Why the Internal Revenue Manual Is Valuable to Your Clients

Editor: Valrie Chambers, Ph.D., CPA

Practice & Procedures

The Internal Revenue Manual (IRM) is essentially the IRS employee handbook. It contains instructions on how to carry out all administrative and procedural matters, such as how to audit specific tax returns, collect taxes, process returns, or assess penalties. The IRM may be the most important tool provided to IRS employees as it contains vital information to help them do their jobs. Nonetheless, practitioners often wonder why it matters to them. The IRM itself is not the law, and the procedures set forth in it are not mandatory or binding on the IRS. Practitioners tend to look to the real legal authorities (e.g., the Internal Revenue Code, Treasury regulations, and court cases), not the IRM.

However, understanding how IRS personnel are instructed to perform certain procedures can be valuable to practitioners. For example, gaining insight into how the IRS will audit a specific area on a return (such as the techniques they use or the items they request) can help a CPA prepare for an audit, address IRS inquiries, or prepare tax returns. Additionally, and perhaps most importantly, certain items in the IRM are not available anywhere else. A CPA who never refers to the IRM cannot fully serve his or her clients. This item contains several key areas of the IRM that should be noted in tax practice. (The IRM can be accessed online at irs.gov/irm.)

First-Time Penalty Abatement (IRM §20.1.1.3.6.1)

The IRM contains first-time abate (FTA) procedures that allow IRS employees to remove failure-to-file, failure-to-pay, and failure-to-deposit penalties from a taxpayer’s account if they meet certain criteria. The policy behind this procedure is to reward taxpayers for having a clean compliance history—­everyone is entitled to one mistake.

To qualify for an FTA, a taxpayer must not have been required to file a return or must have no prior penalties (except an estimated tax penalty) for the preceding three years, must have had no penalties added to or removed from its account for the past three years, must have filed (or filed a valid extension for) all required returns, and must have paid, or arranged to pay, any tax due.

An FTA can save a taxpayer thousands of dollars, and sometimes it can be obtained over the phone. IRS employees can usually pull up the taxpayer’s account and quickly determine whether the taxpayer meets the criteria. The clincher is an FTA is granted only to taxpayers that request one. Thus, knowing about this penalty relief procedure is imperative, but it is not mentioned anywhere in IRS guidance, only in the IRM. A practitioner may call the Practitioner Priority Service line (866-860-4259) or the number on the client’s notice to request an FTA (Form 2848, Power of Attorney and Declaration of Representative, is required).

Note that if a client does not meet the FTA requirements, a CPA should review the IRS’s reasonable-cause criteria (see IRM, Part 20, Penalty and Interest). Penalty abatement is based on the client’s facts and circumstances. The IRM outlines common scenarios that constitute reasonable cause, such as reliance on a tax professional or a death, serious illness, or unavoidable absence of the taxpayer or a member of his or her family.

Audit Techniques (IRM, Part 4, Examining Process, and Audit Technique Guides)

Specific audit information is also contained in the IRM and/or in the IRS’s Audit Technique Guides (ATGs)—but nowhere else. (The ATGs are available at www.irs.gov.) The IRM provides IRS agents general information and instructions for auditing taxpayers and examining returns, and the ATGs help agents during audits by providing insight into issues unique to a specific type of taxpayer or to a specific industry. The IRM and ATGs help IRS personnel perform audits, but they are also valuable to practitioners. They shed light on how income will be examined, what interview questions will likely be asked, how evidence will be evaluated, and more.

For example, IRM Section 4.10.4.3.7 includes a provision stating that the agent may use Google or other search engines to look for domain names and evidence of the taxpayer’s internet presence. The IRM goes on to advise IRS agents to use LinkPopularity.com to search for websites under the taxpayer’s control or the Wayback Machine to search for archived business websites.

Among the ATGs, a valuable resource to practitioners is the Cash Intensive Businesses ATG, which provides guides to IRS agents for a number of types of cash-oriented businesses. This ATG makes it clear that, in an audit of a cash-intensive business, the agent will likely perform reasonableness checks of the amount of revenues reported via comparative analysis and ratio tests. It also describes how the analysis and test will be performed. Preparation is critical to success in an audit, and the IRM and the ATGs allow practitioners to know what they need to be prepared for.

Preserving Appeal Rights/Understanding the “30-Day Letter” (IRM, Part 8, Appeals)

Many practitioners do not recognize the practical effect of a “30-day letter,” but it actually has significant implications for appeal rights. A 30-day letter is a letter from the IRS that proposes adjustments to a taxpayer’s liability. Upon receiving this letter, a taxpayer has three options: (1) pay the proposed tax liability, (2) contest the findings with the IRS Appeals Division, or (3) do nothing and wait to receive a Statutory Notice of Deficiency (a 90-day letter). If the taxpayer does nothing and receives the Statutory Notice of Deficiency, he or she has lost the right to go through the IRS Appeals office to resolve the dispute. The taxpayer must then file a petition in Tax Court to address the issue.

Understanding what is considered a 30-day letter can be important to preserve a client’s appeal rights. For example, the common CP2000, Notice of Underreported Income, serves as a 30-day letter. In fiscal year 2013, the IRS mailed more than 4 million CP2000 notices to taxpayers, which yielded over $7.7 billion in assessments (IRS Tax Stats/­Information Reporting Program by Fiscal Year, available at www.irs.gov). Therefore, it is likely that a CPA will have many clients each year that receive this notice.

If the taxpayer contests the proposed changes in the CP2000, the taxpayer should not only indicate on the response form that he or she does not agree with some or all of the changes, but the accompanying explanatory statement should also be sure to meet the requirement of contesting the findings with Appeals. Therefore, it is recommended to include language in all CP2000/underreporter responses such as, “If you disagree with all or part of the information contained in this letter, the taxpayer requests a conference with the IRS Office of Appeals.” This tip is not commonly known to practitioners. In the event the IRS disagrees with an item provided, an Appeals agent should contact the CPA (as the client’s representative) via phone, and the issue may be resolved informally.

These are just a few of the highlights of useful IRM procedures that practitioners should note. More valuable information is contained in the IRM that can help CPAs serve their clients and remain their most trusted adviser.