By Dave DeWitte
Larger business taxpayers will be seeing new IRS examination strategies this year as the nation’s tax collector strives to become more effective on a limited budget.
One of the examination strategies the IRS has been known is the “fishing expedition” document request. The agency uses a scoring system to determine which tax returns are most likely to contain errors, then sends out broad information requests to those with the highest scores in hopes that their responses reveal filing errors.
A new and different examination procedure called ‘campaigns’ was unveiled in mid-2015 by the IRS’ new Large Business and International (LB&I) division, which deals primarily with taxpayers having more than $10 million in assets or doing business internationally.
The campaigns seek to improve the agency’s effectiveness by identifying and making public the areas of tax returns with the biggest risk of non-compliance. From a list of 600 issues initially submitted by IRS examiners for consideration, the LB&I division on Jan. 31 came out with 13 initial campaigns that will be the focus of its examination efforts this year.
The 13 campaigns may be arcane to non-tax professionals. They include a campaign on repatriation of income from outside the United States, another on losses claimed by S corporation members in excess of their basis, and a third on micro-captive insurance, or companies that create “captive” insurance companies for their own use. But knowing the campaigns can help businesses understand what tax return areas are most likely to face scrutiny and begin to prepare, said Patti Burquest, a principal in RSM US LLP’s Washington, D.C., Tax Controversies practice.
Ms. Burquest will be one of the hosts on a Feb. 15 webcast explaining the IRS campaigns and related changes. She said the IRS isn’t going soft.
“It’s a more transparent IRS,” she said. “They can be very aggressive on some of these issues.”
Still, taxpayers and preparers who take time to understand the new system will have a better opportunity to gauge their risk of an examination, and gather the paperwork needed if their return is selected. And just because a taxpayer’s return involves an issue addressed by an IRS LB&I campaign doesn’t mean they should fear the worst.
“It doesn’t always mean, once they pick a campaign issue, that they’re going to examine the tax returns,” Ms. Burquest said. “They may come up with something different. They call them treatment streams.”
The treatment streams differ in their approach. One could prescribe a focused examination of a tax return, while another may include published guidance on handling tax issues. The latter might also include information on “safe harbor” tax-reporting practices the IRS finds acceptable.
Another alternative to an examination that a taxpayer could receive is a “soft letter,” Ms. Burquest said. It’s intended to guide the taxpayer or preparer, whose returns may be infringing on one of the areas identified in a campaign, and explaining what they can do to maintain compliance. Although the letter may not require immediate action, it could be a precursor to an IRS examination the following year if the flagged reporting practice isn’t addressed.
A leaner, meaner IRS
The IRS changed both its examination procedures and the structure of its LB&I division in 2015 in response to serious budgetary constraints. It created nine different practice areas to explore compliance issues and suggest campaigns. Although four of the practice areas are geographically based, five were set up to address specific tax subjects.
“Right now, we’re at 2009 IRS budget levels,” Ms. Burquest said. “Their budgets have been declining and their workforce is declining. Right now, there’s a hiring freeze.”
Ms. Burquest said the new organizational structure also includes a more team-oriented approach to major decisions on a taxpayer examination.
The IRS instituted the changes against a backdrop of studies that showed the audit rates for different categories of taxpayers could vary widely. One study by the U.S. Treasury Inspector General’s office found that the audit rate for very large partnerships was less than 1 percent, while the audit rate for similar-sized taxpayers organized as corporations was 12.2 percent in the 2014 fiscal year.
Ms. Burquest and RSM Senior Director David Click will also discuss on the webcast how taxpayers should respond to the term “any and all” in fishing expedition document requests, and when and how to make an early election in 2017 under new partnership audit rules.