Howard's IRS and the Law Blog

Can the IRS continue to audit me year after year?

by Howard Levy on December 22, 2008

in Audits, Tax Court

There are limits on the IRS continuing audits year after year.  These audits are known as “repetitive audits.” Their scope is limited by Internal Revenue Manual 4.10.2.8.5.

The Internal Revenue Manual states that if you are contacted by the IRS, and had a similar issue examined by them in either of the two prior years, and there was no change or a small change in the tax from the audit, the new examination will be discontinued.  If a substantive tax change resulted from the prior audit, the IRM provides that the repetitive audit procedures do not apply and the examination will go on.

The issue in a potential repetitive audit is whether the prior case had a small change (discontinue) or a substantive change (continue).

What if the IRS accepts 97% of taxpayer verifications in a one year audit, resulting in a $5,000 tax deficiency, but seeks to audit the next year’s return after completing the audit?  This is a real life case currently pending with one of my clients before the IRS, involving a successful real estate agent who was able to verify 97% of auto mileage, subcontractor labor and match income on the return to that on his bank statements.  But the IRS wanted to audit a second year.

Isn’t a 97% verification rate saying the taxpayer is abiding by the laws?  Or is a $5,000 deficiency substantial enough to continue on?  IRS Policy Statement 4-21 provides that auditors are to make efficient use of examination staffing and resources and promote the highest degree of voluntary compliance.  How does this situation fit within that directive?  Is further pursuit of a 97% verification rate promoting more voluntary compliance?

There are no limitations by law as to repeat audits.  The limitations are administrative and discretionary within the IRS from the Internal Revenue Manual.  That being said, if you are being audited and the IRS has found minimal changes, but wants to go into other years, be sure to assert your rights against repetitive audits.

Here are the final five situations to look for when the IRS cannot take collection action:

  • When the value of the property is protected by exemptions provided by Section 6334 of the Internal Revenue Code.  There is certain property that the IRS cannot take under any circumstance, including your furniture and household goods valued up to $7,900, necessary clothing, unemployment benefits and child support.  More on that here at “Can the IRS take my stuff?
  • When the liability is $5,000 or under, the IRS cannot seize your personal residence.
  • When business assets of an individual are at stake, only if a determination is made by the IRS that other assets are insufficient to pay the liability.  In addition, the proposed seizure must be approved by an IRS Area Director.  See Internal Revenue Code Section 6334(e).
  • When the IRS has requested your appearance by summons to ask you questions and determine your assets, no collection can occur on the day of your appearance.  See Internal Revenue Code 6331(g).
  • When you can show the IRS that the amount you owe is likely incorrect, IRS policy is to exercise restraint in collections until the issue is reasonably resolved.  See IRS Policy Statement 5-16.

With the situations listed in Part I and Part II, that makes 15 situations where you are protected from the IRS.  This is not meant to be an exclusive list – there are actually more, but these are some of the more common and practical situations.

Here are five more situations in which the IRS is barred from taking collection action against you:

  • When the timeframe to collect the liability has expired.  The IRS has 10 years to collect a liability from the date it puts the liability on its books. When the 10 years is up, the tax is cleared from the IRS’s books and can longer be collected.  More on that here at “When does the collection of IRS debt expire?”
  • When you are in bankruptcy.   Section 362 of the Bankruptcy Code creates what is known as an “automatic stay” that prevents creditors, including the IRS, from pursuing collection of a debt. Bankruptcy is also an extremely effective way of releasing IRS seizures and garnishments.   Properly done, it can also eliminate tax liabilities.  More on that here at “But I thought you can’t eliminate taxes in bankruptcy.”
  • When seizure of a personal residence is being considered, the IRS must first bring an action in U.S. District seeking court approval.  The IRS cannot do take your house on their own.  Incidentally, IRS seizures of personal residences are very rare (676 total of personal and real property across the country in 2007).  More on that here at “IRS by the numbers.”
  • When a Collection Due Process appeal is pending. After the IRS sends its Final Notice of Intent to Levy, you have the right to dispute and stop the collection action by filing a request for an appeals hearing. Provided the request is filed timely (within 30 days), while this hearing is pending, the IRS cannot take action to collect.

Stay tuned, there is more coming…Part III will be next.

The list of when the IRS cannot take property is fairly extensive, so I will do this in parts to break it down simply. Here is Part I of when the IRS is prohibited from taking collection action:

  • When there is insufficient equity in the property.  There must be sufficient net proceeds from the sale to provide funds to apply to the taxpayer’s unpaid tax liabilities.  This protects, for example, your car that is worth $5,000 but has a $5,000 loan against it – there is no equity for the IRS (the loan would be paid first if the IRS took it).  Same goes for houses, personal belongings, etc.
  • When an installment agreement is in effect.  If you are making payments, the IRS will leave you alone.
  • If your installment agreement is terminated or your request for an IA is denied, you have the right to appeal those decisions.  The IRS cannot take action during the 30 day time period after notice of termination or denial, and while an appeal filed within that 30 day period is pending.
  • When an offer in compromise is pending, and while an appeal of a rejected offer is being decided.
  • When a innocent spouse claim is pending.  I have had clients with IRS garnishments come into my office frustrated because they did not have involvement or knowledge of the liability and have a strong innocent spouse claim.  Upon submission of the innocent spouse claim, the IRS garnishment is immediately released.  There is no further collection action while the claim is being reviewed by the IRS.

