Part 3 - Representation, Practices & Procedures - Unit 3 - Content

Question 1

Methods of Payment

Answer 1

• Taxpayers generally have several options to make payments owed on their tax returns or for estimated taxes. The following methods of payment are currently accepted by the IRS:

1. Direct debit (note: this is not the same thing as “Direct Pay”),
2. Credit card,
3. Personal check, cashier’s check, or money order,
4. Installment agreement requests,
5. Electronic Federal Tax Payment System (EFTPS),
6. Electronic funds withdrawal,
7. Federal Tax Application (same-day wire transfer),
8. Direct Pay,
9. Cash (only through select, IRS-approved retail stores, and with dollar amount and frequency limitations). https://www.irs.gov/payments/pay-with-cash-at-a-retail-partner

• Payments do not have to be sent at the same time an electronic return is transmitted. For example, the return may be transmitted in January, and the taxpayer may mail payment by check at a later date. As long as the payment is mailed by the due date of the return, it will be considered timely.

Question 2

Tax Refunds

Answer 2

• Taxpayers have a number of options related to their tax refunds. They may:
  
  • Apply a refund to next year’s estimated tax.
  • Receive the refund as a direct deposit.
  • Receive the refund as a paper check.
  • Split the refund, with a portion applied to next year’s estimated tax and the remainder received as direct deposit or a paper check or split the refund between three different accounts.
  • Use the refund (or part of it) to purchase U.S. Series I Savings Bonds.
• Refunds may be designated for direct deposit to qualified accounts in the taxpayer’s name. Qualified accounts include savings, checking, or retirement accounts (for example, IRA or money market accounts).
• Direct deposits cannot be made to regular credit card accounts but can be made to prepaid debit cards.
• Qualified accounts must be in financial institutions within the United States.
• The number of refunds electronically deposited into a single account is limited to three. A preparer is required to accept any direct deposit election to a qualified account at an eligible financial institution designated by the taxpayer. A preparer may not charge a separate fee for direct deposit.

Question 3

Direct Deposit Cannot Be Rescinded

Answer 3

• A preparer must advise the taxpayer that a direct deposit election cannot be rescinded once a return is filed. In addition, changes cannot be made to routing numbers of financial institutions or to the taxpayer’s account numbers after the IRS has accepted the return.
• A preparer should verify account and routing numbers with the taxpayer each year.
• Example: Karla e-filed her tax return and chose direct deposit for her refund. Three days later, her purse was stolen, and she had to close her bank account to prevent fraud. The direct deposit information cannot be changed on her return after it has been e-filed. The IRS will attempt to deposit her tax refund, but once the bank declines her deposit, her refund will default to a paper check.

Question 4

Tax Payment Options

Answer 4

• If a taxpayer owes a balance after filing a return, the IRS will send the taxpayer a bill for the amount due, including any penalties and interest, which must be paid within 30 days.
• For taxpayers who are unable to pay the tax they owe, options include extensions of time to pay, installment agreements, and offers in compromise.

Question 5

Installment Agreements

Answer 5

• Installment agreements are arrangements in which the IRS allows taxpayers to pay liabilities over time. Before applying for any installment agreement, the taxpayer (or business) must file all required tax returns.
• A taxpayer who files electronically may apply for an installment agreement once the return is processed and the tax is assessed. Taxpayers must either submit Form 9465, Installment Agreement Request, or apply online if they qualify.
• The IRS charges a one-time user fee to set up an installment agreement. An agreement will be granted only if it provides for full payment of the taxpayer’s account.

Question 6

“Guaranteed” Installment Agreements

Answer 6

• “Guaranteed” installment agreement: A taxpayer who owes $10,000 or less in tax cannot be turned down for an installment agreement, assuming that all of the following apply:
  
  • The taxpayer (and spouse, if married) has timely filed all income tax returns and paid all tax due during the past five years;
  • The IRS has determined the taxpayer cannot pay the tax owed in full when it is due;
  • The taxpayer agrees to pay the full amount he or she owes within three years; and
  • The taxpayer has not entered into an installment agreement with the IRS in the prior five years.
• If a taxpayer fails to make a payment on an installment agreement, an automatic 30-day notice is generated. The IRS typically charges a fee for reinstating an installment agreement that has gone into default.
• Do not confuse a long-term installment agreement with a “short-term payment plan.” Short-term payment plans do not require a fee, and typically the balances must be paid within 180 days.

Question 7

EFTPS

Answer 7

• Taxpayers can use the Electronic Federal Tax Payment System (EFTPS) for any type of IRS payment. Taxpayers and businesses enroll in EFTPS by using an online application.
• Businesses and individuals can pay all their federal taxes using EFTPS. Individuals can pay their quarterly estimated taxes, and they can make payments weekly, monthly, or quarterly. Businesses can schedule payments up to 120 days in advance of their tax due date.
• Individuals can schedule payments up to 365 days in advance of their tax due date. Domestic corporations must deposit all income tax payments by the due date of the return.

