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August 09, 2019

The IRS Gets Audited: Results from the TIGTA Report

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As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists individuals and businesses with representation in tax examinations, audits, and civil litigation with the Internal Revenue Service (the “Service”) and the Ohio Department of Taxation. As part of that representation, our tax attorneys keep individuals and businesses informed about new information and guidance provided by the IRS. This article highlights a report on a recent audit of the Service’s Large Business and International Division (“LB&I”) performed by the Treasury Inspector General for Tax Administration (“TIGTA”) (the “Audit”).

The Audit

The Service uses taxpayer penalties to enhance voluntary compliance by demonstrating fairness to compliant taxpayers and penalizing noncompliant taxpayers. The Service’s examination program is made up of three operating divisions: LB&I, which is responsible for the tax compliance of partnerships, S and C corporations with assets of $10 million or more, and individuals with high wealth or with international tax implications; the Small Business/Self-Employed Division (“SBSE”), which examines other businesses with assets less than $10 million; and the Wage and Investment Division (“WI”), which examines taxpayers who claimed certain refundable credits. A Service examiner (the “Examiner”) is primarily responsible for determining a taxpayer’s correct tax liability through the examinations the Examiner conducts. An Examiner is also responsible for considering any applicable penalties associated with an examination and is required to document and explain each proposed penalty. This includes accuracy-related penalties.

The Service reported that the gross underreported income tax for large corporations, for tax years 2008 through 2010, averaged $28 billion annually. This creates substantial challenges for LB&I Examiners, especially as it relates to accuracy-related penalties. TIGTA conducted the Audit from August 2017 through December 2018. The Audit acted as a performance review of the imposition of accuracy-related penalties by LB&I, as well as an analysis of the percentage of penalties sustained by the Service’s Office of Appeals (the “Appeals Office”). The Audit reviewed the imposition of accuracy-related penalties and Appeals Office practices for tax years 2015 through 2017 (the “Audit Period”).

The Results

The TIGTA report outlines the Audit findings in three main categories that demonstrate the Service’s and LB&I’s areas in need of improvements:

Accuracy-Related Penalties Are Infrequently Proposed by LB&I
and Often Reduced or Eliminated by the Appeals Office

During the Audit Period, LB&I reviewed 6,709 business tax returns. Of these returns, Examiners proposed accuracy-related penalties on 519 returns in the amount of $1.8 billion. Taxpayers appealed 308 of the 519 returns, which amounted to $1.5 billion in penalties. By December 2018, the Appeals Office reviewed 195 of the 308 returns, and eliminated or reduced penalties worth $765 million on 183 of the returns.

The Audit pulled an additional 4,600 business tax returns from examinations that resulted in additional tax assessments in excess of $10,000. These additional assessments totaled $14.4 billion. Of these 4,600 returns, Examiners proposed accuracy-related penalties on 295—or six percent. By comparison, the SBSE examined 22,370 business tax returns from examinations that resulted in additional tax assessments in excess of $10,000. Of those 22,370 returns, Examiners proposed accuracy-related penalties on 5,634 of the 22,370 returns—or twenty-five percent. TIGTA highlighted this as a significant discrepancy between LB&I and SBSE examination practices.

Examiners Did Not Always Consider or Justify Accuracy-Related
Penalties and Supervisors Were Not Always Involved in Penalty
Development and Approval

It is the responsibility of the Examiner to identify the appropriate penalties, determine whether to propose the penalties, and accurately calculate the penalties as they relate to a specific examination. Examiners are also responsible for documenting the considerations, reasoning, and computations for all penalties proposed on a return.

The Audit pulled a stratified sample of 50 closed LB&I examinations containing accuracy-related penalties, as well as a stratified sample of 50 closed LB&I examinations with additional tax assessments greater than $10,000 but without accuracy-related penalties.

