IRS Targets 1040 Schedules, Procedures in Preparer Compliance Visits

In its current round of office visits involving tax preparer compliance, the IRS is targeting practitioners who prepare a high percentage of returns with certain Form 1040 schedules and is checking preparers’ procedures and recordkeeping.

For a second tax season, the IRS has sent reminders to tax preparers of their professional responsibilities and is conducting office visits of some, including CPAs. In November, the IRS sent more than 10,000 letters and said it would make about 2,500 office visits between December 2010 and the end of April 2011.

On its website’s frequently asked questions and answers (FAQs) about the letters and visits, the IRS said preparers were selected who submit large volumes of tax returns with Schedule E, Supplemental Income and Loss, and Schedule C, Profit or Loss From Business (Sole Proprietorship), and Schedule A, Itemized Deductions.

A partner at a CPA firm said the firm’s visit from an IRS agent appeared more specifically to target returns with Schedule E, reporting income or loss of more than 50% of adjusted gross income and high levels of rental property depreciation or loss. Schedule A flags included high levels of charitable contributions or employee business expenses, and either reported as round numbers. The visit lasted about two hours and covered returns filed by only a few of the firm’s preparers, said the partner, who asked that he and his firm not be identified so as not to jeopardize ongoing discussions with the IRS on other matters and to avoid further inquiries from other preparers. The visit also covered the firm’s general procedures for handling taxpayer data and for reviewing the accuracy of each return.

The agent, however, assured them “there was no plan or desire to target clients and that he was not interested in the taxpayer returns and would not keep any notes,” according to the partner.

The agent viewed a random sample of completed Forms 8879, IRS e-file Signature Authorization, and was shown the corresponding returns and supporting documents.

The agent also quizzed the CPAs on Sec. 6695, which prescribes penalties for failure to perform duties such as signing returns, furnishing a preparer tax identification number (PTIN), providing a copy to the taxpayer and retaining copies or lists of returns prepared.

“The visit itself was not an imposition, but it was very threatening,” the CPA said. “The agent’s manner wasn’t threatening, but what he was seeking seemed very ill-defined. It was a giant fishing expedition. When they don’t know what they’re looking for, who knows where it will wind up going?”

Because the agent’s viewing of returns and supporting documents was limited in scope, “we were satisfied that our client confidentiality would not be violated,” the CPA said. But afterward, the firm’s members decided that if an agent requested a closer look, they would require clients’ permission first.

The IRS website’s FAQs indicate that IRS agents will assess return preparer penalties during the visits if warranted. CPAs selected for a visit are expected to have available all tax forms they prepared during 2010, including “all relevant documents,” which the IRS says include “worksheets, interview notes [and] correspondence.” In December 22 and October 29 letters to the IRS, the AICPA expressed its concerns about the audits, particularly these two aspects.

“We believe that requesting to review client files is inappropriate unless an examination of the preparer is opened,” said the December 22 letter from Patricia A. Thompson, chair of the Tax Executive Committee, to Chris Wagner, commissioner of the Small Business/Self-Employed Division.

Also, having available all returns prepared in 2010 may be unreasonable and overly burdensome, since some preparers will have prepared hundreds of returns, with voluminous files that could have to be retrieved from storage. CPAs and other preparers whose offices generally are open throughout the year should be allowed to schedule visits after tax season, she wrote.

Revealing client documents and correspondence could waive the Sec. 7525 practitioner-client privilege or violate a firm’s confidentiality policy, Thompson wrote. It also could amount to an “end-run around” third-party summonses and other due process requests for documents and an erosion of public confidence in tax preparers—the opposite of the IRS’ stated goal for the preparer initiative, Thompson wrote. The IRS website FAQs say that tax clients “generally” will not be contacted as a result of the audits and that any contact that does result “will be to confirm potential violations of the return preparer that may result in penalties against the tax return preparer.” The AICPA also has expressed concerns about professional liability for divulging taxpayer records to the IRS without taxpayer authorization.

CPA professional liability insurer CAMICO suggests CPAs get in touch with the company if they are selected for a visit.

“They should call, if they’re a policyholder, to get specific advice and guidance pertaining to their particular situation,” said Dan Crouch, CAMICO marketing communications manager.

Thompson also wrote that in other contexts, the IRS assesses penalties only after a formal examination. If the Service intends that the office visits may lead to opening such an examination, it should make that distinction clear. The IRS also should make clear, both to the preparers visited, and in any subsequent public report on their results, the method it uses to select preparers for visits. The IRS has not reported any specific results from its 2010 tax season visits, in which about 2,000 preparers were audited.

The AICPA is having a dialogue with the IRS that began last tax season on the letters and visits, said Ed Karl, AICPA vice president–taxation. And the Institute is suggesting that members selected for audit exercise caution to maintain client confidentiality and avoid client liability.

“Our members have a right to know all of the information sought, and the IRS should treat them transparently as to why they were chosen, to know specifically what the IRS wants, and have a right to say ‘no’ where it doesn’t make sense.”

“We continue to speak with the Service, relaying members’ concerns and to try to make a difference in the direction of program,” Karl said.