Question 8

IRS Collection Process

Answer 8

• The IRS has wide powers when it comes to collecting unpaid taxes. If a taxpayer does not pay in full when filing his or her tax return, he or she will receive a bill from an IRS service center. The first notice explains the balance due and demands payment in full. It will include the amount of the unpaid tax balance plus any penalties and interest calculated from the date the tax was due.
• This first notice starts the collection process, which continues until the taxpayer’s account is satisfied or until the IRS may no longer legally collect the tax, such as when the collection period has expired. The date that the IRS is no longer allowed to collect the tax is called the collection statute expiration date (CSED). But this “CSED” period can be extended for a variety of reasons.
• The ten-year collection period (CSED) can be suspended in the following cases:
  
  • While the IRS and the Office of Appeals consider a request for an installment agreement or an offer in compromise,
  • From the date a taxpayer requests a collection due process (CDP) hearing,
  • While the taxpayer is residing outside the United States,
  • A pending bankruptcy proceeding.

Question 9

Substitute for Return (SFR)

Answer 9

• The Substitute for Return Program identifies taxpayers who did not file a required tax return and attempts to bring these taxpayers into compliance. The IRS either secures an income tax return from these taxpayers or prepares a Substitute for Return for taxpayers with a proposed tax assessment based on information return data reported to the IRS combined with other internal data.
• Example: Ambrose has not filed tax returns for several years. The IRS has sent him notices repeatedly, which Ambrose ignored. The IRS prepares substitute for returns (SFRs) for all of Ambrose’s unfiled years. The IRS does this so they can assess tax and begin collection activities. After the SFRs are filed, the IRS sends Ambrose a bill for each year, and collection activity can commence.

Question 10

Bankruptcy

Answer 10

• A filing in bankruptcy court immediately stops all assessment and collection of tax. This is called an automatic stay, and it remains in effect until the bankruptcy court lifts the stay or discharges liabilities, meaning they are eliminated or no longer legally enforceable. Income tax debt that may be discharged in bankruptcy must meet the following general conditions:
  
  • The tax debt must be related to a return that was due at least three years before the taxpayer filed for bankruptcy.
  • The tax return must have been filed at least two years ago.
  • The tax assessment must be at least 240 days old.
  • The taxpayer cannot be guilty of tax evasion, and the tax return cannot be fraudulent or frivolous.
• Example: On January 3, Damian has a car accident and broke both his legs. His medical insurance wasn’t very good, and Damian ended up having insurmountable medical debts. Damian also had a tax debt from the prior year, which he was planning to pay, but after his accident he no longer had the funds to do so. The IRS had already sent Damian a bill, so his account was in collections when his accident occurred. On the advice of his attorney, he files for bankruptcy on June 1. The filing in bankruptcy court immediately stops all assessment and collection of tax, but the running of the collection period is also suspended during the time Damian’s bankruptcy petition is pending with the courts, plus an additional 6 months upon the conclusion of his bankruptcy case.

Question 11

Federal Tax Lien

Answer 11

• A federal tax lien is a legal claim against a taxpayer’s property, including property that the taxpayer acquires after the lien is filed. By filing a Notice of Federal Tax Lien, the IRS establishes its interest in the taxpayer’s property as a creditor and as security for his or her tax debt, and publicly notifies the taxpayer’s other creditors of its claim.
• A Notice of Federal Tax Lien may be filed only after:
  
  • The IRS assesses the taxpayer’s liability,
  • The IRS sends a notice and demand for payment, and
  • The taxpayer neglects to pay the debt.
• Once these requirements are met, a lien is created for the amount of the taxpayer’s debt. The lien attaches to all the taxpayer’s property, such as a house or car, and to all the taxpayer’s rights to property (such as accounts receivable, in the case of a business).
• Example: William owes the IRS $85,000 in back taxes from a prior year in which he won a big lottery prize. Although he filed his taxes on time, William does not want to pay the debt, and he ignores the IRS bills that come to his home. William’s home is worth $250,000, and he has over $175,000 in equity in the home. The IRS files a Notice of Federal Tax Lien against William’s assets. It is on public record, and the tax lien will give the government the authority to seize William’s house if he fails to pay his delinquent debt. William is embarrassed by the public nature of the lien and contacts the IRS to make payment arrangements. Within six months, he has paid his tax debt in full, which is the easiest and fastest way to eliminate a federal tax lien. The IRS releases William’s lien within 30 days after he has paid his tax debt.

Question 12

IRS Seizure (Levy)

Answer 12

• An IRS seizure (or a levy) is the legal act of confiscating a taxpayer’s property to satisfy a tax debt, as authorized by an earlier filed tax lien. A tax lien is the IRS’s authorization to act by seizing property, and the IRS levy is the actual act of seizure.
• A levy allows the IRS to confiscate and sell the property, which may include cars, boats, or real estate. The IRS may also levy wages, bank accounts, Social Security benefits, and retirement income.
• Typically, the IRS may not seize property in the following circumstances:
  
  • When there is a pending installment agreement,
  • While a taxpayer’s appeal is pending,
  • During the consideration of an offer in compromise,
  • During a bankruptcy (unless the seizure is authorized by the bankruptcy court),
  • If the taxpayer’s liability is $5,000 or less in a seizure of real property,
  • While innocent spouse claims are pending.
• The IRS may not seize a main home without prior approval from the IRS district director or assistant district director; judicial approval is also generally required for the seizure of a main home.

