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The Examination
Process and Representation
When tax
returns are filed, the IRS checks for form, execution and mathematical
accuracy. Often, supporting evidence is required to substantiate the income
and/or deductions reported on the returns. It is critical to understand the
different "levels" of examination and the need to be represented
by a qualified professional.
There are several categories of examination:
in a correspondence exam, the taxpayer is asked to explain or send
supporting evidence by mail. Such examinations are conducted by
correspondence only when warranted by the nature of the questionable items
and by the convenience and characteristics of the taxpayer. An office
examination primarily relies on interviewing the taxpayer. During the
interview, the taxpayer may point out to the examining officer any amounts
included in the return that are not taxable or any deductions that the
taxpayer failed to claim on the return. Primarily, however, the examination
will revolve around explaining and/or substantiating certain questioned
items on the return. A field examination involves an examination of the
taxpayer's books and records on the taxpayer's premises. An examiner checks
the entire return filed by the taxpayer and examines all books, papers,
records and memoranda dealing with matters required to be included in the
return. If the return presents an engineering or appraisal issue, the
return may be examined by an engineeer agent who makes a separate report.
During the examination process, the
examining agent or the taxpayer may request technical advice from the
National Office as to a particular issue when the law is unclear. The
examination process may be interrupted and the IRS may immediately issue a
"statutory notice of deficiency" if the statute of limitations on
assessment is about to expire for the tax period under examination. The
taxpayer can avoid this by agreeing to extend the period for making
assessment.
Each and every type of examination can
result in a "no change", an agreed upon assessment or an unagreed
assessment. It is critical that you have proper expert representation from
the earliest stages of the examination process. Once you clearly indicate
your desire to consult and be represented, the examining agent must comply
with your request. You will need to provide the examining agent with a
fully executed Power of Attorney to enable your representative to speak and
correspond with the agent. We will discuss "unagreed assessments"
and the appeals process in an upcoming issue.
Read more...
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Greetings!
Hope all
are having a great summer. As we approach the dog days, we are reminded
that the IRS never takes a vacation.
This month's tax newsletter has a decided IRS
"flavor". Some thoughts and planning tips...
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· Everyone Needs
a Hobby--Except for the IRS
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 In general,
taxpayers may deduct all the ordinary and necessary expenses attributable
to a trade or business or an activity engaged in for profit. Generally,
when expenses exceed the income from an activity, the deduction of the
expenses creates a loss that may offset the taxpayer's income from other
sources. However, this is in contrast to the rule for activities not
engaged in for profit, i.e "hobby losses"--in those cases, no
deduction is allowed for expenses except to the extent of income from the
activity. Originally, Congressional concern stemmed from a recognition
that wealthy individuals had invested in certain activities, e.g. farm
activities, solely to obtain tax losses to reduce their tax on other
income. Note that the hobby loss rules apply to individuals,
partnerships, and S corporations.
There are
some definite "dos and dont's" that need to be adhered to, with
proper proof and documentation, in order to establish a profit motive and
not run afoul of the hobby loss rules: Do: (1) prepare a business plan,
(2) keep detailed and accurate books and records, (3) keep separate
checking accounts, (4) advertise and promote the activity in a
business-like manner, (5) if the activity is unsuccessful, make changes
to the operation designed to contain costs and avoid futher losses, (6)
consult with experts before entering the activity, (7) engage in research
and study to increase expertise, (8) devote significant personal time and
effort to the activity, (9) be willing to withdraw from another
occupation to devote most energies to the activity, (10) if devoting only
a limited amount of time to an activity, employ competent and qualified
persons to carry on the activity, (11) be prepared to show that
appreciation of assets used in the activity is substantial in relation to
losses, (12) be prepared to demonstrate a history of converting
activities from unprofitable to profitable enterprises, (13) demonstrate
that the losses from the activity were customary or usual for the
activity and be aware of the length of the customary start-up period,
(14) keep track of business circumstances and personal setbacks beyond
the taxpayer's control that may have contributed to the activity's
losses, (15) invest substantial resources in the activity to demonstrate
a serious intent to create a success, (16) minimize any personal pleasure
or recreation derived from the activity. As for "don'ts", do
not: (1) commingle business and personal funds and records, (2) allow
losses to grow without making efforts to change operations or consult
experts, (3) disregard the results of a study or expert advice in making
major decisions, (4) make major decisions about the activity based on
personal enjoyment rather than business prospects, (5) incur continuing
losses of a magnitude out of proportion to the expected gains from the
activity, (6) appear indifferent to the lack of profits, (7) expect that
the activity will become profitable solely due to the anticipated
appreciation in the value of assets, (8) attempt to claim deductions from
an activity where the possibilty of profit is small in comparison to the
substantial possibilty of personal gratification. Remember, the burden of
proof is on the taxpayer to demonstrate that the activity generating the
losses was established with a profit motive--losses in excess of profits
in three out of five consecutive years provides a rebuttable presumption
of the existence of a "hobby" and, therefore, the disallowance
of the tax loss.
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· The August 15th
Deadline
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For all individual taxpayers who filed an Application for
Automatic Extension of Time to File your individual income tax returns on
or before April 15, 2004, please remember that you must provide an
acceptable reason if you plan to file for an Additional Extension of Time
to File (Form 2688) until October 15th. This extension is granted at the
discretion of the IRS and, if denied, you will likely have only 10 days
from the receipt of the denial to complete and file your tax return. The
most common reason for acceptance of the additional extension is that you
are waiting for missing information from 3rd party providers, e.g.
partnership or S corporation K-1's, brokers, etc.
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