Field Examinations Part Two

Time Limitations

It is the Service's policy to complete an examination within a certain time limit after the return is filed: this is termed the audit cycle. The clock starts on the date the return is due or the date it was filed, whichever is later. Examinations and dispositions must be completed within twenty-six months for individual tax returns, twenty-seven months for corporate returns, and eighteen months for estate tax filings. There are exceptions: for example; fraud cases, international operations cases, and National Office cases which usually involve taxpayers with assets in excess of $250 million.

Utilization of the audit cycle as a tactical tool is a basic practice of tax attorneys. The common belief is that the agent faced with a looming deadline will become a more cooperative agent, and one who will dispense with undeveloped avenues of opportunity. However the agent is not without his own pressure tactics in this situation. He may set up tax adjustments that are only partially developed and ask the taxpayer for an extension of time. He can establish heavy adjustments as a potentially punitive measure if he is suspicious of the taxpayer's behavior.

Identifying Potential Tax Return Adjustments

There are three initial steps required of the agent:

• Identify items that indicate adjustment may be in order;

• Verify items on the return by gathering appropriate evidence;

• Apply the provisions of the Code, as interpreted.

Step One

The first step calls for identification of the "LUQs." Factors involved in defining a questionable item as large and unusual include the following:

Comparative size of the item An expense of $5,000 may seem excessive when total expenses are $30,000; within the framework of a $300,000 expense claim it seems less significant.

Inherent character of the item While the value of the item may be minor, it might seem out of place: travel expenses for a fireman might seem significant.

Evidence of intent to mislead Indicators in this category might include missing or incomplete schedules, or an incorrectly categorized item.

Beneficial effect of the manner in which an item is reported Expenses claimed on a business schedule rather than as an itemized deduction may be an indicator.

Relationship to other items on a return An example here might be no deduction for interest when real estate taxes are claimed.

Step Two

For the second step, the requirements of the Code and the guidelines of the Service put great priority on the examination of substantiating records; in other words, building the case. This requires verification of income reported, deductions and expenses itemized, and the veracity of any credits claimed against the tax owed. After ascertaining the actual worth of each item, the examiner must then analyze and determine whether the taxpayer has complied with relevant sections of the Code and other "interpretative rulings of the Service."

Step Three

After the debate has ceased, it is within the agent's purview to "apply the provisions of the Code, as interpreted." At this point, the agreements on adjustments are joined to those adjustments, if any, that the agent has unilaterally determined shall apply. It is these last, the "provisions of the Code as interpreted," that may bring the taxpayer to pursue his rights of appeal.