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Articles Posted in IRS Tax Audit

Due to the ongoing COVID-19 Pandemic, the IRS has provided relief to taxpayers by extending filing and other deadlines. Now, in an internal memorandum from Fred Schindler the Director of Headquarters Collection (SBSE), the IRS continues to provide relief to taxpayers with tax debt by suspending most tax collection activities. These changes mirror the previous relief provided by the IRS, and restates the relief contained in the People First Initiative.  Our tax litigation attorneys are advising our clients that they can expect enforced tax collection activities to be suspended unless there is an exigent circumstance including the loss of the opportunity for the government to collect taxes due. The expiration of the statute of limitations is one example.

The importance of the memo is that while it mostly repeats and fleshes out the People First Initiative, it is a direct “order” from the head of SBSE Collection to all Collection Executives. The People First Initiative is a bit more nebulous in terms of its actual impact on the activities of rank and file employees.  The collection activities outlined in the memo include most activities related to the collection process such as meeting with taxpayers, filing new Notices of Federal Tax Liens (NFTL), issuing levies, taking or scheduling seizures actions, and pursuing civil suit proceedings. Automated tax levy programs are also suspended. The memorandum also directs Collections not to default installment agreements for missed payments due between April 1 and July 15, 2020 (the suspension period).  Due to the ongoing and ever changing nature of the COVID-19 epidemic in the United States, the IRS may extend the suspension period and the incorporated relief provisions further.

It is important for taxpayers and their advisors to remember that even though collection enforcement activity will be rare from now through July 15th, once the suspension period ends the IRS may begin filing liens and levies with a vengeance. Our tax lawyers are therefore recommending to our clients that, to the extent practicable, they position themselves to take appropriate action to forestall collection after the suspension period ends. This includes submitting offers in compromise, and requesting installment agreements now.

In a 2019 U.S. Tax Court case, Palmolive Building Investors, LLC v. Commissioner, 152 T.C. No. 4, (2019) (Palmolive II), the Tax Court held that both penalties determined by the Revenue Agent in a tax audit and additional penalties later determined  by an Appeals Officer in the IRS Independent Office of Appeals met the written approval requirements of I.R.C. § 6751; thus making Palmolive Building Investors, LLC (Palmolive) a two-time loser. Palmolive was initially in Tax Court in 2017 (Palmolive I) over a disallowed charitable deduction for a façade easement.  As the owner of a historical building in Chicago, it had donated a façade easement to a conservation organization and took a large charitable deduction for the easement. In addition to questioning the $33,410,000 valuation of the easement, the IRS argued that the mortgages on the building limited the easement’s protection in perpetuity. The Tax Court agreed and concluded that the façade easement was not protected in perpetuity and therefore failed to qualify for a charitable deduction under I.R.C. § 170(h)(5)(A).

Following the disallowance in Palmolive I, the taxpayer returned to the Tax Court to dispute whether the penalties assessed by the IRS complied with the provisions of IRC Section 6751(b)(1).  During a tax audit, a Revenue Agent had asserted in a 30-day letter that Palmolive was responsible for a 40% penalty for a gross valuation misstatement and a 20% negligence penalty. These two penalties were approved on Form 5701 by the Revenue Agent’s supervisor. Subsequently, a 60-day letter was issued. The taxpayer took its case to the IRS Office of Appeals. The Appeals Officer assigned to the case proposed four penalties: the two assessed by the Revenue Agent and the Substantial Understatement and Substantial Valuation Misstatement penalties. The Appeals Officer’s immediate supervisor approved all of these penalties on Form 5402-c. In Tax Court, Palmolive argued that the initial determination of penalties was made by the Revenue Agent who did not assert the Substantial Understatement and Substantial Valuation Misstatement penalties; therefore the penalties asserted by the Appeals Officer were not approved as part of the first determination of the penalties.