Question 13

Exempt from Levy

Answer 13

• The following items are exempt from IRS levy:
  
  • Wearing apparel and schoolbooks.
  • Fuel, provisions (food), furniture, personal effects in the taxpayer’s household, arms for personal use, or livestock, up to an allowable amount.
  • Books and tools necessary for the trade, business, or profession of the taxpayer, up to an allowable amount.
  • Undelivered mail.
  • Unemployment benefits.
  • Workers’ compensation, including amounts payable to dependents.
  • Certain annuity or pension payments, but only if payable by the Army, Navy, Air Force, Coast Guard, or under the Railroad Retirement Act or Railroad Unemployment Insurance Act. Traditional and Roth IRAs are not exempt from levy.
  • Judgments for the support of minor children (child support).
  • Certain public assistance and welfare payments and amounts payable for Supplemental Security Income for the aged, blind, and disabled under the Social Security Act. Regular Social Security payments are not exempt from levy.

Question 14

IRS Levy: Example

Answer 14

• If an IRS levy creates a severe economic hardship, it may be released at the discretion of the IRS. A levy release does not mean the taxpayer is exempt from paying the balance due.
• Example: Bradley owes $295,000 to the IRS because of a failed business venture. Bradley closed the business and started working for a department store as a manager. The IRS issues a continuous levy under IRC §6331 to Bradley’s employer and the department store withholds a portion of his paycheck every month for his outstanding tax debt, remitting the amount to the IRS each month for the next four years. At the end of the year, Bradley’s teenage daughter, Mandy, becomes ill, and as a result, Bradley’s living expenses increase significantly due to Mandy’s large medical bills. The IRS levy is now causing a severe economic hardship to the taxpayer. Bradley contacts the IRS and asks the IRS to release the levy. The IRS determines that Bradley is experiencing severe economic hardship, and the IRS agrees to stop the wage garnishment temporarily.

Question 15

IRS Summons

Answer 15

• If a taxpayer or other witness refuses to comply with requests for IRS records or other information, the IRS has the power to issue a summons. An IRS examiner may issue an administrative summons to the taxpayer (or other third parties).
• The IRS will use a summons to request documents and records from taxpayers and businesses, but usually only after other methods have been unsuccessful. A summons cannot require a witness to prepare or create documents, including tax returns, which do not exist. A summons also cannot be issued solely to harass a taxpayer or to pressure the taxpayer into settling a dispute.
• The IRS must follow precise procedures in serving a summons upon a taxpayer or third party. The summons must be delivered in person to the taxpayer or left at his or her last known residence.
• Example: In recent years the IRS has given more scrutiny to cryptocurrency exchanges. The Department of Justice filed a court petition, asking the IRS to serve a “John Doe” summons on Coinbase, a popular cryptocurrency exchange. This “John Doe” summons directed Coinbase to produce records identifying U.S. taxpayers who have used its services. The summons was triggered after the IRS found instances of tax evasion involving Coinbase customers. Coinbase initially opposed the summons, arguing that it was too broad. The IRS subsequently narrowed the demand to a smaller number of heavy traders, and Coinbase eventually produced the requested records.

Question 16

Relief from Joint Liability

Answer 16

• Married taxpayers often file jointly because of benefits this filing status affords. In the case of a joint return, both taxpayers are liable for the tax and any interest or penalties, even if they later separate or divorce. “Joint and several liability” means that each taxpayer is legally responsible for the entire liability. This is true even if only one spouse earned all the income, or if a divorce decree states that a former spouse is or is not responsible for any amounts due on previously filed joint returns.
• In some cases, however, a taxpayer who filed a joint return can receive relief from joint and several liability:

1. Innocent Spouse Relief: Provides relief from additional tax if a spouse or former spouse failed to report income or claimed improper deductions.
2. Separation of Liability Relief: Provides for the allocation of additional tax owed between the taxpayer and his spouse or former spouse because an item was not reported properly on a joint return. The tax allocated to the taxpayer is the amount for which he or she is responsible.
3. Equitable Relief: May apply when a taxpayer does not qualify for innocent spouse relief or separation of liability relief for items not reported properly on a joint return and generally attributable to the taxpayer’s spouse. A taxpayer may also qualify for equitable relief if the correct amount of tax is reported on his or her joint return but the tax remains unpaid.

Question 17

Injured Spouse Claims

Answer 17

• Innocent spouse relief should not be confused with an injured spouse claim. A taxpayer may qualify as an injured spouse if he or she filed a joint return and the injured spouse’s share of the refund was applied against past due amounts owed by the other spouse.
• An injured spouse may be entitled to recoup only his or her share of a tax refund. When a joint return is filed, and the refund is used to pay one spouse’s past-due federal tax, state income tax, child support, spousal support, or federal nontax debt (such as a delinquent student loan), the other spouse may be considered an injured spouse. The injured spouse can request his or her share of the refund using Form 8379, Injured Spouse Allocation.
• Example: Ginny and Carl marry and file jointly. Unknown to Ginny, Carl has unpaid child support and delinquent student loan debt. Their entire refund is retained to pay Carl’s outstanding debts. Ginny may qualify for injured spouse treatment and recoup her share of the tax refund. The IRS will keep Carl’s share of the refund to pay his delinquent debts.

