Chapter 2 -
The Examination Process
Learning Objectives
• Understand the different types of audits that the IRS conducts.
• Determine the appropriate way to handle an audit notice.
• Determine how to respond to IRS inquiries and requests.
• Understand your responsibilities when representing your client in front of the IRS.
• Understand how to advise a client at the conclusion of an audit.
Introduction
For many of our clients, a letter from the IRS requesting clarification of an item reported on a
return creates terror. The IRS does its part to help foster that. It attempts to time press releases
about tax evasion cases during filing season to help bolster compliance. After all, promoting
compliance with the tax law is one of the IRS’s missions.
The audit process is not defined in the Tax Code. The IRS conducts audits in the way that it
thinks will be the most efficient way to assess tax. There is no one way to handle an audit
because no two IRS examiners are the same and no two taxpayers are the same.
The IRS makes it quite clear that the responsibility of a tax preparer is to determine and report
the correct amount of tax. When a preparer signs a tax return, he is declaring, under penalties of
perjury, that the return and its schedules are true, correct, and complete based upon all
information of which the preparer has knowledge. The tax auditor is also attempting to
determine the correct amount of tax based upon all the available information. So, in theory, we
have the same goals.
A thorough knowledge of the examination process and the various types of audits will help
preparers represent their clients and guide them through the process.
This chapter looks at Service Center Examinations, Office Audits, and Field Examinations and
will take you, the preparer, through the steps needed to successfully get your clients through the
process.
The Return Selection Process
There are many different ways a return may be selected for audit. The most common method is
the DIF (Discriminant Function) score. The DIF score is a mathematical formula used to score
income tax returns as to examination potential. These formulas were developed based on
National Research Program (NRP) available data. Each return measured under DIF receives a
DIF score. Generally, the higher the score, the greater the audit potential. The highest scored
returns are made available to Examination upon request. DIF mathematical formulas are
confidential and for official use only. The IRM states that a DIF score assigned to a return should
not be disclosed to the taxpayer (IRM 4.1.3.2).
The following types of returns are computer scored under the DIF System:
• Individual Returns
• Corporation Returns
• S Corporation Returns
• Partnership Returns
• Fiduciary Returns
Returns may also be selected as part of a special project or for research by the IRS. Individual
revenue agents may also request returns for audit from the Service Center if they discover
information that suggests there may be audit potential on a return.
Correspondence Audits
Most individuals that will have contact with the IRS are likely to have that contact in the form of
a Service Center Audit. Typically, the taxpayer will receive a CP 2000 notice that requires a
timely response. Explanations and supporting documents are mailed to the appropriate Service
Center, and the item is resolved. The entire audit may be done by correspondence.
The CP 2000 Notice – See Exhibit 2-1
The IRS is increasing the number of correspondence audits. Many of them are initiated due to
mismatching of third-party information with items reported on the return. The IRS reports that
Schedule D items, capital gains and losses, tend to be a high-problem area.
The Service Center may also issue CP 2000 notices requesting receipts to verify other expenses
such as charitable contributions.
Clients should be instructed to immediately bring any letters or notices they receive from the IRS
to their preparers. Many CPAs put such a clause in their engagement letter. Speed is of the
essence here because the taxpayer only has 30 days from the date of the notice to respond to the
IRS.
The CP 2000 letter is a 30-day notice of an assessment of tax. Failure to have the response at the
IRS Service Center by the date indicated on the letter will usually result in the amount being
assessed. Once assessed, the taxpayer will have to follow the procedures outlined in the 90-day
letter and petition the tax court.
Upon receipt of the CP 2000 by the taxpayer, it is generally advisable to prepare a Form 2848,
Power or Attorney, and submit it to the IRS as soon as possible. If the client wishes to attempt to
save money by handling the response herself, it is a good idea to submit the POA so that it is on
the record in case the preparer should need to become involved.
The CP 2000 offers taxpayers the opportunity to examine the information that the IRS has
received and compare it to his records. The taxpayer may agree totally, disagree totally, or agree
partially with the IRS proposal. If the taxpayer finds that he made an error on the original return,
he should not file an amended return. He may mark that he agrees with the changes and sign the
form. This gives the IRS permission to immediately start assessment procedures, and he will
soon receive a bill. Or, the taxpayer may enclose a check with the form to stop interest and
penalties from accruing.
If the response is fairly simple, such as simply having to show the IRS where some income was
reported on the return, the taxpayer or his representative may call the IRS and provide that
information. If the notice was generated from Brookhaven, Ogden, or Philadelphia, the phone
number to call is 800-829-8310. If the notice was generated from Atlanta, Austin, or Fresno, the
number to call is 800-829-3009.
If written evidence needs to be submitted, it should be submitted to the address indicated in the
letter. Make copies of all relevant documents and submit them with the explanation and a copy
of the original CP 2000.
If the taxpayer cannot completely respond to the notice by the date indicated on the letter, he
must notify the IRS. He or his representative may call the number at the top of the notice or
write the Service Center. In either event, this must be done before the 30-day period has expired.
The IRS may allow an additional 30 days to wait for a response, or longer if it is a complicated
issue. However, no response by the due date will usually result in the 90-day letter being issued.
A taxpayer’s correspondence audit is not assigned to one person at the service center. If there
are multiple communications, it is imperative that each correspondence be properly identified so
that it will be associated with prior correspondence.
Office Audits
In the case of an office audit, a taxpayer is typically sent a letter that his return has been selected
for audit. The letter details the items on the return that are being examined and requests that the
taxpayer produce specific records pertaining to those items in person at an IRS office at a
specified time and date.
The date and time of the audit is easily changed. The IRS does not expect most people to be
available at the random date and time that it chose to put on the letter. Therefore, there is no
negative connotation placed upon a taxpayer or representative that calls to change the
appointment.
An Overview of the Typical IRS Office Audit
Office audits are not as complex as field examinations and are usually restricted in scope to the
items mentioned in the notice. Most office audits are allotted initial time slots of about two
hours. The examiner has a worksheet that she will fill out upon examining the evidence that the
taxpayer or representative present for the items listed on the audit letter. The auditor did not
write the audit letter. However, an examiner may expand the scope of an audit based upon her
findings.
Preparing for an Office Audit
Generally, the meeting at the IRS office is fairly informal and relaxed. The examiner in an
office audit has to complete a form to create his report. He uses Form 4700 to record what he
has seen and verified. The key to a successful audit outcome is organization. A representative
should have thoroughly reviewed all documentation that will be presented to the auditor. If there
are multiple receipts to verify a particular expense, they should be organized together preferably
with an adding machine tape to show the totals. The auditor may test some of the tapes to verify
the accuracy.
Most issues in an office audit are centered around whether or not the taxpayer has receipts to
verify deductions and whether or not there is unreported income. Common areas for an office
audit include itemized deductions, employee business deductions, and less complex Schedule C
and Schedule E issues.
The representative should be on time and have a copy of the Power of Attorney with him even if
it has already been submitted. The POA should include all open tax years for the taxpayer. If
the auditor finds a significant issue in one year, he is very likely to look at the same issue in any
other years that are currently open by statute.
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