I will post Part II next.

The IRS offer in compromise program has been promoted endlessly over the last several years. Turn on your television, open up the newspaper, or listen to the radio, and there it is.

My clients usually are very interested in the compromise program, but the first thing I do is set them straight that this is not a “freebie” program.

The numbers speak for themselves.  Compare:

-     In 2001, the IRS accepted 38,643 offers.

-     In 2007, the IRS accepted 11,618 offers.  

That is a 70% decline.  Pretty significant.

With over 2 million active balance due accounts in 2007, the IRS arguably should be as welcoming as the advertisements lead one to believe.

Think about it:  2 million balance due accounts, 11,618 offers accepted.

The reality is that this is anything but a “loose” program.  In certain situations it can be very helpful, but a hard analysis of income and expenses under the strict IRS financial guidelines is essential to success.

Since I often help clients close out IRS audits when their records are lacking, I thought it was time to answer this question:

I recieved a letter to meet an auditor from the IRS to audit my 2005 – 2007 taxes. My house was broken into several times, and I don’t have any of my paperwork to show deductions. My computer was also taken the first time, and I did fill out a police report. What will happen if I don’t go to the audit, or if I go without anything?

There are many issues raised here, all important.

1.     Poor records/lost records for the audit.  Of course, the best case for an IRS audit is to have perfect records.  Few people do.  And that, believe it or not, is okay.

There is a well-recognized U.S. Tax Court case that permits recreating expenses when direct records do not exist.  The case is Cohan v. Commissioner, 39 F. 2d 540 (2d Cir. 1930).  Cohan established a rule that permits estimates to be made of paid expenses when direct proof does not exist. To make the estimate, a foundation has to be laid that the expenses were actually incurred.  Here is a real life example:

Over-the-road truck driver hauls furniture for individuals moving cross country.   He subcontracts in each city with laborers to load and unload the personal belongings of his clients.  He cannot load and unload the furniture by himself.  But he pays in cash, no receipts.  Over $80,000 in expenses for this were being questioned by the IRS, a significant amount.

As a beginning premise, we knew he incurred the expense – couches and refrigerators do not move by themselves.  So, we recreated from his travel log and calendar each job he did.  He knew that if he moved 10,000 pounds of furniture, it would take two men a total of 8 hours to complete the job, and the going rate was $150/day.  He recreated a spreadsheet for each day, listing the city he was in, his recollection of the weight of the load, how many men he used and the time it took to complete the job.

This took some work, but an $80,000 deduction was on the line.

The IRS allowed everything he recreated.  We were able to establish that the amounts were actually paid, and a reliable method was used to prove it.

I have had similar cases, for example, for an owner of a landscaping company, who paid his subcontractors in cash and kept no receipts.  Those lawns were not mowed by themselves.  Jobs and customers were recreated, detailing how many workers were used per job.  This Cohan method of recreating expenses has been applied to have the IRS allow other expenses like charitable contributions, or business miles driven by a real estate agent (recreating a mileage logbook).  Cohan is an important rule that should be used to alleviate a harsh result in cases where perfect records do not exist to prove expenses that were clearly paid.

2.     Understand who you are dealing with.  IRS auditors sometimes take very narrow views of substantiation cases.  But if you cannot reach an agreement in audit, you have the right to have an appeals hearing or to take your case to U.S. Tax Court.  In appeals, there is a broader view of your case.  The question appeals officers ask themselves is “If this case went to court, what would happen?”  If you can testify to a reasonable basis to the expenses being incurred, appeals officers will likely allow a portion of the expenses. Appeals officers try to replicate what a Tax Court judge would do.  Auditors are often too distant from that reality, and usually do not allow enough leeway.   See my prior post “Tax Court – proving a level playing field in audits.”

3.     Do not ignore the audit.  If you do, the IRS will send you what is called a “Notice of Deficiency.”  This is your notice that the IRS has found a “deficiency” in your taxes, and calculates the tax, interest and penalties they are charging.  If you ignore this notice, the amount becomes final and the IRS will start collection activities.  Participate in the audit to the extent that you can determine if the auditor is open to application of the Cohan rule (they should be).  If the audit is not going your way, exercise your rights to have an appeals hearing, and if necessary to have your expenses reviewed by the Tax Court.  If you are entitled to it, you will be allowed expenses equal to the level of your credibility.

If you incurred the expenses, do not walk away from the audit.  There are methods to recreate the expenses and reach the correct result.

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