Question 18

OIC Applications

Answer 18

• An offer in compromise (OIC) is an agreement between a taxpayer and the IRS that settles the taxpayer’s tax liabilities for less than the full amount owed. Submitting an offer application does not guarantee that the IRS will accept the offer.
• To apply for an OIC on the grounds of “doubt as to collectibility” or “exceptional circumstances,” a taxpayer must submit an application fee and initial nonrefundable payment along with Form 656, Offer in Compromise. Fees may be waived for low-income taxpayers.
• There is no fee required to apply for an OIC on the grounds of “doubt as to liability,” and Form 656 L is used instead.
• The taxpayer may appeal a rejected offer in compromise within 30 days.

Question 19

OIC Programs (3 Grounds)

Answer 19

• A taxpayer may submit an OIC on three grounds:
  
  • Doubt as to Collectibility: Doubt exists that the taxpayer could ever pay the full amount of tax liability owed within the remainder of the statutory period for collection.
  • Doubt as to Liability: Doubt as to liability exists where there is a genuine dispute as to the existence or amount of the correct tax debt under the law.
  • Exceptional Circumstances (Effective Tax Administration): There is no doubt that the tax is correct, and there is potential to collect the full amount of the tax owed, but an exceptional circumstance exists. A taxpayer must demonstrate that the collection of the tax would create a serious economic hardship or would be unfair.

Question 20

OIC Examples

Answer 20

• Example, Doubt as to Collectibility: Constance owes $80,000 for unpaid tax liabilities and agrees that the tax she owes is correct. Constance is terminally ill and cannot work. She does not own any property and does not have the ability to fully pay the liability now or through monthly installment payments.
• Example, Doubt as to Liability: Darla was the vice-president of a corporation from 2006 to 2022. In 2023, the corporation accrued unpaid payroll taxes, and Darla was assessed a trust fund recovery penalty. However, Darla had resigned from the board of directors in the summer of 2022, prior to any of these delinquent payroll taxes accruing. Since there is legitimate doubt that the assessed tax liability is correct, she may apply for an OIC under doubt as to liability.
• Example, Exceptional Circumstances: Valerie and Walter Smith have sufficient assets to satisfy their tax liability. However, they provide full-time care to their dependent child, who has a serious chronic illness. The unpaid taxes were a result of the Smiths providing necessary medical care for their sick child. They will need to continue to use their assets to provide for basic living expenses and ongoing care for the child. There is no doubt that the tax is correct, but to pay the tax would endanger the life of their child and would create a serious hardship.

Question 21

Overview of the IRS Audit Process

Answer 21

• The IRS accepts most tax returns as they are filed but selects a small percentage for examination. An IRS examination is also commonly called an “IRS audit.”
• The IRS typically audits approximately 1% of the total number of individual tax returns filed. Higher income earners were audited much more frequently than those who earned less.
• The IRS reports the audit rate for individual returns with total income of $1 million or more was 10.80%.
• Returns claiming refundable credits, such as the EITC, are also audited at a higher rate than normal returns. Of all the individual returns audited, more than a third were returns with Earned Income Tax Credit claims.

Question 22

Types of Audits

Answer 22

• The three types of IRS examinations are:

1. Correspondence audit, which is conducted entirely by mail,
2. Office audit, which takes place at a nearby IRS field office, and
3. Field examinations, which typically take place at the taxpayer’s home or place of business.

• The IRS conducts most examinations entirely by mail (around 73%). In these correspondence audits, a taxpayer will receive a letter asking for additional information about certain items shown on the return, such as proof of income, expenses, and itemized deductions.
• Correspondence audits typically occur when there is a minor issue that the IRS needs to clarify. For example, the IRS may have detected a math error, or there may be a discrepancy between the tax return and the 1099 statements sent by brokers, banks, or mutual funds. Other times, the IRS simply requests evidence that a particular transaction has transpired as reported on the tax return.
• Example: The IRS selects Evelyn’s return for examination. Evelyn had claimed her older half-brother as a qualifying child based on his permanent disability, and she had also claimed head of household (HOH) status. The IRS asks for proof of disability and residency, and Evelyn provides copies of doctors’ records and additional evidence that her brother lives with her full-time. The IRS accepts Evelyn’s documents and closes the case as a no-change audit. Evelyn does not have to meet with the IRS auditor, as the entire audit is conducted by mail.
• Example: Rocio receives a CP-2000 notice saying that she has unreported wages. Rocio carefully reads the notice and realizes that the missing Form W-2 has her name and Social Security number, but she has never worked for the company. In fact, the company is in a completely different state than where she currently resides. Someone has stolen Rocio’s Social Security number. Rocio is a victim of employment-related identity theft. Her SSN is being used by another person without her permission for employment purposes. Rocio responds to the notice and also files Form 14039, Identity Theft Affidavit, reporting the identity theft. A few weeks later, the IRS sends her a letter that it has accepted her return as filed. Rocio should also consider obtaining an Identity Protection PIN (IP PIN) to protect her account against tax-related identity theft.

