method that the IRS schedules is not convenient, the taxpayer may request a change, including a change to another IRS office if the taxpayer has moved or business records are there.
The audit notification letter tells which records will be needed. Taxpayers may act on their own behalf or have someone represent or accompany them. If the taxpayer is not present, the representative must have proper written authorization. The auditor will explain the reason for any proposed changes. Most taxpayers agree to the changes and the audits end at that level.
What is an Examination?
There is no statutory or common law definition of the term “examination.” However, an examination, or audit, may be described as the systematic inspection of the books and records of a taxpayer for the purpose of making a determination of the correct tax liability.
Because government entities are generally exempt from federal income tax, our compliance efforts are generally focused on employment tax and information return reporting.
During examinations, FSLG Specialists search for errors or omissions on employment tax and information returns.
Examples of common adjustments include the following:
* The employer discontinued the reporting of wages for FICA tax purposes before the annual wage limitation was reached.
Compensation taxed for Federal income tax withholding purposes
* but not for FICA and/or Medicare tax withholding.
* Employers did not report the wages of all employees. Examples of common errors of this type include the wages of janitors, part-time or seasonal workers, etc.
* The amount of wages or income tax withheld was incorrectly reported.
* The employer did not report bonuses, vacation pay, or other payments that constitute additional wages for employment tax purposes.
* The employer did not report the fair market value of non-cash compensation.
In addition, the FSLG Specialist will:
* Verify that all appropriate returns were filed timely. If not, filing deadlines and associated penalties will be discussed and assessed, and any delinquent returns will be secured.
*Verify that all deposits were made timely. If they were not, deposit requirements and failure to deposit penalties will be discussed.
Scheduling the Opening Interview
Generally, a telephone call is used to contact the organization to schedule an appointment in the field for an employment tax interview. The FSLG Specialist will contact an authorized individual.
An “authorized individual” is someone who has authority under the applicable state law to legally bind the entity. Usually state law, the government entity's regulations, or its charter specifies who is "authorized" to engage in certain kinds of activities. The mayor, city manager, school superintendent or comptroller/treasurer (or similar positions in other types of government entities) are other individuals who are most likely “authorized” by law to bind the organization.
During the telephone call with the authorized government official, the FSLG Specialist will generally:
* Set an appointment for the opening interview that is mutually agreeable,
* Discuss the tax returns and periods under audit,
* Provide information about taxpayer rights and the examination process,
* Discuss power of attorney procedures,
* Discuss the format and availability of books and records,
*Provide general information about issues initially planned to be examined and inform the taxpayer that additional issues may be examined depending upon the information obtained during the examination.
The FSLG Specialist will then send the taxpayer an audit confirmation letter with Publication 1 (Your Rights as a Taxpayer), Notice 609 (Privacy Act Notice), and a Form 4564 (Information Document Request (IDR). Sometimes the initial contact is made by an appointment letter. This general occurs when the FSLG Specialist has difficulty locating a telephone number for an authorized individual.
Information Document Request
The IDR will include requests for documents needed to support issues the FSLG plans to examine. The IDR will list the specific information and documents the taxpayer should provide to the FSLG Specialist. Although FSLG Specialists strive to phrase items in terms that are understandable to the taxpayer, sometimes terminology is unclear. If you have a question about what is requested, you should contact the Specialist for clarification.
Items frequently requested include:
* Books and records such as general ledger, cash disbursements journal, accounts payable ledger, etc.
* Trial balance
* Financial statements
* Forms 940, 941 or 944, 945
* Forms W-2
* Forms 1099
* Employee handbooks
* Employer-provided fringe benefit packages
* Collective bargaining agreement and contracts, if any, with employees
Generally an IDR is sent with audit appointment letter, which will list the specific information and documents the taxpayer should have available at the initial appointment. Another IDR may be issued to the taxpayer following the initial interview to request information and documents needed to support issues that were discussed during the initial interview but not available at that time. Additional IDRs may be sent to the taxpayer until all compliance questions are resolved. IDRs will always have a deadline for information to be received. The date listed on the IDR should provide the organization a reasonable amount of time to gather and provide the information, generally between two and four weeks. If this is not sufficient, the government entity should contact the FSLG Specialist to discuss a more reasonable date.
Examinations can be completed in a professional and timely manner when the IRS and Taxpayer/POA work cooperatively together. Time is a valuable resource for both parties and open communication will provide the framework for timely completion of the examination.
If You Agree with a Proposed Increase to the Tax
If you agree with a proposed increase to tax, you can sign an agreement form and pay any additional tax you may owe. You must pay interest and applicable penalties on any additional balance due. If you pay when you sign the agreement, interest is generally figured from the due date of your return to the date of your payment. If you do not pay the additional tax and interest, you will receive a bill If you are entitled to a refund, you will receive it sooner if you sign the agreement form at the end of the examination. You will also be paid interest on the refund.
If You Do Not Agree with a Proposed Increase in tax
If you do not agree with the proposed changes, the examiner will explain your appeal rights. You may request an immediate meeting with the examiner’s supervisor to explain your situation. If you cannot reach an agreement with the supervisor, the FSLG Specialist will prepare a report explaining your position and the IRS position. The examiner will forward your case to the Area office for processing.
You will receive:
* A letter (known as a 30-day letter) notifying you of your rights to appeal the proposed changes within 30 days,
* A copy of the FSLG Specialist’s report explaining the proposed changes, and
* An agreement or a waiver form.
You generally have 30 days from the date of the 30-day letter to tell us whether you will accept the proposed changes or appeal them. The letter will explain what steps you should take, depending on what action you choose. Be sure to follow the instructions carefully. Appeal rights are explained in the Appeals Process article.
If you do not respond to the 30-day letter, or if you respond but do not reach an agreement with an appeals officer, we will send you a 90-day letter, also known as a Notice of Deficiency. This is a legal document that explains the proposed changes and the amount of the proposed tax increase. You will have 90 days (150 days if it is addressed to you outside the United States) from the date of this notice to file a petition with the Tax Court. If you do not petition the Tax Court you will receive a bill for the amount due.
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