when clients face ‘unreal’ irs audits

irs adopts confusing, misleading terminology. but it’s all very real.

by rick telberg
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tax professionals and accounting firms need to be aware that their clients may face two kinds of internal revenue audits: real and unreal.

really.

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and it’s the “unreal” audits that are going to become more common.

over irs objections, the tax advocacy service is using the term “unreal” audits in its 2017 annual report to congress. the irs called the terms “inaccurate, misleading and a mischaracterization of irs interactions with taxpayers” because the so-called “unreal” audits do not, in the irs opinion, qualify as audits, which, in its tax code, involve inspections of books and records.but the tas insists that taxpayers see little distinction between the two kinds of compliance actions, explaining in a footnote that “receipt of a notice stating that the irs will increase the taxpayer’s liability unless the taxpayer responds and provides acceptable documentation to support his or her return position feels like an audit, regardless of whether it is technically an audit…”

the difference

the difference is crucial. because of the irs’s narrow definition of what constitutes an audit, the tas says that

• the irs ends up reporting misleading information to the public,
• taxpayers end up with a limited option to appeal, and
• after being subjected to an “unreal” audit, taxpayers may face a “real” audit, in denial of their right to be audited just once in a fiscal year.

among the types of taxpayer contacts that the tas considers to be “unreal” audits are:

• math or clerical errors that allow the irs to adjust returns;
• the automated underreporter program, which uses third-party documents (such as those of employers, banks, etc.) that indicate a discrepancy;
• the program to stop identity theft and refund fraud, which identifies returns that merit additional scrutiny;
• the automated substitute for return program for taxpayers who apparently have a significant tax liability but have not filed a return.

these contacts and their requests for information can lead to the same bullets of sweat as notification of an impending audit, and in some cases there is little difference in the way the irs conducts the two types of audits. the big difference is in the protections that come with a “real” audit but not with the less real kind. taxpayers essentially lose their right to challenge the irs position because the non-audit isn’t considered a real audit.

less deterrence

the differentiation also leads the irs to report what the tas calls misleading information on compliance contacts. for example, in 2016, the irs conducted fewer “real” audits, so its audit rate dipped to 0.7 percent, down from 0.9 percent in 2014. however, if the 8.5 million “unreal” audits were counted, the audit rate would be 6.3 percent. in effect, the tas says, “the irs is masking the true extent of its compliance activities, which touch millions more tax returns each year.” if the irs reported the larger number, it might deter taxpayers from the temptations of noncompliance.

the situation is expected to worsen next year.

“the irs’s ‘future state’ initiative calls for the increased use of these types of “unreal” audit programs,” the tas report says, which will undoubtedly impact many more taxpayers.”

the tas issued four recommendations to the irs.

1. to review its definition of “audit” so it reflects irs compliance activity and application of the taxpayer bill of rights.
2. to include “unreal” audits in its audit rate and roi calculations.
3. to grant taxpayers the right to appeal certain cases.
4. to address all audits as “real” and avoid a double event—an “unreal” audit followed by a “real” one.

posted on february 6, 2018