Question 23

How Returns are Selected for Examination

Answer 23

• The IRS selects returns for examination using a variety of methods, including:
• Potentially Abusive/Tax Avoidance Transactions: Some returns are selected based on information obtained by the IRS through efforts to identify promoters of and participants in abusive tax avoidance transactions.
• Computer Scoring/DIF Score: Returns may be chosen on the basis of computer scoring. A computer program called the Discriminant Inventory Function System (DIF) assigns a numeric score to each individual and certain corporate tax returns after they have been processed.
• Information Matching: Some returns are examined because third-party reports, such as Forms W-2 or 1099, do not match the applicable amounts reported on the tax return.
• Related Examinations: Returns may be selected for audit when they involve transactions with or issues related to other taxpayers, such as business partners or investors, whose returns were selected for examination.
• Third Party Information: Returns may be selected as a result of information received from other third-party sources or individuals. Sources may include state and local law enforcement agencies, public records, and individuals. The information is evaluated for reliability and accuracy before it is used as the basis of an examination (or a possible criminal investigation).
• Example: Harvey is an EA with a client, Jamila, who received an audit notice this year. Jamila’s prior-year tax return was selected because she had a large number of tax credits and very little taxable income. However, her tax return was prepared correctly. Jamila had adopted four special-needs children and was able to take the Earned Income Credit and a large Adoption Credit. Harvey provided proof of the adoptions to the examining officer, which resulted in a positive outcome for Jamila: a “no-change” audit.
• Example: Alfred embezzled money from his employer and was arrested for felony embezzlement. The case was made public, and the police shared its information with the IRS. The IRS then contacted Alfred and proposed adjustments to his tax returns, assessing additional tax, interest, and penalties for fraud for failing to report the embezzled funds as income. This is an example of third-party information that can trigger an IRS criminal investigation.

Question 24

Taxpayer Examination Rights and Obligations

Answer 24

• An IRS examiner must explain the examination and collection process and the taxpayer’s rights during the process. These rights include:
  
  • A right to professional and courteous treatment by IRS employees
  • A right to privacy and confidentiality about tax matters
  • A right to know why the IRS is asking for information, how the IRS will use it, and what will happen if the requested information is not provided
  • A right to representation, either by oneself or an authorized representative
  • A right to appeal disagreements, both within the IRS and before the courts
• During an examination, the IRS has the right to confirm every item on a taxpayer’s return. Form 4564, Information Document Request (IDR), is used to request information from the taxpayer.
• The taxpayer must make available any documents the IRS requests, including providing access to bookkeeping files such as QuickBooks. If a taxpayer fails to produce requested documents, an examiner must determine whether to issue a summons to secure the documents.

Question 25

The Taxpayer’s Representative

Answer 25

• A taxpayer may always represent himself or herself during an examination. Alternatively, the taxpayer may use a qualified representative before the IRS.
• The taxpayer does not have to attend the audit if the representative has the proper power of attorney authorization and is an enrolled practitioner under Circular 230.
• If a taxpayer becomes uncomfortable during the audit and wishes to consult with a qualified representative, the IRS must suspend the interview and reschedule it.
• Example: Kimberly is an EA. A taxpayer named Lloyd hires her to represent him before the IRS during the examination of his tax return. Lloyd does not want to attend the audit. He signs Form 2848 indicating that Kimberly is now his authorized representative for all his tax affairs. Kimberly attends the examination on Lloyd’s behalf.
• Example: Mitchell is a 23-year-old accounting student who is not an enrolled practitioner, but is currently studying for the CPA exam, so he has some tax knowledge. The IRS mails an audit notice to Mitchell’s older sister, Aimee. Aimee does not want to speak to the IRS, so she designates Mitchell as her authorized representative by signing and submitting Form 2848 to the IRS. Mitchell may practice before the IRS in this limited circumstance because of the familial relationship with the taxpayer. Mitchell has full representation rights before the IRS with regards to his sister’s tax issue.
• Example: Brandt is a self-employed mechanic who owns an auto body shop. The IRS is auditing his return (the amounts reported on his Schedule C). A licensed CPA prepared his return, but Brandt doesn’t want to pay the CPA to represent him during the audit. Brandt decides to represent himself during the examination of his business in order to save money. Brandt meets with the IRS auditor at his shop. The auditor begins asking complicated questions, and Brandt becomes uncomfortable right away. He regrets not hiring someone to represent him. Brandt tells the IRS auditor that he wants to discontinue the audit, because he wants to hire someone to represent him. The auditor must immediately suspend the audit and allow Brandt time to seek representation.

Question 26

Audits of Joint Returns

Answer 26

• When a jointly filed (MFJ) tax return is selected for examination, either spouse may meet with the IRS, or the qualified representative may meet with the IRS without either spouse present.
• Without an administrative summons, the IRS cannot compel a taxpayer to accompany an authorized representative to an examination interview.
• Example: Lucia and Javier are married and have always filed jointly. During the year, Lucia and Javier receive an audit notice. Lucia tries to encourage Javier to hire a representative, but Javier refuses to respond to the notice or participate in the audit process. Since it is a joint return, both spouses are jointly and severally liable for all the items shown on the return. Lucia contacts Mohammed, a licensed CPA, and hires him to represent her during the audit process. Mohammed obtains a signed Form 2848 from Lucia and speaks with the IRS on his client’s behalf. Mohammed does not represent Javier; he only represents Lucia. Lucia can have Mohammed represent her during the IRS audit process and she does not need to be present. Mohammed will do his best to represent Lucia during the audit process.

