Category Archives: Audits

IRS Tentacles Extend to Electronic Records

If you think IRS’ longstanding audit techniques have been intrusive, get ready for the era of IRS Chief Counsel Advice 201146017 (link goes to PDF file).

The Counsel comments on a number of issues related to IRS’ ability to summon a taxpayer’s original electronic data files or backup files to obtain information including who, when, and how the information was created.

Recall that IRS has always been empowered to examine books, papers, records and other data for purposes of ascertaining the correctness of any return, making a return if none has been made, determining the tax liability of any person, and collecting that liability.

In this electronic age, however, it seems IRS existing authority isn’t perceived as broad enough.  The CCA guidance stands for the proposition that the phrase “books, papers, records, and other data” expressed in IRC Section 7602 was more than broad enough to encompass the compelled production of the electronic documents themselves.  And a taxpayer’s offer to provide paper copies may be construed as insufficient from IRS’ point of view.

Further, the CCA believes it can similarly summon such data from a third party, such as the taxpayer’s accountant.

Big Brother never stops watching.

So You Disagree With Your Auditor’s Findings…

You’ve gone through a tax audit, put up with the IRS auditor’s seemingly endless requests for information, and his or her conclusions arrive one day in your mail — including the amount of the tax deficiency (and interest and penalties) which the auditor has computed.

And let’s just assume that you don’t agree with the auditor’s findings — what next?

The most common “next step” is a plea to the Appeals Office within IRS. This office is often able to reach a settlement with you, without your having to resort to the more costly and protracted judicial remedies available to you.

The Appeals Office is separate from, and independent of, the IRS office taking the action with which you disagree. Conferences with Appeals Office personnel are informal in nature, and in some cases can even by completed via telephone. And you can represent yourself, though such is not generally a good idea for a variety of reasons — let your tax pro handle it for you.

(Check out the Pros and Cons of Appealing an IRS Audit.)

If you request the intervention of the Appeals Office, you usually will first have to file a formal written “protest,” outlining the background of your case, and your position in the matter. And if, ultimately, you still can’t come to a palatable resolution of your case, you can still forge ahead to the U.S. Tax Court, the Court of Federal Claims, or your U.S. District Court. Before making this decision, however, consider the costs (including the time to be consumed out of your remaining life expectancy!) as opposed to be benefits which may arise if you are successful. And be sure to include the legal fees in your calculations, inasmuch as legal representation will probably be a must at this point.

IRS Audit Guide Targets Attorneys

IRS has released its Attorneys Audit Technique Guide (ATG) to help auditors sniff out what are perceived potential problems with the way attorneys complete their income tax returns.

Some of the highlights:

1. Unreported income – Generally an attorney will deposit a litigation award into his trust account, later disbursing the client’s share and paying the attorney his fees. Sometimes, he may simply cash the award check, or deposit the check directly into a personal or investment account, which could lead to omission (intentionally or by mistake) of the income from the eventual tax return.

2. Deferral of income – After resolution of a case, an attorney may attempt to defer income truly earned by allowing the legal fees to remain in the trust account until the next year. To do so would clearly be a tax avoidance move under the “constructive receipt” doctrine.

3. Noncash payments instead of fees for services rendered – The ATG suggests, for example, that an attorney might borrow a large sum of money from a client, and then pay it off by performing legal services. While the loan may be shown on the attorney’s books, the income resulting from the obvious relief of debt may somehow escape the bookkeeper’s attention! Also, bartering may find its way into the relationship between the attorney and the client. Auditors are told by the ATG to be on the lookout for situations in which the attorney’s workload has not decreased from one year to the next, but reported fees has declined — a possible indication that the attorney is rendering services in exchange for noncash payments.

4. Advanced client costs – Often, attorneys who take cases on a contingency basis may pay litigation costs on behalf of clients, only to later recover those costs when the eventual award comes in the door. Attorneys on the cash basis of accounting may be inclined to deduct these advanced costs when paid. ATG concludes, however, that courts have determined that costs paid on behalf of a client are more properly treated as loans for tax purposes, thus not deductible as a current year cost of doing business. The expectation of reimbursement is the issue here.