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Correspondence Examinations Part 1 - Elements of the program  08/15/08
The information contained in this presentation is current as of the date it was presented.
It should not be considered official IRS guidance.
TRANSCRIPT

John: Hello I’m John Caggiano, program manager of Campus Examination Policy in the IRS’s Small Business/Self-Employed Division. This is a reenactment of an IRS National Phone Forum from August of 2008 covering correspondence examinations. This is part one of a three-part series and I’m joined by my colleague, tax analyst Mike Landsmann, whom you’ll hear in parts two and three. Welcome, Mike.

Mike: Thank you, John, and thanks to our listeners for your interest in the Correspondence Examination Program.

John: The three-part series will provide general information about our correspondence examinations and it will be helpful if you listen to them in order. The topics we will cover are based on feedback and concerns from tax practitioners and preparers.

In Part one I’ll discuss:

  • The role of correspondence examination and why correspondence examinations are so important to the IRS’s compliance strategy.
  • I’ll also cover the major types of correspondence examinations and how a tax return is selected for audit.

In part 2, Mike will discuss:

  • The overall notice process. He’ll talk about the timing of our notices and the types of letters used to open an examination.
  • He’ll briefly provide an overview of how a correspondence examination is conducted, and share some key points to consider when responding to a correspondence examination letter.
  • And to close part two he’ll discuss concerns raised by practitioners and our recent efforts to improve our processes based on feedback received from tax professionals.

And in part 3, we’ll answer some commonly-asked questions about correspondence examinations.

Now I’d like to cover the role of correspondence examinations in the IRS’s compliance strategy.

Correspondence examinations are very efficient and allow for broad compliance coverage. They require much less time to conduct than an audit done in a field office by a revenue agent or tax compliance officer. A correspondence examination is conducted by a correspondence examination technician or a tax examiner. These employees receive extensive tax law and continuing professional education training each year on updates and changes to the tax law.

The IRS has expanded and refined the correspondence examination program considerably over the past 8 years. Most correspondence examinations are conducted out of a “campus” operation. You may have heard us refer to a campus as a “service center” in the past. Before the IRS restructured to its present configuration of business operating divisions, a service center was assigned a geographic area for its correspondence examinations. Today, each campus works a national inventory. This may explain why tax professionals may be dealing with two or more campuses if you have clients who live in the same area and were selected for a correspondence examination.

There are three primary factors that determine the assignment of a correspondence examination to a campus.

  • Number one, the schedules attached to a return
  • Number two, the campuses’ need for work and
  • Number three, the audit issue being examined

In the Small Business/Self-Employed Division, correspondence examinations are conducted on returns that have a Schedule C, E, F or Form 2106 attached. However, this doesn’t necessarily mean our audit will focus on these schedules. Our SB/SE campuses are:

  • Brookhaven in Holtsville, New York
  • Cincinnati in Covington, Kentucky
  • Memphis, Tennessee
  • Ogden, Utah and
  • Philadelphia Pennsylvania

The IRS’s Wage and Investment Division also conducts correspondence examinations from their locations in:

  • Andover, Massachusetts
  • Atlanta, Georgia
  • Austin, Texas
  • Fresno, California and
  • Kansas City, Missouri.

There has been tremendous growth in campus correspondence examinations over the past eight years. The number of correspondence examinations has grown from fewer than 400,000 in fiscal year 2000, to more than a million in 2007. We expect the number will continue to grow in the future.

We are continually evaluating what issues can be audited via a correspondence examination to support the steady increase in coverage. We test, or pilot, an audit issue to evaluate its suitability for a correspondence examination. We also consider the complexity of the tax law and other factors such as taxpayer burden as it pertains to the audit issue.

Presently, we are looking at the Schedule C to increase our correspondence examination coverage. For example, we have developed selection criteria and training for certain expenses on this schedule.

When determining which cases we will examine, we constantly strive for a balanced compliance approach. Examination resources are shifted to reduce the tax gap while providing a balanced approach to coverage of individuals.

While we look to expand the use of correspondence exams we also work to ensure balance in our audit coverage. About a year or two ago, the IRS was put under close scrutiny for potentially putting too much emphasis on low-income taxpayers. For this purpose, we defined a low-income taxpayer as an individual who is eligible for or received the Earned Income Tax Credit, or EITC. Even though the number of correspondence exams has increased, as previously explained, we are examining fewer low income taxpayers. From fiscal year 2005 to 2007 we significantly decreased the percentage of low-income taxpayers who were brought into our correspondence examination program from 43 to 36 percent of our total examinations.

The criteria for a correspondence examination are pretty straightforward.

First, the scope of the examination will be a single or limited audit issue. The focus is on a specific schedule or a line item on the tax return rather than the entire return. The audit issues are generally less complex issues when contrasted with an examination or audit conducted by a revenue agent or tax compliance officer.

Next, the focus is on recordation to substantiate tax return entries. A correspondence examination essentially asks for the documentation or recordation to support an entry on a tax return or schedule. If the requisite documents or records are not provided, we will disallow the item.

Here are some examples:

  • The IRS will ask for receipts to support a car and truck expenses on Schedule C, or
  • The IRS may ask for canceled checks to support a charitable contributions deduction, or
  • Birth certificates and school records could be asked for to support an exemption or claims for the EITC.