Question 27

Contact of Third Parties

Answer 27

• During the examination process, the IRS may contact third parties regarding a tax matter without the taxpayer’s permission. Third parties may include neighbors, banks, employers, or employees.
• However, the IRS must give the taxpayer reasonable notice
• The Taxpayer First Act of 2019 (TFA) revised IRC §7602(c)(1) to require the IRS to provide advance notice of the intent to contact third parties, specify in the notice the time period (i.e., not to exceed one year) in which contact will be made and send the notice 45 days before the first contact with a third party.
• The IRS Chief Counsel has stated that contacts with other governmental agencies are not subject to TFA’s advance notice requirements.
• The IRS must provide the taxpayer with a record of persons contacted, either on a periodic basis or upon the taxpayer’s request. However, this requirement does not apply:
  
  • To any pending criminal investigation.
  • When providing notice would jeopardize collection of any tax liability.
  • When providing notice may result in reprisal against any person.
  • When the taxpayer has already authorized the contact.
• Example: Feliciano is a business owner, but he uses his business to launder money from illicit activities. The IRS selects Feliciano’s tax return for audit. The auditor sees several clues and immediately suspects unreported income related to possible criminal activity. The IRS auditor later discovers that Feliciano is also being investigated by the FBI and the Department of Justice for drug trafficking. Because this is a pending criminal investigation, the IRS is not required to give Feliciano notice before contacting the FBI or the Department of Justice about Feliciano’s tax matters.

Question 28

Audit Determinations

Answer 28

• An audit can be closed in one of three ways:

1. No Change: An audit in which the taxpayer has substantiated all of the items being reviewed and which results in no changes.
2. Agreed: An audit in which the IRS proposes changes and the taxpayer understands and agrees with the changes.
3. Unagreed: An audit in which the IRS proposes changes and the taxpayer understands but disagrees with the changes. A conference with an IRS manager may be requested for further review of the issues. In addition, the taxpayer may request fast track mediation or an appeal. A taxpayer does not have to file a written protest to request fast-track mediation. The taxpayer may also choose to go to court and contest the IRS determination.

Question 29

Closed Examinations

Answer 29

• The IRS will not typically reopen a closed examination case to make an unfavorable adjustment and assess additional tax unless:
  
  • There was fraud or misrepresentation,
  • There was a substantial error based on an established IRS position existing at the time of the examination, or
  • Failure to reopen the case would be a serious administrative omission.

Question 30

Audit Reconsideration

Answer 30

• In certain cases, the IRS will reevaluate the results of a prior audit if additional tax was assessed and remains unpaid or a tax credit was reversed.
• A taxpayer may request audit reconsideration if he or she disagrees with an earlier audit assessment, but he or she must provide new information, with documentation, that was not considered during the original examination. The IRS may accept a taxpayer’s reconsideration request if:
  
  • Information that is submitted has not been considered previously.
  • The taxpayer filed a return after the IRS completed a substitute return for him or her.
  • The taxpayer believes the IRS made a computational or processing error in assessing his or her tax.
  • The tax liability remains unpaid or credits are denied.
• Example: Cedrick is a sole proprietor who files on Schedule C. After an IRS examination, he was assessed $1,900 of additional taxes because he had lost the file with his receipts and other documentation supporting his business deductions. Cedrick disagrees with the findings of the examination, and a couple of weeks later, he finds the missing file, which includes his original receipts. Cedrick requests an audit reconsideration due to the new documentation.
• Example: Gracie received a Notice Number CP504. The notice says – “Urgent! The IRS intends to levy Certain Assets.” Gracie had moved in the prior year and also hadn’t filed a tax return, so the IRS did not have an updated address for her. She did not respond to any prior notices because she did not receive them. The tax has already been assessed, but Gracie doesn’t believe that she owes the amount listed on the notice. Gracie may request an audit reconsideration.

Question 31

Repeat Examinations

Answer 31

• The IRS tries to avoid repeat examinations of the same items, but sometimes this happens. If a taxpayer’s return was audited for the same items in the previous two years and no change was proposed to tax liability, the taxpayer may request the IRS discontinue the examination.
• Example: Eleanor donates a large percentage of her salary to her church. For the last two years, the IRS has selected Eleanor’s return for examination based on her large donations. In both instances, Eleanor was able to substantiate her donations, and no change was made to her tax liability. Her tax return is selected again for the same reason in the current year. Eleanor contacts the IRS to request that the examination be discontinued, and the examining officer agrees to do so.

