Improved Documentation Is Needed to Ensure Taxpayers Are Informed of Their Rights When Requested to Extend the Assessment Statute

September 2002

Reference Number: 2002-40-175

This report has cleared the Treasury Inspector General for Tax Administration disclosure review process and information determined to be restricted from public release has been redacted from this document.

September 24, 2002

MEMORANDUM FOR COMMISSIONER ROSSOTTI

FROM: Pamela J. Gardiner /s/ Pamela J. Gardiner

Acting Inspector General

SUBJECT: Final Audit Report - Improved Documentation Is Needed to Ensure Taxpayers Are Informed of Their Rights When Requested to Extend the Assessment Statute (Audit # 200240006)

This report presents the results of our review to determine whether the Internal Revenue Service (IRS) is complying with Internal Revenue Code (I.R.C.) Section (§) 6501(c)(4)(B) requiring the IRS to provide notice to taxpayers of their rights to refuse to extend the assessment statute of limitations or to request that any extension be limited to a specific period of time or to specific audit issues.

The Treasury Inspector General for Tax Administration (TIGTA) is required to provide information annually regarding the IRS’ compliance with I.R.C. § 6501(c)(4)(B). The IRS is required to advise taxpayers of their rights whenever requesting an extension of the statute of limitations on assessment of additional tax and penalties. In passing this law, the Congress expressed concern that taxpayers were not being adequately advised of their rights to refuse to extend the statute of limitations or to request that a statute extension be limited to a specific period of time or to specific issues.

In summary, employees properly advised taxpayers of their rights to refuse or restrict the scope of the statute extension in 32 of 48 (67 percent) of the tax returns sampled. However, in 16 of 48 (33 percent) of the tax returns sampled, we could not determine if employees advised taxpayers of their rights because related case files did not contain a record that taxpayers had been advised of their rights. In 22 of the 24 (92 percent) jointly filed returns sampled, there was no documentation in the related case files that each taxpayer listed on the return was separately informed of his or her rights (i.e., dual notification). Additionally, in 24 of the 33 tax returns sampled (73 percent) where taxpayers made a declaration of representation, there was no documentation in the related case files that the IRS had provided both the taxpayers and the representatives with the advice of rights.

Management’s Response: IRS management responded favorably and agreed with the information included in our report. Specifically, they stated that they are pleased our review found that they are addressing the issues relating to I.R.C. § 6501(c)(4)(B).

Management’s complete response to the draft report is included as Appendix V.

Copies of this report are also being sent to the IRS managers who are affected by the report. Please contact me at (202) 622-6510 if you have questions or Michael R. Phillips, Assistant Inspector General for Audit (Wage and Investment Income Programs), at (202) 927-0597.

Table of Contents

Background

Compliance With Dual Notification Requirements Needs Improvement

Compliance With Procedural Regulations Needs Improvement

Appendix I – Detailed Objective, Scope, and Methodology

Appendix II – Major Contributors to This Report

Appendix III – Report Distribution List

Appendix IV – Outcome Measures

Appendix V – Management’s Response to the Draft Report

Background

The Internal Revenue Service (IRS) is required by Internal Revenue Code (I.R.C.) Section (§) 6501 to advise taxpayers of their rights whenever requesting an extension of the statute of limitations on assessment of additional tax and penalties. In passing this law, the Congress expressed concern that taxpayers were not being adequately advised of their rights to refuse to extend the statute of limitations or to request that a statute extension be limited to a specific period of time or to specific issues.

If the IRS audits a tax return and determines there is an additional tax liability, it generally must be assessed within 3 years from the date that a return was due or the date that the return was actually filed, whichever is later. This 3-year assessment statute of limitations normally cannot be extended without the taxpayer’s written agreement. To extend the assessment statute, the IRS asks the taxpayer to sign a statute extension agreement form (consent).

A consent extends the assessment statute of limitations to either a specific period of time or for an unlimited, indefinite period. The statute is usually extended for a period that both the IRS and the taxpayer agree is reasonable to complete the audit. The consent can also be negotiated to apply only to certain audit issues.

A taxpayer might agree to extend the assessment statute of limitations for the following reasons:

· The taxpayer may want to pursue additional audit issues that are in the taxpayer’s favor in offsetting a proposed tax or that might allow for a tax refund.

· If the remaining time before the statute expires is too short, the IRS may have to prematurely stop the audit process and issue a notice of deficiency that limits the time for the normal appeals process before the taxpayer must file a petition to the United States Tax Court.

There are also certain circumstances when a taxpayer may decide to limit or refuse to extend the assessment statute of limitations.

· The taxpayer may not want to provide the IRS additional time to consider additional audit issues.

· The taxpayer may not want to allow the IRS the opportunity to further develop audit issues already under consideration after the normal statute period has expired.

