Scott Estill is a tax attorney and a former IRS senior trial attorney who now operates his own law practice in Denver, Colorado. He specializes in handling IRS controversies, including audits, criminal investigations, trials, and collections. Estill also addresses business meetings, conferences, and seminars on the subject of dealing with the IRS.
INTRODUCTION 1 1 MEET THE IRS 3 1. A Brief History of Income Tax 3 2. So What Is the IRS? 4 3. How to Play with the IRS 7 3.1 The rules 7 3.2 Your rights 8 3.3 Some useful publications 9 2 THE IRS RECORD-KEEPING SYSTEM: WHAT DOES THE IRS KNOW? 11 1. Understand the IRS Record-Keeping System 11 1.1 Let the IRS know where you are 12 1.2 Keep the IRS correctly informed 12 2. Know What the IRS Knows About You 12 3. Don't Be Afraid to Request Information 14 3.1 Freedom of Information Act requests 15 3.2 IRS transcript of account requests 18 3 THE FILING PROCESS: WHO, WHAT, WHERE, WHEN, AND WHY 22 1. Who Doesn't File a Tax Return? 22 1.1 Previous negative encounters with the IRS 22 1.2 No money to pay 23 1.3 Lack of records to prepare a return 23 1.4 Personal problems 23 1.5 Tax protests 25 1.6 Did not earn minimum gross income 25 2. Preparing the Return 25 2.1 Tax refunds 26 2.2 Deductions 26 2.3 Married filers ' joint or separate? 27 CONTENTS vii viii Tax This! 3. Timely Returns, Late Returns, and Amended Returns 28 3.1 Reasons to file tax returns on time 28 3.2 Extensions to file 28 3.3 Late-filed returns 29 3.4 Amended returns 30 3.5 Before filing a return 31 4 BUSINESSES AND THE IRS 33 1. Different Business Structures 34 1.1 Sole proprietorships 34 1.2 C corporations 35 1.3 S corporations 36 1.4 Partnerships 38 1.5 Limited liability companies 40 2. Employment Taxes 40 5 THE AUDIT PROCESS: WHAT ARE THE ODDS? 43 1. What Are the Odds of an IRS Audit? 43 2. How Can You Reduce the Odds of an Audit? 45 3. How Are Tax Returns Selected for Audit? 47 3.1 Statistical analysis 47 3.2 IRS matching programs 48 3.3 IRS special projects 49 3.4 Informant tips 49 3.5 Evidence of criminal activity 49 3.6 Random audits 49 3.7 Prior IRS audits 50 6 GOING THROUGH AN AUDIT 51 1. Understand Your Rights 51 2. Understand What the IRS Can Do During an Audit 52 2.1 The IRS can examine books and records 52 2.2 The IRS has access to other documents and information 53 2.3 What does the IRS know? 53 3. Types of Audits 54 3.1 Correspondence audit 54 3.2 Office audit 54 3.3 Field audit 55 3.4 Repetitive audit 55 3.5 Taxpayer Compliance Measurement Program (TCMP) National Research Program audits 55 Contents ix 4. Prepare for an Audit 56 4.1 Keep all your records 56 4.2 Know why your return was selected 57 5. The Audit Process 58 5.1 The audit appointment 58 5.2 Common audit questions 59 5.3 What happens after an audit? 61 5.4 What if the IRS is wrong? 61 5.5 What does an IRS audit cost? 64 7 GENERAL AUDIT RULES 67 1. General Rules of IRS Audits 67 1.1 Use all the time the IRS gives you 67 1.2 Capitalize on the IRS's inability to communicate effectively 68 1.3 Use the complex tax laws to your advantage 68 1.4 Don't fight the IRS alone 69 1.5 Don't volunteer information to the IRS 69 1.6 Ask questions 70 1.7 Never trust the IRS or anything that an IRS employee tells you 70 1.8 Remember that appearances are important 71 1.9 Don't let the IRS into your home 71 1.10 Never alter documents or lie to the IRS 71 1.11 Don't bribe or threaten IRS agents 72 1.12 Don't file any tax returns while an audit is pending 72 1.13 Stay focused 72 1.14 Be patient 73 2. Some Common Issues 73 2.1 What if I forgot to claim some deductions on my return? 73 2.2 What if I don't have any records? 73 2.3 How much time does the IRS have to audit my return? 74 2.4 Can the IRS audit me if I don't file a return? 76 2.5 Can the revenue agent settle a case? 77 2.6 What if I failed to appeal and the auditor was wrong? 