Under the Microscope of the IRS

Written By: Bryan Esarco, CPA, Director at Porte Brown, LLC

There is always a likelihood that a taxpayer’s tax return will be selected for IRS Examination. The chances for examination will vary depending on the types of tax returns that are filed, the geographic location of the taxpayer and the amounts of items reported on the taxpayer’s tax return. It is important to note that the IRS can’t conduct more than one examination of the tax return for any particular year.

The IRS uses personnel and an automated computer system to begin the examination process. IRS personnel check tax returns for obvious errors on a routine basis. More commonly, though, tax returns are checked by a computer system process that rates each tax return for possible errors via a mathematical based technique known as the Discriminate Inventory Function (DIF). The higher a tax return scores on the DIF system, the greater the chances of an examination.

Types of Examinations:

1. Automated Underreporter Program – Technically this is not considered an examination, so the IRS could examine this tax return subsequently under any of the following methods below. This process is the simplest and involves computer matching of forms the IRS has knowledge of (W-2 and 1099) to the taxpayer’s tax return. If the IRS feels that an item of income has been omitted from the tax return, they will send a notice proposing a change to the tax return and the taxpayer will have the opportunity to respond with additional information.
2. Correspondence Examination – This is completed by an IRS agent, whereby the IRS agent will send a letter questioning a tax return issue or line item on the tax return. The correspondence will indicate the questions at hand and what information the taxpayer needs to provide to support the position taken on the tax return. The taxpayer can provide receipts, cancelled checks or a written explanation as to how a calculation was derived.
3. Office Examination – The IRS Agent will invite the taxpayer to the local office at a specified date and time. The examination letter will inform the taxpayer of the premise of the audit and suggest what documents or information that the taxpayer should bring to the meeting to support their tax position taken on the tax return. The taxpayer should be represented by a person authorized to practice before the IRS but is not required to have representation. Office examinations are generally limited to tax returns that report smaller amounts of business transactions and income.
4. Field Examination – The IRS Agent will schedule a time to visit the taxpayer's place of business or the site where books and records of the business are maintained. The IRS agent will consider the timing of the examination in cases where the business is seasonal. The agent will provide the taxpayer with information about the examination process and the taxpayers rights as it relates to the examination. The agent will have the authority to request copies of other tax returns that are relevant to the examination. The IRS has the authority to request any books, papers, records, or additional data that may be relevant to verifying the accuracy of the tax return. The field examination is the most complete review of the taxpayer’s financial history. The IRS can extend the audit to other tax years if items are found in the current year exam that make that a reasonable course of action.
5. Research Examination – This type of examination is done to reduce the nations “tax gap.” The tax gap is the difference between the amount of tax owed and the amount of tax collected. This type of examination is systematically based on selecting random returns based on taxpayers’ social security numbers. The IRS agent will thoroughly examine each line item of the tax return regardless of the dollar value. All returns selected in the research examination will go through the examination process even if there are no apparent issues or controversies thought to be identified on the tax return.

It is highly advisable that you should be represented by a skilled and experienced representative who has working knowledge of the IRS examination process. Please contact Bryan Esarco, CPA, at Porte Brown at 847-956-1040 to discuss your IRS correspondence, so you can be sure that all relevant facts are considered in your case and that the IRS examination process is handled in an efficient manner.