In addition, the IRS Restructuring and Reform Act of 1998 (RRA 98) § 3201 requires the IRS to send any notice relating to a jointly filed return separately to each individual filing the joint return. Federal regulations require that any notice or other written communication (or copy) required or permitted to be given to a taxpayer in any matter before the IRS must also be given to the taxpayer and, unless restricted by the taxpayer, to the taxpayer’s representative.

The Treasury Inspector General for Tax Administration (TIGTA) is required to provide information annually regarding the IRS’ compliance with I.R.C. § 6501(c)(4)(B). This report presents the results of the TIGTA’s third annual review of the IRS’ compliance with the statute extension provisions of the law. In the prior two reviews, the TIGTA evaluated the IRS’ assessment statute extensions processed from January 1 to March 24, 2000, and April 1 to September 30, 2000, respectively. We reported that in the majority of the related case files reviewed, IRS employees advised taxpayers of their rights to refuse or restrict the scope of the statute extension (95 and 94 percent, respectively).

For this year’s audit, we reviewed assessment statute extensions recorded on taxpayer accounts from October 1, 2000, to September 30, 2001. The results of this review should not be compared with those of the prior reviews since the sampling methodology used this year is not consistent with those used in the prior years. This review was performed in the Small Business/Self-Employed Division Headquarters and the Office of Appeals Headquarters.

We performed the audit between March and July 2002 in accordance with Government Auditing Standards. Detailed information on the audit objective, scope, and methodology is presented in Appendix I. Major contributors to the report are listed in Appendix II.

Most Related Case Files Documented That Taxpayers or Their Representatives Were Advised of Their Rights Regarding Assessment Statute Extensions

In 32 of the 48 tax returns sampled (67 percent), IRS employees advised taxpayers or their representatives of their rights to refuse or restrict the scope of the statute extension. We considered that IRS employees advised taxpayers of their rights if any of the following documentation was found in the related case files:

· A copy of Letter 907 (L-907) or Letter 967 (L-967), “Request to Extend Statute of Limitation Period” or comparable cover letter, updated to include an explanation of taxpayer rights.

· A record that Extending the Tax Assessment Period (Publication 1035) was provided to the taxpayer and/or representative, as documented in the audit contact record or as shown as an enclosure on a cover letter.

· The audit contact record showed the taxpayer and/or representative was given the required notification of his or her rights.

For the remaining 16 tax returns sampled (33 percent), the related case files did not contain a record that taxpayers had been advised of their rights. For these 16 tax returns, 12 extensions were requested in Examination and 4 were requested in Appeals. As a result, for these taxpayers, we could not determine if the IRS protected the taxpayers’ rights to be advised of their statute extension options. This occurred because employees were not following IRS internal guidelines.

However, for 4 of the 16 tax returns, the IRS requested multiple extensions. Although the IRS advised taxpayers of their rights for extension requests at some time during the audit, there was no record in the related case files to verify the taxpayers were notified of their rights for the last extension requests. Though the IRS did not comply with I.R.C. § 6501 for each and every extension, we believe the legislative purpose of the section was fulfilled, i.e., the taxpayers had an understanding of their rights.

I.R.C. § 6501 provides that the IRS must notify the taxpayer of his or her rights on each occasion when the taxpayer is requested to consent to an extension. It would be a potential violation of taxpayers’ rights if the IRS did not notify taxpayers of their options when requesting assessment statute extensions. If taxpayers were not notified of their rights, taxpayers might not be aware of their rights to refuse to extend the period of limitations or to limit such extensions to particular items or particular periods of time. This could result in a violation of taxpayer rights.

Employees were not always following IRS internal guidelines

Although 31 of 48 tax returns sampled (65 percent) had some form of documentation of rights in the related case files, not all related case files had complete documentation.

In the Examination-related case files reviewed, 27 of 35 (77 percent) had incomplete documentation. The Examination function manual covering the examination of tax returns requires that when IRS employees request that a taxpayer extend the assessment statute, they provide the taxpayer with an L-907 (maintaining a copy of the letter in the related case files) and a Publication 1035 as an enclosure. They also must document on a contact record whether the taxpayer was notified of his or her rights.

In the Appeals-related case files reviewed, 4 of 13 (31 percent) had no documentation. In August 2000, Appeals National Headquarters issued an alert providing procedures to ensure documentation is maintained in the related case file to verify rights are provided. However, at the time Appeals requested the extensions, Fiscal Year (FY) 2001, the Appeals manual did not provide procedures requiring documentation of the advice of rights.

The dates to complete corrective actions were postponed

In the FY 2000 review of assessment statute extensions, we recommended the IRS include a requirement that Examination group managers, before approving the statute extension forms, review the related case files for documentation that rights were explained to taxpayers. This corrective action was postponed, and the IRS is in the process of seeking concurrence from the TIGTA to withdraw this FY 2000 action item. Instead, the IRS implemented a corrective action recommended in the TIGTA’s FY 2001 report.

