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Articles Posted in IRS Tax Audit

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

How Many Years Does a Tax Audit Cover
The IRS generally will look at returns filed during the last three years during a tax audit. The Assessment Statute Expiration Date (ASED) places a limit for the time period the IRS has to make a tax assessment. The ASED is three years from the day the return was filed, but there are a number of exceptions to this three-year limit.

How Failing to File Affects a Tax Audit

If you do not file a tax return, the IRS has an unlimited amount of time to assess the tax. The IRS usually does not look back more than six years, but they can if they choose to. Once you file a delinquent return, the three-year ASED begins to run.

Key-Steps-in-Preparing-for-an-IRS-Tax-Audit-300x167
It doesn’t necessarily mean you have done anything wrong, but it still is something every taxpayer should be prepared for: notification of an IRS tax audit. Of course the best approach to preparing for a tax audit would be to ensure that your tax filings don’t warrant any undue attention, but that shouldn’t prevent you from taking every deduction to which you are legally entitled. An audit may simply be based on random selection, but that is very rare. The most prudent assumption is that the IRS believes that there may be errors with your return that need to be addressed. If you’ve been selected for a tax audit, here are some of the important steps to take:

  1. Gather All Your Records – Be sure to have all of the pertinent documentation together in one place that will substantiate any deductions or exemptions you claimed on your returns. Generally, the IRS is happy to receive digital copies of records. If you don’t have all your records duplicates can usually be obtained from financial institutions and vendors, but that takes time. Therefore you should get started as soon as you are notified of the tax audit. If you are in business you should review your bank statements, and compare them to your tax returns to make sure you reported all of your income. You should have tax returns for at least the past three years.
  2. Research – Make use of IRS publications that explain the procedure for audits, your rights as a taxpayer, the appeals process and more. Keep in mind though that IRS publications do not always represent all the nuances of the law, and the IRS is not required to follow its own publications.