Question 32

Centralized Partnership Audit Regime

Answer 32

• The Bipartisan Budget Act of 2015 (BBA) repealed the prior audit rules under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) and replaced them with the centralized partnership audit regime (CPAR).
• Under the centralized audit regime (CPAR), tax is generally determined, assessed, and collected at the partnership level as a result of an audit. The new “centralized partnership audit” regime is mandatory unless the partnership qualifies to elect-out. Certain partnerships with 100 or fewer partners to elect out of this new regime.
• Eligible partnerships can elect out of the CPAR on Schedule B-2 of a timely filed tax return (Form 1065). When the entity elects out, IRS proceedings and adjustments will be assessed at the partner level under the general audit rules applicable to individuals instead of at the entity level. To elect out of the new partnership rules, in addition to the maximum 100-partner requirement, the partnership must only have “eligible” partners, which are:
  
  • Individuals.
  • C corporations (and any foreign entity that would be treated as a C corporation if it were a domestic corporation).
  • S corporations (if an S corporation as a partner, the number of shareholders in that S corporation counts towards the 100-partner threshold),
  • Estates of deceased partners only (NOT bankruptcy estates).
• Note: An “eligible partner” does not include a disregarded single-member LLC, trust, grantor trust, or a bankruptcy estate, even if the disregarded entity is wholly owned by an eligible partner. Partnerships with non-qualified partners cannot opt-out of the centralized audit regime, even if the partnership has fewer than 100 partners.

Question 33

IRS Office of Appeals

Answer 33

• Because taxpayers often disagree with the IRS on tax matters, the IRS has a formal appeals process.
• The IRS Independent Office of Appeals is independent of any other IRS office and serves as an informal administrative forum for any taxpayer who wishes to dispute an IRS determination.
• IRS Appeals provides taxpayers an alternative to going to court to fight disagreements about the application of tax law. The role of Appeals is to resolve disputes on a fair and impartial basis that does not favor either the government or the taxpayer.
• Appeals officers are directed to give serious consideration to settlement offers by taxpayers or their representatives.

Question 34

Appeals System Overview

Answer 34

• The IRS Appeals Office is a separate division and independent of IRS examinations and collections. A taxpayer has three choices to protest an IRS determination on their taxes:

1. You may appeal either formally or informally within the IRS appeals system.
2. You may take your case directly to the U.S. Tax Court.
3. You may bypass both IRS Appeals and the Tax Court and take their case to the U.S. Court of Federal Claims or to a U.S. district court.

• The contested tax does not have to be paid first if a taxpayer opts for either IRS Appeals or the Tax Court, but if the taxpayer goes directly to the Court of Federal Claims or a U.S. district court, the taxpayer must pay the tax first and then sue the IRS for a refund.

Question 35

IRS Appeals System (2)

Answer 35

• An IRS appeal does not normally abate penalties and interest on the tax due. These continue to accumulate until one of two events occurs:
  
  • The balance of the debt is paid, or
  • The taxpayer wins the appeal and is granted a no-change audit.
• Reasons for an appeal must be supported by tax law. An appeal cannot be based solely on moral, religious, political, constitutional, conscientious, or similar grounds.

Question 36

Appealing After an Examination

Answer 36

• The 30-Day Letter: Within a few weeks after a taxpayer’s closing conference with an IRS examiner, he or she will receive what is commonly called a “30-day letter.” This letter includes:
  
  • A notice explaining the taxpayer’s right to appeal the proposed changes within 30 days
  • A copy of the revenue agent report (RAR) explaining the examiner’s proposed changes
  • An agreement or waiver form
  • A copy of Publication 5, Your Appeal Rights
  • The taxpayer has 30 days from the date of notice to accept or appeal the proposed changes.
• An unenrolled tax return preparer may be a witness for a taxpayer at an appeals conference but may not serve as an authorized representative for the taxpayer before IRS Appeals.
• Example: Vladimir is an Enrolled Agent who represents Tracy, a sole proprietor who runs a small restaurant. The IRS audited Tracy’s business return and found multiple discrepancies on her Schedule C. Tracy receives a 30-day letter stating that she owes an additional $32,000 in tax. Tracy disagrees with the amount, so Vladimir files a formal protest within 30 days with the IRS Appeals office. In the protest, Vladimir details why the proposed assessment is incorrect and the legal basis for his argument. He also submits the required practitioner declaration and a copy of Form 2848. Vladimir then schedules a conference with an Appeals Officer. When they meet, they discuss the matter and reach a settlement agreeable to each party. Since the IRS has a signed Form 2848 authorizing Vladimir to be Tracy’s representative, she was not required to attend the appeals hearing.

Question 37

Notice of Deficiency (90-Day Letter)

Answer 37

• If a taxpayer does not respond to a 30-day letter, or if they cannot reach an agreement with an Appeals officer, the IRS will send them a Notice of Deficiency, which is also known as the 90-day letter. A Notice of Deficiency is required by law and is used to advise the taxpayer of their appeal rights to the U.S. Tax Court.
• A Notice of Deficiency is a formal legal notice, sent by certified or registered mail. This letter is the final notification a taxpayer will receive before the IRS makes its final assessment of tax due.
• A Notice of Deficiency must be issued before a deficiency is assessed and the taxpayer can go to the Tax Court. The taxpayer has 90 days (150 days if addressed to a taxpayer outside the United States) from the date of the notice to file a petition with the Tax Court.
• If the taxpayer does not file the petition in time, the tax is due within ten days, and the taxpayer may not take their case to Tax Court. If the taxpayer does file a petition in time and the case is docketed before the Tax Court, their file will again go to an IRS Appeals office to see if it can be resolved before going to court. More than 90% of all tax cases are resolved before going to Tax Court.
• Example: Maddox was sent several IRS notices about a prior-year return, but he ignored them. On March 30, he receives a Notice of Deficiency (a 90-day letter) and finally decides to respond. He has only 90 days from the date of the letter to file a petition with the Tax Court, otherwise the IRS will make a final assessment and begin collection action. Maddox responds to the letter on May 1, challenging the tax that the IRS has proposed by filing a Tax Court petition in the U.S. Tax Court. His file will be sent to the IRS appeals office first, giving him a prior opportunity to resolve his case before going to an actual hearing in the Tax Court.
• Example: Angela is a U.S. citizen that lives and works in Panama. She files U.S. tax returns as required by law. Her prior year return comes under audit, and she receives a 90-day letter, which is mailed to her residence in Panama. Since she has a foreign address, she has 150 days to respond to the letter, rather than the normal 90 days.

