This is the second article in a series of articles we are doing on IRS audits. The purpose of this series is to demystify the audit process, inform readers about how IRS audits are conducted, and provide readers with an understanding of the audit process. In Part I of this series, we discussed how taxpayers are selected by IRS for audit. We also discussed the various types of examinations that are conducted. In this article, we discuss the audit process. Next month, we will take a look at special types of audits, including partnership audits and employment tax audits.
The Audit Process
The audit process differs depending on the type of taxpayer that is being examined, the items being examined, and the type of examination being conducted. As we noted in Part I of this series, there are three types of examinations: correspondence audits, office audits, and field audits. Correspondence audits are the most common type of audit conducted by IRS and the least intrusive. They usually involve individuals and small businesses, and they are usually limited to one or two specific items. Office audits, like correspondence audits, usually involve examinations of individual and small business taxpayers. With office audits, however, the issues presented are usually more complex than those involved with a correspondence audit. For this reason, office audits are usually conducted by higher level employees – i.e., tax compliance officers or revenue agents – and they usually involve a meeting with the examiner at an IRS field office.1 Field audits are the most complex type of audit that IRS conducts. Although these types of audits may involve any type of taxpayer, they frequently involve business taxpayers. Unlike office audits, which usually involve only one meeting between IRS and the taxpayer, field audits may take place over several months, possibly even years. With all three types of audits, the basic process is the same. Correspondence audits differ from office and field audits, however, in the response required to the initial correspondence informing the taxpayer of the examination. For this reason, they are addressed separately below.
For all three types of audits, the IRS initiates the examination by sending the taxpayer a letter informing the taxpayer that it has been selected for examination. For correspondence audits, this letter, which is known as the initial contact letter,2 indicates the type of examination being conducted, the periods and issues under examination, how to respond, and when the response is due.3 With a correspondence audit, the initial contact letter indicates that IRS is conducting an examination of specifically identified items and requests the taxpayer to respond by mailing the documents and information requested to the IRS Service Center conducting the examination.
When a correspondence audit is being conducted, the taxpayer should respond by sending the documents and information requested to the address of the IRS Service Center listed in the initial contact letter no later than the date the information is requested. Once the information is received and reviewed, the taxpayer will receive either a no change letter indicating that no changes will be made to the taxpayer’s return, or the taxpayer will receive a notice of proposed adjustment. If the examination results in a proposed adjustment, the IRS will follow the same procedures applicable to office and field audits, which are discussed below under the heading “Concluding the Examination.”
Office and Field Audits
As noted above, office and field audits are usually more extensive than correspondence audits. They also involve at least one meeting with the IRS. With office and field audits, the taxpayer usually receives a version of IRS Letter 2205A, notice of examination, informing the taxpayer of the audit.4 The notice will include the name and title of the IRS employee conducting the examination. It will also state that a meeting is requested and set forth a date and time at which the meeting will be held.5 For office audits, the meeting will take place at an IRS field office.6 For field audits, the meeting will be held at the taxpayer’s place of business.7 With both office and field audits, the initial contact letter will usually include an initial Information Document Request (IDR), IRS Form 4564, listing specific documents the taxpayer needs to bring to the initial meeting.
For office and field audits, the initial response should be a phone call to the examiner to schedule or confirm the date of the initial meeting. During the call, the taxpayer or the taxpayer’s representative should clarify the issues under review. They should also clarify the documents that will need to be provided at the initial meeting. After contacting the examiner, the next step is to gather the documents and information that will be needed for the meeting. For office audits, the documentation that the taxpayer will need to provide is usually less extensive than that required in field audits.8 With an office audit, for instance, the notice of examination may indicate the IRS is examining certain business expenses reported on the return, and the IDR may simply request the taxpayer bring invoices, receipts, or other documents substantiating the expense to the initial meeting. By contrast, with field audits the list is usually more expansive. The initial IDR typically includes, among other things, copies of bank statements and cancelled checks for the year(s) covered by the audit, copies of investment account statements, year-end bank reconciliations, invoices, general ledgers, charts of accounts, detailed depreciation schedules, accountant work papers, and copies of tax returns.
IDRs are an important part of the audit process.9 The taxpayer or their representative should make sure they have enough time to gather the required documents prior to the first meeting. The documents should be organized so that they are easily accessible, and each document should be copied and cataloged before it is provided to the examiner. Originals should not be provided if possible.
With office audits and field audits, the initial meeting is a crucial event because it sets the tone for the remainder of the audit. If an office audit is being conducted, the taxpayer or their representative should familiarize themselves with the location of the IRS field office well in advance of the meeting. On the date of the meeting, the taxpayer or their representative should show up early if possible. Everything that occurs will color how the examiner views the case. If the taxpayer or the taxpayer’s representative is on-time, organized, and prepared to respond to questions and provide information, the meeting is more likely to conclude with a positive result.