78 8 HOW TO DEFEND YOURSELF IN AN AUDIT AND WIN 80 1. Standard of Living 81 2. The Search for Unreported Income 81 2.1 Direct (specific item) method 81 2.2 Indirect methods 82 x Tax This! 3. Exemptions and Deductions 85 3.1 Medical expenses 85 3.2 Casualty and theft losses 86 3.3 Rental income and expenses 87 3.4 Miscellaneous deductions 87 3.5 Safe deductions 87 3.6 Questionable deductions 88 4. Economic Reality Audits 88 5. Tax Shelters 92 6. Tax Protestors 93 7. IRS Dirty Dozena Tax Scams 94 9 TAX AUDITS OF BUSINESSES 96 1. Odds of an IRS Audit 96 1.1 How to reduce the odds of an IRS audit 96 1.2 How business tax returns are selected for audit 98 2. Specific Business Tax Audit Issues 100 2.1 The hunt for unreported business receipts 100 2.2 Questions concerning business expenses 101 2.3 Independent contractor versus employee 104 2.4 Schedule C businesses (sole proprietorships) 107 2.5 Hobby-loss businesses 107 2.6 Other audit issues for small businesses 108 3. What to Expect During a Business Tax Audit 108 3.1 What if I'm missing some records? 109 3.2 What does the IRS know about my business? 109 3.3 Where will the audit take place? 110 3.4 Common questions during business tax audits 110 10 IRS PENALTIES AND NOTICES: WHAT THEY REALLY MEAN 112 1. IRS Notices 112 1.1 Reasons IRS notices are wrong 113 1.2 Fighting an IRS notice 114 2. IRS Penalties 114 2.1 Inaccurate tax returns 114 2.2 Failure to file/Late filing 116 2.3 Fraud 117 2.4 Fraudulent failure to file tax returns 118 2.5 Late payment of tax 119 Contents xi 2.6 Estimated tax penalty 119 2.7 Trust fund recovery penalty 119 3. Penalty Abatement 127 3.1 Reasonable cause 127 3.2 Challenge penalties 135 11 THE IRS COLLECTION PROCESS: KEEP YOUR MONEY AND ASSETS 136 1. Assessments 136 2. The IRS Collection Division 137 2.1 The Automated Collection System 137 2.2 The revenue officer 138 2.3 Basic rules 139 3. Options When Dealing with the Collection Division 141 3.1 Payment in full 141 3.2 Installment Agreements 141 3.3 Payments to the IRS 144 4. Collection Forms 145 4.1 Forms 433-A and 433-B 145 4.2 Form 870 160 4.3 Form 900 160 4.4 Form 2261 161 4.5 Form 2751 164 5. Collection Powers 165 5.1 Summons 165 5.2 IRS levy and seizure powers and authority 167 5.3 The Federal Tax Lien 180 5.4 IRS accounts as currently not collectible 184 5.5 Private collection agencies 184 12 HOW TO PAY PENNIES ON THE DOLLAR: THE OFFER IN COMPROMISE PROGRAM 189 1. When Can You Make an Offer in Compromise? 190 1.1 Doubt as to collectibility 191 1.2 Doubt as to liability 192 1.3 Effective Tax Administration Offer 193 2. How Do You Make an Offer in Compromise? 193 2.1 How do you decide how much to offer? 198 2.2 Documents you need to submit an Offer in Compromise 200 2.3 Disadvantages of filing an Offer in Compromise 200 xii Tax This! 3. The IRS Investigation Process 202 3.1 What if the IRS accepts the offer? 203 3.2 Collateral agreements 204 3.3 What if the IRS rejects the offer? 204 13 BANKRUPTCY LAW AND TAXES: FORCE THE IRS TO SAY YES 206 1. Types of Bankruptcy 207 1.1 Chapter 7 bankruptcy 207 1.2 Chapter 13 bankruptcy 207 2. Discharge of Taxes in Bankruptcy 208 2.1 Taxes not dischargeable in bankruptcy 209 2.2 Effect of bankruptcy on a Federal Tax Lien 209 3. Advantages of Bankruptcy 209 3.1 Automatic stay 209 3.2 Redetermination of taxes due 210 3.3 Elimination of tax debts after discharge is received 210 3.4 Forcing the IRS to accept a payment plan 210 4. Disadvantages of Bankruptcy 210 4.1 Incurs expense 210 4.2 Results in a negative credit report 210 4.3 Increases IRS collection time 211 4.4 Incurs trustee fees 211 14 THE CRIMINAL INVESTIGATION DIVISION: BEWARE THE AGENTS WITH GUNS 212 1. How Many IRS Criminal Investigations Occur Each Year? 212 2. IRS Criminal Investigation Procedures 214 2.1 The referral process 214 2.2 Rules for criminal investigations 215 2.3 Types of IRS criminal investigations 216 3. Types of Criminal Tax Violations 216 3.1 Criminal tax evasion 216 3.2 Filing a false return 218 3.3 Criminal failure to file a tax return 218 3.4 