In examining the validity of the penalty assessments, the court cited I.R.C. § 6751(b)(1) which states that penalties can only be assessed when the initial determination of such penalties are approved in writing by the immediate supervisor of the person making the determination. The court also pointed out that the Congressional motive behind enacting this provision was to make sure penalties were not used as bargaining chips. The court first noted that all penalties were approved in writing. The next issue was what defines an “initial determination” for the purposes if I.R.C. § 6751(b)(1). The court held that the initial determination is when the penalties were first communicated to the taxpayer. The court stated that the Revenue Agent’s 2008 mailing of the 30-day letter was the date of the initial determination and the Appeals Officer’s 2014 issuance of the Notice of Final Partnership Administrate Adjustment are both initial determinations. Since the IRS forms were signed by the respective supervisors prior to the time of the initial determinations, the penalties met the requirements of Section 6751(b) (1).

I Don’t Agree With the Findings of My IRS Examiner. Should I Appeal?
Appealing the results of an IRS examination is usually beneficial to a taxpayer if there is a basis for disputing the findings. The process doesn’t cost anything (although it’s highly recommended that you retain a tax audit attorney), and could potentially result in significant tax savings, making it a good investment for many taxpayers. You could go directly to Tax Court to resolve your issues instead, but this is a more costly procedure, and you can generally go to Tax Court after filing your IRS appeal if you still aren’t satisfied.

Keep in mind that you should have a legitimate reason for disputing the tax liability before filing an appeal. If your only issue is that you can’t pay the tax, you can file an Offer in Compromise or request an installment agreement that allows you to pay off your tax debt over time.

How to Request an Internal IRS Appeal

Exceptions to The Three-Year Statute of Limitations for IRS Tax Audits
The general rule of the IRS is to audit returns that have been filed in the last three years. Because of this, some taxpayers may breathe a sigh of relief once the three-year period has expired, but the rules regarding the statute of limitations are not quite that simple. There are circumstances where the IRS can go back even further to audit your return or assess additional tax, and the IRS has unlimited time to assess tax in the case of an unfiled return.

IRS Audits for Substantial Errors

If the IRS detects a substantial error on your return, the IRS can wait up to six years after your return was filed to conduct an audit. A substantial error involves an understatement of income of more than 25%, based on the income claimed on the return. Congress has extended this definition of a substantial error to include basis overstatements which result in less capital gains tax being owed after the sale of property. Some of those are discussed below.

What Causes an IRS Tax Audit?
The IRS has several methods of selecting returns for a tax audit. First, returns are identified that may possibly contain incorrect amounts, causing a review of the return by an auditor. If everything on your return checks out, the auditor can accept your return as submitted. If the auditor suspects that something is amiss, your return can be selected for an examination.

How Returns Are Selected for Audit

The IRS can select your return for an audit if any of the following happens:

What to Expect During an In-Person IRS Tax Audit
No one looks forward to receiving a letter from the IRS notifying you that you have been selected for an examination, also known as an IRS tax audit. The IRS may choose to complete the examination by mail by requesting additional information about certain items on your tax return, or they may complete an in-person examination.

Just because your return is selected for an audit, it does not automatically mean that something is wrong. The IRS uses automated methods to select returns for tax audits, but an audit does not always result in an increase in your tax bill.

However, you still want to be cautious whenever you are selected for a tax audit. If you have any concerns about items on your return, you should strongly consider consulting with a tax attorney before you speak to the IRS. If you make false statements to the IRS, or if you accidentally say something that can be used against you, it could lead to more serious problems, including criminal tax charges.

How to Appeal Your IRS Tax Audit
Most audits can be appealed internally within the IRS, without requiring litigation in Tax Court. The IRS Appeals Office is independent from the IRS auditing division, and would prefer to settle cases quickly rather to take them to Tax Court.

There are several reasons taxpayers should consider appealing the results of an IRS tax audit:

  • you can receive substantial savings on your tax bill
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