A review of the 50 closed examinations that did not contain accuracy-related penalties showed that Examiners did not even consider accuracy-related penalties for twenty percent of the examinations. And, in the examinations where Examiners considered accuracy-related penalties, twenty percent of the exams failed to provide sufficient documentation on the considerations, reasoning, and computations related to penalties assessed on the returns.

A review of all 100 closed LB&I examinations pulled indicated that in sixty-six percent of the examinations, the Examiner’s supervisor either did not approve the proposed penalties or was entirely not involved in the proposal of penalties. The Examiner-supervisor relationship is an important part of the Service’s Examination procedures, however, the Audit revealed glaring issues related to this relationship within LB&I.

Many Closed Examination Paper Case Files Were Missing or Incomplete

The Audit also reviewed a sample of 90 closed LB&I examination paper case files to determine their completeness. To do so, TIGTA requested 90 random paper case files from the Service’s Integrated Data Retrieval System (“IDRS”) according to standard Service procedures. Not only did TIGTA experience longer than expected processing times in receiving the case files, but TIGTA also discovered several instances of incompleteness. Of the requested files, IDRS provides partial files for twenty-seven percent of the files and could not retrieve six percent of the requested files.

The Recommendations

Based on the Audit’s results, the TIGTA report offered the following recommendations to the Service and LB&I for improving the issues described above:

  1. Conduct a study to understand why Examiners’ proposed tax assessments and accuracy-related penalties are not being sustained by the Appeals Office and whether Examiners consider all relevant facts and circumstances prior to proposing tax adjustments and accuracy-related penalties.
  2. Ensure Examiners and their supervisors are properly trained to consider accuracy-related penalties for each examination, follow the proper procedures for documenting penalty consideration and development, and follow the Service’s requirements for supervisor involvement in each examination.
  3. Revise the Internal Revenue Manual to indicate which Examiners are responsible for penalty development and documentation and provide more specific requirements as to a supervisor’s involvement in approving penalty decisions.
  4. Ensure adequate quality review systems are in place that can accurately determine whether Examiners properly consider penalties, provide adequate support for such penalties, involve managements throughout the examination processes, and obtain all necessary approvals.
  5. Use the Service’s internal process improvement team to evaluate the procedures for closing, shipping, and storing paper examination case files.

Overall, the Service was generally receptive of the recommendations provided by TIGTA and agreed that several changes needed to be made to correct the issues and concerns addressed in the TIGTA report.

Nardone Limited Comment: Going forward, taxpayers filing returns within the purview of LB&I examination should take great caution to ensure the accuracy of the returns. With the results and recommendations that came out of the TIGTA report, taxpayers can expect greater scrutiny from Examiners and their supervisors. We expect to see a rise in accuracy-related penalties assessed to LB&I returns going forward. We recommend that taxpayers contact experienced professionals regarding all accuracy-related concerns on a return before filing. Getting it right the first time has never been more important. We also expect to see changes made at the appeals level. The TIGTA report highlighted the trend occurring at the Appeals Office whereby penalties appealed to the Appeals Office were being severely reduced or even eliminated in almost every case brought to appeals. We anticipate this to stop and expect the Appeals Office to increase its scrutiny at all levels of the appeals review process. If you are assessed an accuracy-related penalty, or any penalty for that matter, it is important that you retain the appropriate professional advisors who will take a more detailed approach when submitting your cases to Appeals.

Conclusion

If you are assessed similar proposed assessments or accuracy-related penalties on your business or personal income tax return, it is important to work with a qualified tax professional to review those assessments or penalties and your opportunities for appeal. The tax and business attorneys at Nardone Limited are experienced in federal, state, and local tax controversies, including examinations by the SBSE and LB&I. If you believe the Service wrongfully proposed an assessment or penalty, or are under examination by a taxing authority, our firm can assist you.  Contact Nardone Limited today.

The full report is available at: https://www.treasury.gov/tigta/auditreports/2019reports/201930036fr.pdf

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August 09, 2019

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