In an IRS Counsel advisory email, the Service interpreted Code Section7605 (b) to determine that “routinely” looking at an individual taxpayer’s returns a “number of times” does not amount to an examination of the return, and thus does not trigger the restriction in IRC Section to only conduct one examination.
Under Code Section 7605(b), “no taxpayer shall be subjected to unnecessary examination or investigations, and only one inspection of a taxpayer’s books of account shall be made for each taxable year unless the taxpayer requests otherwise or unless the Secretary, after investigation, notifies the taxpayer in writing that an additional inspection is necessary.”
Under Internal revenue Manual (IRM) 184.108.40.206, repetitive audits is a factor that must be considered before an in-depth pre-contact analysis is performed (other factors are statute of limitations, conflicts of interest, and repeat audits by the same examiner are other considerations). Consideration of these factors should be given and may prevent examiners from even initiating an examination. Additionally, after considering these factors, the examiner is also responsible for determining the scope of the audit, and must conduct a pre-contact analysis including a thorough review of the case (See IRM 220.127.116.11). Under IRM 18.104.22.168.2, for non-business returns, the pre-contact actions required include completing a preliminary t-account analysis for office examination returns with a Schedule C or F.
Under IRM 22.214.171.124, the Service sets forth procedures for when examinations are repetitive. Repetitive audit procedures apply to individual tax returns without a Schedule C or Schedule F, when the following criteria are met: a) An examination of one or both of the two preceding tax years resulted in a no change or a small tax change (deficiency or overassessment), and b. The issues examined in either of the two preceding tax years are the same as the issues selected for examination in the current year. Prior year surveys do not meet the criteria for repetitive audit procedures.
IRS Counsel’s position is not a particular surprise given the Service’s procedural position in Rev. Proc. 2005-32 that the following items are excluded from examinations: 1) looking at the return; 2) matching the return with other records in the Service’s position; or 3) considering voluntarily provided information. Moreover, while the Counsel advice memorandum does not set forth the specific facts involved, it notes that the repetitive audit procedures apply to individual returns without a schedule C or Schedule F. Accordingly, the determination appears consistent with both the IRM and Rev. Proc. 2005-32.
While not particularly new, this interpretation is maintained when high income taxpayers are being audited a disproportionately higher rates than low income taxpayers. For instance, in 2014, taxpayers with adjusted gross income of between $1 and $200K had an examination coverage of under 1%, but examinations of higher-income returns had much higher percentages of cover: $200K-$500K (1.75%); $1M – $5M ($3.62%); $5M-$10M (10.53%); and $10M or more (16.22%). See https://www.irs.gov/uac/soi-tax-stats-examination-coverage-individual-income-tax-returns-examined-irs-data-book-table-9b. While the Service is doing what it can with limited resources, and under particularly high scrutiny from Congress, repeatedly stopping taxpayers solely for “looking at the return” at some point should amount to “unnecessary examinations or investigations” under the Internal Revenue Code. Take the opposite situation in which a low income taxpayer repeatedly receives notices regarding the same income tax return, whether the non-examination is being done to “look at the return,” match records, or otherwise. From the individual taxpayer’s perspective, receiving multiple notices for the same tax year starts to feel like an audit. A high income taxpayer with a small business (i.e. a taxpayer who may file a Schedule C) should not be subject to a different result.
Moreover, continuous or duplicative examinations may have a practical effect of chilling the otherwise longstanding ability to voluntary disclose and amend tax positions before the IRS contacts the taxpayer. If the taxpayer feels he or she is under perpetual examination, some disclosure practices may appear less desirable, or even not available (qualified amended returns or voluntary disclosures may not be available if an examination is perceived to have begun).
While the comments herein go beyond the settled definition of what an “examination” is for purposes Code Section 7605(b), permitting the routine review of a single taxpayer’s return for the same year raises important policy considerations regarding how many times the Service should look at a taxpayer in a given year before its focus is considered an examination.
CORY STIGILE – For more information please contact Cory Stigile – email@example.com or 310.281.3200 Mr. Stigile is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a CPA licensed in California, the past-President of the Los Angeles Chapter of CalCPA and a Certified Specialist in Taxation Law by The State Bar of California, Board of Legal Specialization. Mr. Stigile specializes in tax controversies as well as tax, business, and international tax. His representation includes Federal and state civil and criminal tax controversy matters and tax litigation, including sensitive tax-related examinations and investigations for individuals, business enterprises, partnerships, limited liability companies, and corporations. His practice also includes complex civil tax examinations. Additional information is available at www.taxlitigator.com