Question 38

U.S. Tax Court

Answer 38

• The U.S. Tax Court is a federal court separate from the IRS where taxpayers may choose to contest their tax deficiencies without having to pay the disputed amount first. The court issues both regular and memorandum decisions.
  
  • A regular decision is when the Tax Court rules on an issue for the first time.
  • A memorandum decision is when the Tax Court has previously ruled on identical or similar issues.
• Example: Ms. Singleton-Clarke, is a registered nurse (RN) working as a hospital administrator. During an examination, she disagreed with an IRS assessment that disallowed educational expenses she had claimed while pursuing an MBA degree for health professionals. Ms. Singleton-Clarke paid the entire cost of the program for the MBA program. Ms. Singleton-Clarke deducted $14,787 in unreimbursed employee business expenses (on Form 2106) for education expenses. The IRS disallowed the entire amount. After receiving a notice of deficiency, she took her case to the Tax Court and won.
• (Singleton-Clarke v. Commissioner, T.C. Summ. Op. 2009-182, 2009).
• Any individual taxpayer may represent himself or herself before the U.S. Tax Court. This is referred to as “pro se,” which is a legal term meaning “for oneself” or “on one’s own behalf.” A taxpayer may also choose to be represented by a person admitted to practice before the Tax Court.
• Note: Enrolled agents and CPAs must be “admitted to practice” before the Tax Court by first passing a separate exam specific to this purpose.
• “Practice before the IRS” does not include practice before the Tax Court. Licensed attorneys are the only practitioners who are not required to pass the Tax Court exam before practicing before the court.

Question 39

Tax Court Jurisdiction

Answer 39

• The Tax Court has jurisdiction over the following tax disputes:
  
  • Notices of deficiency
  • Review of the failure to abate interest
  • Notices of transferee liability
  • Adjustment of partnership items
  • Administrative costs
  • Worker classification (employee versus independent contractor)
  • Review of certain collection actions
• The Tax Court has jurisdiction over the following types of tax:
  
  • Income tax
  • Estate tax and gift tax
  • Certain excise taxes
  • Re-determine transferee liability
  • Worker classification
  • Relief from joint and several liability on a joint return
  • Whistleblower awards

Question 40

Small Tax Case Procedure

Answer 40

• Small tax case procedures (also known as S case procedures) in the Tax Court are one avenue to resolve disputes between taxpayers and the IRS. Small tax cases are handled under simpler, less formal procedures than regular cases. Often, decisions are handed down quicker than in other courts. However, the Tax Court’s decision in a small tax case cannot be appealed by the taxpayer.
• The decision is final, as the IRS is not allowed to appeal, either, if it loses the case. In contrast, either the taxpayer or the IRS can appeal a decision in a regular, non-S case to a U.S. Court of Appeals.
• The taxpayer, the IRS, and the Tax Court must all agree to proceed with the small case procedure. Generally, the Tax Court will agree with the taxpayer’s small case request if the taxpayer otherwise qualifies. A decision entered in a small tax case is not treated as precedent for any other case and is not typically published.
• Since the taxpayer cannot appeal a decision by the Small Tax Case Division, he or she must consider whether using the small case procedure is worth the risk of not being able to contest an adverse decision in a higher court.

Question 41

Other Court Appeals

Answer 41

• The vast majority of taxpayers who use the court system appeal their disputes in the Tax Court. However, a minority of taxpayers choose to challenge the IRS in a U.S. district court or Court of Federal Claims.
• In this case, a taxpayer must pay the contested tax deficiency first. If either party loses at the trial court level, the court’s decision may be appealed to a higher court.
• Note: Although Enrolled Agents and CPAs have unlimited rights of representation before all levels and officers of the IRS, they cannot represent taxpayers in disputes with the IRS before U.S. district courts, bankruptcy courts, courts of appeal, or the U.S. Supreme Court. That authority is reserved only for licensed attorneys.
• Example: During the course of an audit, the IRS disallows a large deduction on Cassie’s return. Cassie disagrees with the assessment, and the IRS eventually issues a notice of deficiency in the amount of $45,000. Cassie knows the deduction she has taken on her return is contrary to the IRS position, but there is a recent court case where another taxpayer took a similar deduction and prevailed against the IRS. Cassie does not wish to contest the tax through the IRS Appeals Office or the Tax Court. Instead, she feels that she would have better luck if she went straight to a U.S. district court. She must first pay the contested liability in full and then sue the IRS for a refund.