We also examine issues with a limited potential for the need to meet in person with the taxpayer or their representative. While at times these issues seem best resolved face to face, the majority can be - and are - resolved through the mail.

Now I’ll cover some of the details of how the IRS selects our inventory.
The IRS has developed several formulas that analyze the complete set of data from a tax return and project the potential for an adjustment. For the most part, these formulas are updated each year and use information such as:

  • Results of prior audits that suggest what returns may have a higher potential for a tax adjustment than others, and
  • Information from third parties that will tell us if a supporting information return, such as a W-2, is incorrect or false, and
  • Entries made on the return that are compared and contrasted to look for seemingly contradictory information. For example, a return with no business income should not have an entry for a Fuel Tax Credit.

We also receive a significant number of referrals from our peers in Criminal Investigation or from the enforcement activities related to return preparers or promoters - such as the groups in our Abusive Tax Avoidance Transactions (ATAT). Our correspondence examinations support our colleagues in their efforts. For example, the results of our audits are considered when sentencing an individual who was convicted of a criminal charge involving the tax law.

Another factor we consider in our inventory selection is when to conduct the examination. That is, whether we conduct the examination before or after processing a refund requested on the tax return.

A pre-refund examination (also referred to as a pre-refund audit) will stop a tax refund from being issued until the examination is completed.

The IRS has found pre-refund audits to be effective in preventing revenue loss. Pre-refund correspondence examinations are conducted only for those returns the IRS is most confident that the outcome of the examination will result in a tax adjustment or a disallowance of a tax credit.

The decision to conduct a pre-refund examination is based on the analysis of prior year examinations and the characteristics of a return that suggest a tax adjustment is likely. A refund is stopped if supporting information, such as the Form W-2, is verified to be false through third party contacts. The refund is also stopped if there is an unallowable condition that needs to be resolved through a correspondence examination, such as an entry for a fuel tax credit where there is no business income.

Post-refund issues are worked after the refund has been issued and the return data has been analyzed. Generally, a good degree of collectability is maintained on the issues worked in post-refund examinations.

Three of the biggest issues addressed via correspondence examinations are, the Earned Income Tax Credit (or EITC), some non-filers, and Schedule A issues.

  • With EITC a correspondence examination is the best venue to quickly conclude an audit. Documentation, such as a birth certificate to support the claim for the credit, is requested.
  • With certain non-filing conditions, the IRS receives information from third parties, such as employers and payers of interest, which is then compared against a tax return. If no tax return has been filed, a return is prepared using the third party information via the correspondence examination program.
  • The Schedule A is a growing part of the inventory and also an area with a high level of incorrect deductions. As a result, the number of correspondence examinations dealing with Employee Business Expenses (or EBE) has increased, showing this issue, overall, is conducive for a correspondence examination. For example, there are a high percentage of examinations where the individual agreed the EBE was incorrect. Charitable contributions is another Schedule A deduction that will be audited via a correspondence examination. We continue to see misreporting in charitable contributions.

We also examine a broad number of other issues on the tax return and the supporting schedules, such as the self-employment tax, or adjustments to income, such as alimony, but these are major inventory sources.

Let’s walk through how a return would be selected for a correspondence examination involving the EITC.

The IRS receives information from other government agencies and third parties, which we use to validate information on a tax return. The Federal Case Registry (FCR) data provides us with information regarding custodial rights for a dependent or qualifying child.

Information from the Social Security Administration (or SSA) is used to validate that the Social Security number (or SSN). The SSA data associates the name with the SSN and also the date of birth. As with all inventory, not only third party information is used, but also prior results to project the potential for a tax adjustment or a disallowance of a tax credit. Certain attributes on the return help determine the tax adjustment potential.

Once the entries on the tax return with EITC are analyzed, they are prioritized based on the potential for a tax adjustment.

Once an EITC return is selected there are some key points about the examination that I would like to highlight.

Earlier I mentioned that a refund is held until the audit issue is resolved via a correspondence examination. When an EITC tax return is examined, only the EITC amount is frozen. The non-EITC refund amount will be issued within normal refund timeframes.

A CP-75 notice is issued to the taxpayer advising them of the intent to audit the EITC amount and will ask for certain documentation to support their claim for the EITC.

Case assignment is part of the efficiency of correspondence examinations, but one that is understood as being a source of frustration for taxpayers and their representatives. Cases are assigned to an examiner only when a reply is received. Additionally, if no response is received from our contacts with a taxpayer, examination is systemically advanced through the various stages of the audit: first contact, issuance of the 30-Day Letter, issuance of the 90-Day Letter or Statutory Notice of Deficiency, and finally, closure of the examination. This is why it’s important to hear from you. Sometimes, more time is needed to gather the requested information; that isn’t known unless you contact the office conducting the examination.

Cases may also be handled by several correspondence examination technicians or examiners. Leave schedules and leveling of workloads affect the handling of cases.

This concludes the first of a three-part recording about the Correspondence Examination Program. In the next segment Mike will explain a little about the notice process, including how it relates to Earned Income Tax Credit examinations.