As noted above, office audits usually involve only one meeting. During the meeting, the examiner will explain the issues involved and review the documents and information requested in the IDR. Depending on the nature and extent of the issues, the examiner may review the documents and make a determination regarding any adjustments at the conclusion of the meeting. Most often, however, the examiner will take what has been provided and review it after the meeting has concluded.
With field audits, the initial meeting is more of a planning session for the meetings that will follow. In addition to reviewing the issues and familiarizing the agent with the documents and information being provided, the revenue agent and the taxpayer or its representative will discuss a preliminary timeline for concluding the examination. They will also schedule additional meetings and discuss the issues that will be addressed and the activities that will be conducted. The initial meeting usually concludes with the revenue agent issuing additional IDRs related to issues that were identified during the meeting.
Subsequent Meetings and Events
The course of the audit following the initial meeting depends on a number of factors, including the type of audit involved, the nature, complexity, and number of issues involved, and the responsiveness of the taxpayer or the taxpayer’s representative to the examiner’s requests for documents and information. Office audits usually do not involve subsequent meetings. However, it is not uncommon for the examiner to issue additional IDRs. By contrast, field audits involve multiple meetings that take place over several months at a minimum. Taxpayers involved in field audits should expect additional IDRs to be issued following each meeting. In addition to reviewing documents, the revenue agent may request a tour of the business’s premises.10 They may also request interviews with the taxpayer’s officers or other employees.11 If the items under review involved novel or complex legal issues, the revenue agent may request guidance from the IRS Office of Chief Counsel. Depending on the industry and the issues involved, the revenue agent may bring in any number of different specialists, such as economists, engineers, appraisers, and others, to assist with the examination.12
Throughout the examination, the taxpayer’s goal is to conclude as quickly as possible and limit the scope of the examination to the years identified in the notice of examination. The taxpayer is more likely to achieve this result if the taxpayer has been responsive to IDRs and provides timely, complete, and accurate answers to the examiner’s questions. If information is requested, but not provided, the examiner may issue summonses to obtain the information from a third-party.13 In addition, the examiner could expand the issues or periods that are being reviewed. In the case of an office audit, the examination may be converted into a field audit. Finally, if the examiner determines that sufficient “badges of fraud” exist, the examiner may refer the case to a fraud specialist for a determination of whether the case should be referred to IRS Criminal Investigation Division for investigation or whether civil fraud penalties should be pursued.14
Audits cannot last forever. The IRS generally has three years after a return is filed to examine the return and assess any additional tax that may be due.15The statute of limitations on assessment continues to run during the course of an audit. At some point, IRS will have to decide to either make an assessment based on the information then available, or request the taxpayer extend the statute of limitations on assessment. The decision whether to extend is a strategic choice and the discussion is beyond this article.
Concluding the Examination
Once the examiner has obtained all the documents and information needed to address the issues under review. The examiner will issue a notice of proposed adjustments, otherwise known as a revenue agent’s report or 30-day letter. At this point, the taxpayer has three options. First, it could consent to the proposed adjustments by signing IRS Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax), which will be included with the notice of proposed adjustments. In that case, IRS will immediately assess the tax due as a result of the adjustments. Second, the taxpayer could appeal some or all of the proposed adjustments to the IRS Office of Appeals. The notice of proposed adjustments is sometimes referred to as the 30-day letter because the taxpayer has 30 days from the date of the notice of proposed adjustments to file the appeal.16 The final alternative is to do nothing. In that case, IRS will issue a Notice of Deficiency (“NOD”) after the 30-day period has expired for filing an administrative appeal.
The NOD is a procedurally important point in the audit because it triggers the taxpayer’s right to judicial review prior to assessment of the taxes in question.17 The taxpayer has 90 days from the date of the NOD to file a Petition with the United States Tax Court contesting the proposed adjustments.18 If a petition is timely filed, the IRS cannot assess or collect the proposed adjustments until after the Tax Court proceedings have concluded and all rights to appeal have been exhausted.19 If, however, the taxpayer fails to petition the Tax Court for judicial review within 90 days from the date of the NOD, the IRS can assess and collect the tax attributable to the adjustments, and the taxpayer loses the right to pre-assessment judicial review. The taxpayer’s only recourse to contest the assessment is to pay the tax, request a refund, and sue in federal district court or the court of federal claims if the refund is not granted.
A lot of thought and strategy is involved in determining when and how to respond to an IRS request for information, the notice of proposed adjustments, and the NOD. There are myriads of considerations to factor into account and discussion of the issues is beyond the scope of this article. Those decisions, however, should not be made lightly.
- I.R.M. 18.104.22.168.2(2) (02-11-2016) (“Generally, the examination will be conducted in the IRS office closest to the taxpayer’s residence, providing the office has appropriate office examination personnel. In extenuating circumstances, the examiner may meet with the taxpayer at the taxpayer’s home or place of business. This situation could occur due to the nature of the taxpayer’s business or due to the incapacity of the taxpayer.”).
