The IRS has expanded the use of correspondence examinations of individual income tax returns. The IRS initiates a correspondence examination by mailing either Letter 566 (CG), often termed an initial contact letter, advising the taxpayer that a return has been selected and listing the items to be verified, or a CP 2000 notice, which contains proposed adjustments based on information documents issued by third parties, such as Forms W-2, Wage and Tax Statement; 1099-MISC, Miscellaneous Income; and 1098, Mortgage Interest Statement. The examinations are handled at an IRS Service Center or campus.
Selection of Returns
When the IRS receives returns, it compares them against norms for similar types of returns. The IRS develops the norms from audits of statistical random samples of returns that are selected as part of the National Research Program, which the IRS conducts to update return selection information.
The IRS typically selects returns for correspondence examinations based on data indicating that the taxpayer has not reported income, claimed improper deductions, or claimed erroneous tax credits. Some typical items for which the IRS requests verification include alimony, moving expenses, various itemized deductions, casualty losses, employee expenses, Schedule C receipts and expenses, foreign tax credits, earned income credits, and education credits.
Responding to Correspondence
A practitioner should advise a client in advance, usually by having an explanatory paragraph in the tax engagement letter, to notify the preparer if the client receives correspondence from the IRS. Clients sometimes presume that notices are correct and pay proposed assessments without contacting their return preparers.
After securing a power of attorney from the client, the CPA should carefully study the IRS notice along with the tax return and supporting documents. If the CP 2000 notice is correct, the CPA should advise the taxpayer to sign the agreement sent with the letter and pay the deficiency.
If an assessment in a CP 2000 notice is incorrect or if a response is to be made to the initial contact letter, the practitioner should consider whether to ask that the matter be transferred from the IRS campus to a local office. The IRS tends to not want to transfer cases because of the possibility of delay, and it is usually more economical for the agency to handle the matter by correspondence. Regs. Sec. 301.7605-1(e)(1) provides that the IRS will consider, on a case-by-case basis, written requests to change the examination venue. Many IRS campuses take the view that correspondence examinations will be transferred only in instances of hardship. If there are problems in transferring an examination, the practitioner may want to contact the local taxpayer advocate’s office and request assistance in having the matter transferred to the local IRS office.
If the practitioner sends a written response to the IRS Service Center, he or she should submit the necessary documentation and explain whether an adjustment is appropriate.
Unlike a field examination, a correspondence audit is not assigned to a specific examiner. When the IRS receives correspondence, the file is assigned to an auditor. If there is no response from the taxpayer, the process moves through an automated system. After a certain period of time, the IRS issues a second notice, and if there is no reply, it will issue a statutory notice of deficiency or a 90-day letter.
The IRS has been having workload problems in timely responding to taxpayer or practitioner letters that provide the requested information or express disagreement with proposed adjustments. Often correspondence is not assigned to the auditor who reviewed earlier documents. Correspondence tends to not be reviewed for several months, resulting in the IRS sending letters advising the taxpayer that it needs additional time to review the correspondence. When the IRS finally issues reports, in some cases the proposed adjustments are not correct because proper consideration and evaluation have not been given to the documents and substantiation furnished by the taxpayer or his or her representatives.
Reports of Other Offices
In 2010, the Treasury Inspector General for Tax Administration (TIGTA) issued a report conducted as part of Treasury’s fiscal year 2009 annual audit plan, which concluded that correspondence audit results are sometimes inaccurate and overstated and that there are operational problems with the program, including significant mail processing delays (TIGTA, The Discretionary Examination Program Performance Results Are Incomplete; Therefore, Some Measures Are Overstated and Inaccurate (August 6, 2009)). The delays can result in taxpayers who send documentation in a timely manner being assessed taxes and interest because their correspondence was not dealt with promptly once it reached the IRS.
In her report to Congress for the office’s fiscal year 2011 objectives, Nina Olson, the national taxpayer advocate, expressed concern about the correspondence audit program. She found that statutory notices of deficiency were prematurely issued due to various problems:
- The IRS was not considering requests for managerial conferences and Appeals hearings;
- The IRS was not considering requests to transfer correspondence audit cases to local offices;
- Documentation was not being associated with audit cases because of inadequate procedures for receipt, control, and routing; and
- Issues were not being resolved because the IRS was not having enough phone conversations with taxpayers.
Olson is working with IRS correspondence audit improvement teams to correct procedures that result in the premature issuance of deficiency notices. She has also challenged the IRS to develop telephone contact strategies within the audit program to address shortcomings in addressing taxpayer needs.
Valrie Chambers is a professor of accounting at Texas A&M University–Corpus Christi in Corpus Christi, TX. Joe Marchbein is with Jack P. Fitter CPA, A.P.C., in Chesterfield, MO. They are both members of the AICPA Tax Division’s IRS Practice and Procedures Committee. For more information about this column, contact Prof. Chambers at email@example.com.