Category Archives: Audit

Paid Tax Return Preparer Audits

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Philip Falco
Paid Tax Return Preparer Audits

Over the years we have represented several tax preparers who the IRS selects for examination as part of the Paid Preparer Due Diligence Program. The IRS has gotten better at zeroing in on the preparers who abuse refundable tax credits. These audits can be frightening with the serious potential to lead to criminal investigation.

If you file returns with PTIN and/or EFIN, the IRS is tracking you. These are very effective audits. The IRS can select one preparer with a pattern of abuse and audit several hundred returns. Oftentimes, the preparers are unlicensed. They are not CPA’s, attorneys, or enrolled agents. They may have taken some courses over the years but really do not know what they are doing.

The preparers are often high volume preparers with clients in the hundreds. Oftentimes, their clients have earned income credit, head of household, or the child tax credit along with Schedule C. The dependents may be questionable, such as being on more than one return or not living with the taxpayer. A pattern of using Schedule C to optimize these credits is identified, examined, and seriously questioned. Schedule C abuse is serious in the eyes of the IRS.

The legal basis for these audits is the requirement to be compliant with the due diligence requirements by the regulations under the Internal Revenue Code Section 6695(g). There are penalties under IRS 6695(g) and the quickly add up to be draconian.

Form 8867, Paid Preparer’s Due Diligence Checklist, is implicated. Retention of records and substantiation of credits, schedule C. Various records will be probed by the agent under different scenarios. Worksheets and documentation are critical to persuade the agent of the exercise of due diligence. The credibility of the preparer is on the line.

Feel free to call us if you would like representation.

Gotcha: IRS Tax Return Proposed Changes CP2000 – Omitted 1099

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Posted by
Philip Falco
Gotcha: IRS Tax Return Proposed Changes CP2000 – Omitted 1099

We have handled the following situation many times so I figured I would write a post about it. This is very common.

The bad news. Taxpayer receives CP2000 from the IRS, which is IRS’s proposed changes to the 1040 tax return. IRS has a before (shown on return) and after column (as corrected by the IRS). Typically taxpayer has forgotten to include a 1099, such as a 1099-S from the sale of a home, or perhaps a 1099-MISC as to schedule C income.

Taxpayer is scratching his/her head thinking well no tax is owed since the gain from the sale of my home was less than the principal residence tax exclusion of $250,000 or $500,000 for married couples. True but the IRS wants to see the steps.

Also, you might think that the 1099-MISC income was included in schedule C gross income. True but the IRS wants to see the 1099 tied to gros income and reported with the return. In truth, IRS proposed change would double include that 1099 income since it was already included on your schedule C, but the IRS does not know that.

The IRS does not give taxpayers the benefit of the doubt. Taxpayers must apply appropriate tax rules in their return. The IRS assumes worst case scenario when proposing changes, which must then be disproved by the taxpayer. Give us a call to handle this for you.

If you go at it alone, you would have to correct the return and provide the correct documentation to the IRS. If the IRS accepts your corrections, the assessment will be adjusted correctly and you win, or at least set the record straight.

IRS Pre-Audit Investigations

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Posted by
Philip Falco

Audit “Flags” – Straight from the Internal Revenue Manual

Large Unusual Questionable Items (LUQs)

The definition of a large, unusual, or questionable item will depend on the examiner’s perception of the return as a whole and the separate items that comprise the return. Some factors to be considered when identifying LUQs are:

  1. Comparative size of the item — an expense item of $6,000.00 with total expenses of $30,000.00 would be a large item; however, if total expenses are $300,000.00, the item would not be generally considered a large item.
  2. Absolute size of the item — despite the comparability factor, size by itself may be significant. For example, a $50,000 item may be significant even though it represents a small percentage of taxable income.
  3. Inherent character of the item — although the amount of an item may be insignificant, the nature of the item may be significant; e.g., airplane expenses claimed on a plumber’s Schedule C.
  4. Evidence of intent to mislead — this may include missing schedules, incomplete schedules, misclassified entries, or obviously incorrect items on the return.
  5. Beneficial effect of the manner in which an item is reported — expenses claimed on a business schedule rather than claimed as an itemized deduction.
  6. Relationship to other items — incomplete transactions identified on the tax return. For example, the taxpayer reported sales of stock but no dividend income.
  7. Whipsaw issues — occur when there is a transaction between two parties and characteristics of the transaction will benefit one party and harm the other. Examples include alimony vs. child support, sale vs. rental/royalty, employee vs. independent contractor, gift vs. income.
  8. Missing items — consideration should be given to items which are not shown on the return but would normally appear on the returns of similar taxpayers. This applies not only to the examination of income, but also to expenses, deductions, etc., that would result in tax changes favorable to the taxpayer.

The foregoing is an excerpt from the Internal Revenue Manual.  These are some of the recommended procedures to IRS Agents when doing background work before a taxpayer is contacted.

The tax return would have been flagged already.  It is now in the hands of the scrutinizing IRS Agent.  These are some of the items the agent will look at closely before contacting the taxpayer.

Click here to read about IRS Audits including IRS letters.

Excerpt from Publication 1, Taxpayer Rights

The process of selecting a return for examination usually begins in one of two ways. First, we use computer programs to identify returns that may have incorrect amounts. These programs may be based on information returns, such as Forms 1099 and W-2, on studies of past examinations, or on certain issues identified by compliance projects. Second, we use information from outside sources that indicates that a return may have incorrect amounts. These sources may include newspapers, public records, and individuals. If we determine that the information is accurate and reliable, we may use it to select a return for examination.