- The initial contact letter is usually some version of IRS Letter 566 coupled with IRS Letter 886A explaining the proposed adjustments to be made if information is not provided, or IRS Form 4564, Information Document Request. See I.R.M. 22.214.171.124.5.1 (12-08-2017) (describing correspondence examination letters).
- See I.R.M. 126.96.36.199.10.1 (12-03-2018).
- The initial contact letter for office and field audits is typically a version of IRS Letter 2205A. See I.R.M. 188.8.131.52.1.1 (describing initial contact letters for office audits); and I.R.M. 184.108.40.206.1.2 (describing initial contact letters for field audits).
- IRC 7605(a) states, in part, that “the time and place of examination shall be such time and place as may be fixed by the Secretary and as are reasonable under the circumstances.” See also I.R.M. 220.127.116.11.2(1) (02-11-2016) (“It is the Service’s goal to set the time and place for the examination to maximize the convenience of the taxpayer within the constraints of sound and efficient tax administration.”).
- See supra, n. 3.
- See also I.R.M. 18.104.22.168.2(3) (02-11-2016) (“Revenue agents have the responsibility to determine the most reasonable place to conduct the examination based on the circumstances. See IRM 22.214.171.124.2.1. Generally, the location of a taxpayer’s representative will not be a consideration in determining the place of the examination.”).
- See generally I.R.M. 126.96.36.199.1.1 (11-04-2016).
- See I.R.M. 188.8.131.52.2 (01-17-2012) (requesting information or documents from the taxpayer); id. at (1) (describing the purposes of site tours as providing an opportunity to acquire an overview of the business operation, establish that the books and records accurately reflect actual business operations, observe and test internal controls, clarify information obtained through interviews, and identify potential audit issues).
- See I.R.M. 184.108.40.206 (03-01-2003) (Tours of Business Sites and Inspection of Residences).
- IRC 7521(c) states that an examiner cannot require a taxpayer to accompany an authorized representative to an examination interview in the absence of an administrative summons. However, the taxpayer’s voluntary presence at the interview can be requested through the representative as a means to expedite the examination process.
- I.R.M. 220.127.116.11.5.2.1 (01-17-2012).
- Sections 6201(a) and 7601(a) of the Code provide general authority to IRS to make inquiries to ascertain tax liability. Section 7602(a) of the Code authorizes IRS to issue summonses to compel the taxpayer to produce “books, papers, records, or other data,” to give testimony under oath, or both. The summons is the principal mechanism available to IRS for coercing compliance with information requests.
- I.R.M. 18.104.22.168.5.2.5 (04-02-2010) (“If the case has indications of fraud, the examiner will discuss the facts with their group manager and contact a fraud technical advisor (“FTA”) if the manager concurs. If the FTA agrees that there are sufficient indicators to warrant fraud development, the examiner will complete Form 11661, Fraud Development Recommendation – Examination. All parties will follow the fraud development procedures prescribed in IRM 25.1.2, Recognizing and Developing Fraud.”).
- See IRC § 6501(a) (statute of limitations on assessment). In the case of a substantial understatement of income, the statute of limitations is extended to six years. See id. at (e). In the case of fraud, the statute of limitations on assessment is unlimited. See id. at (f).
- If less than one year remains on the statute of limitations on assessment, the Office of Appeals will not consider the appeal unless the taxpayer agrees to extend the statute of limitations on assessment. See I.R.M. 26.6.22. (setting forth policies and procedures related to extension of the statute of limitations on assessment by consent). The reason for this policy is that the issuance of the notice of proposed adjustments (i.e., 30-day letter) does not stop the statute of limitations on assessment from running. The statute of limitations is only suspended upon issuance of the notice of deficiency. See IRC § 6503 (providing that statute of limitations on assessment is suspended until either (i) the 90-day period lapses and no petition is filed, or (ii) if a petition is filed, the decision of the court regarding the liability become final).
- IRC § 6212(a) (“If the Secretary determines that there is a deficiency in respect of any tax imposed by subtitles A or B or chapter 41, 42, 43, or 44 he is authorized to send notice of such deficiency to the taxpayer by certified mail or registered mail.”).
- IRC § 6213 (“Within 90 days, or 150 days if the notice is addressed to a person outside the United States, after the notice of deficiency authorized in section 6212 is mailed (not counting Saturday, Sunday, or a legal holiday in the District of Columbia as the last day), the taxpayer may file a petition with the Tax Court for a redetermination of the deficiency. Except as otherwise provided in section 6851, 6852, or 6861 no assessment of a deficiency in respect of any tax imposed by subtitle A, or B, chapter 41, 42, 43, or 44 and no levy or proceeding in court for its collection shall be made, begun, or prosecuted until such notice has been mailed to the taxpayer, nor until the expiration of such 90-day or 150-day period, as the case may be, nor, if a petition has been filed with the Tax Court, until the decision of the Tax Court has become final.”).
- IRC § 6503.