Other tax-related crimes 219 4. Statute of Limitations 221 5. Taxpayer Rights During Criminal Investigations 221 Contents xiii 15 FIGHT THE IRS IN COURT 223 1. The US Tax Court 223 1.1 Burden of proof issues 225 1.2 Advantages to filing a tax court petition 227 1.3 Disadvantages of filing a tax court petition 228 1.4 Representing yourself in tax court 228 2. Types of Tax Court Cases 229 2.1 Regular cases 229 2.2 Sa cases 234 2.3 Legal costs 236 3. US District Court 236 3.1 Suits for refund 236 3.2 Suits for improper disclosure under IRC -º6103 237 3.3 Suits to stop seizure or sale of assets 238 3.4 Suits to stop IRS collection activities 238 3.5 Suit when IRS fails to release a Federal Tax Lien 238 3.6 Suit for improper browsing 241 3.7 Suit for improper collection actions 241 4. Waiver of Rights 241 5. Termination of Employment 242 16 THE TAXPAYER ADVOCATE: WHEN ALL ELSE FAILS 244 1. The Taxpayer Advocate Program 244 2. Taxpayer Bill of Rights 247 3. Taxpayer Assistance Order 248 4. Use Your Representative in Congress 251 17 CONCLUSION 253 15 Rules for Success in Dealing with the IRS 255 APPENDIX 1 ' IRS DISTRIBUTION AND SERVICE CENTERS 257 a. Distribution Centers 257 b. Service Centers 257 APPENDIX 2 'IRS DISTRICT OFFICES (TAXPAYER ADVOCATE) 258 xiv Tax This! CHECKLISTS 1 Checklist for filing a tax return 32 2 Are you an employee or an independent contractor? 106 FIGURES 1 Organizational structure of the IRS 6 2 Income tax audit procedures flowchart 65 SAMPLES 1 Form 8822 (Change of address) 13 2 Freedom of Information Act request letter 16 3 Freedom of Information Act appeal letter 17 4 Request for transcripts of account 19 5 Form 4506 (Request for copy of tax return) 21 6 Form 1127 (Application for extension of time for payment of tax due to undue hardship) 24 7 Form 4700 (IRS examination workpapers) 60 8 Form 870 (Waiver of restrictions on assessment) 62 9 Affidavit regarding business expenses 75 10 How the bank deposits method works 83 11 Form 8275 (Disclosure statement) 89 12 Form 4822 (Statement of annual estimated personal and family expenses) 91 13 How the bank deposits method works for business audits 102 14 Letter responding to an IRS notice 115 15 Form 4180 (Report of interview with individual relative to trust fund recovery penalty) 121 16 Form 4181 (Questionnaire relating to federal trust fund tax matters of employer) 126 17 Trust fund recovery penalty appeal letter 128 18 Form 843 (Claim for refund and request for abatement) 133 19 Form 433-A (Collection information statement for wage earners and self-employed individuals) 146 20 Form 433-B (Collection information statement for businesses) 152 21 Form 2261 (Collateral agreement for future income ' individual) 162 22 Form 2751 (Proposed assessment of trust fund recovery penalty) 164 23 Form 6639 (Financial records summons) 166 24 Form 2433 (Notice of seizure) 172 25 Form 12153 (Request for a collection due process hearing) 174 26 Form 9423 (Collection appeal request) 176 27 Letter requesting discharge of a Federal Tax Lien 182 28 Letter requesting subordination of a Federal Tax Lien 185 29 Form 656 (Offer in compromise) 194 Contents xv 30 Determining the amount of your OIC 201 31 Tax court petition 224 32 Designation of place of trial 226 33 Trial memorandum 231 34 Appeal of tax court decision 235 35 Form 2848 (Power of attorney) 239 36 Form 911 (Application for taxpayer assistance order) 249 TABLES 1 Where the IRS gets its money 8 2 Minimun gross income needed to file a tax return 26 3 Percentage of individual tax returns audited (by income level) 44 4 Tax returns audited by city 45 5 Average itemized deductions ' 2008 48 6 Percentage of businesses audited 97 7 Number of penalties abated, 19992009 134 8 Monthly expenses allowed by the IRS 159 9 IRS collection statistics 168 10 Number of offers in compromise 190 11 Present value factors 199 12 Number of IRS criminal investigations 213 13 Taxpayer assistance statistics 245