In the FY 2001 report, we recommended that the IRS require that assessment statute extension cover letters (L‑907 and L‑967) confirming advice of rights be attached to statute extension forms when the extension is approved or executed. The cover letter would then be filed together with the extension form directly behind the return to make it easy to locate in the related case file.

Although Small Business/Self Employed Division management issued a memorandum dated February 28, 2002, requiring the attachment of the cover letter to the extension, the action item to incorporate the procedural change into its manual was postponed from January 1 to July 1, 2002. The IRS advised us that the completion of the corrective actions was delayed due to resource limitations. Appeals revised its manual and incorporated the new guidelines on November 30, 2001.

IRS management anticipates that no further documentation will be required. Management believes attaching a copy of the cover letter to the taxpayer consent form will provide documentation to the extent that a determination can be made that the taxpayers were advised of their rights. We agree with this approach and are making no recommendations at this time.

Compliance With Dual Notification Requirements Needs Improvement

In 22 of the 24 (92 percent) jointly filed returns sampled, there was no documentation in the related case files that each taxpayer listed on the return was separately informed of his or her rights (i.e., dual notification). This occurred because employees were not following IRS internal guidelines. However, for all 24 jointly filed returns, at the time of the extension requests, both spouses filing the joint returns resided at the same addresses. For these 22 jointly filed returns, 15 extensions were requested in Examination and 7 were requested in Appeals.

RRA 98 § 3201 requires the IRS to send any notice relating to a jointly filed return separately to each individual filing the joint return. The Congress intended that separate notices would increase the likelihood that separated or divorced spouses receive such notices, as well as increase the likelihood that the IRS will be made aware of address changes that apply to one, but not both, spouses. There could be a violation of taxpayer rights if both taxpayers were not notified of their rights to refuse to extend the period of limitations or to limit such extensions to particular items or particular periods of time.

The Examination manual states that any notice relating to a jointly filed return should be separately mailed to each individual filing the joint return. In addition, Examination management informed us that they would include an article in the IRS Technical Newsletter advising employees of the importance of dual notification requirements.

The Appeals manual does not address dual notification. However, IRS officials issued memoranda on October 28, 1998, and May 13, 1999, that required dual notification for all jointly filed returns. Appeals management informed us that they would revise their manual to include dual notification requirements. We do not believe the risk warrants additional procedures or reviews and are making no recommendations at this time.

Compliance With Procedural Regulations Needs Improvement

In 24 of the 33 tax returns sampled (73 percent) where taxpayers made a declaration of representation, there was no documentation in the related case files that the IRS had provided both the taxpayers and the representatives with the advice of rights. This occurred because employees were not following IRS internal guidelines. For these 24 tax returns, 16 extensions were requested in Examination and 8 were requested in Appeals.

Current manual guidelines and Federal regulations require that any notice or other written communication (or copy) required or permitted to be given to a taxpayer in any matter before the IRS must also be given to the taxpayer and, unless restricted by the taxpayer, to the taxpayer’s representative.

Taxpayer rights or taxpayer burden could be affected if the IRS does not follow the Federal regulations and provide both the taxpayer and the taxpayer’s representative with the rights to refuse to extend the period of limitations or to limit such extensions to particular items or particular periods of time.

However, we consider current guidelines appropriate and adequate at this time. Considering the minimal risk, we are making no recommendations at this time.

Appendix I

Detailed Objective, Scope, and Methodology

The overall objective of this review was to determine whether the Internal Revenue Service (IRS) is complying with Internal Revenue Code (I.R.C.) Section (§) 6501 requiring the IRS to provide notice to taxpayers of their rights to refuse to extend the assessment statute of limitations or to request that an extension be limited to a specific period of time or to specific audit issues. To accomplish the objective, we did the following:

I. Determined whether taxpayers were being advised of their rights related to requests to extend the assessment statute of limitations.

A. Reviewed the Internal Revenue Manual, IRS memoranda, and IRS Chief Counsel opinions and determined policies and procedures for processing requests to extend the assessment statute of limitations.

B. Obtained the Fiscal Year (FY) 2001 (October 1, 2000, to September 30, 2001) Individual Master File and Business Master File databases to identify and review tax returns with adjustments to the assessment statute of limitations within the audit period from October 1, 2000, to September 30, 2001.

1. Analyzed the databases to identify assessment statute adjustments that could have resulted from extensions by the written consent of taxpayers (assessment statutes are often extended for reasons other than the taxpayer’s written consent). For example, all tax returns having a statutory notice of deficiency (90-day letter) have the assessment statute extended for 150 days by law.

2. Judgmentally selected 48 tax returns to review. We had planned to do a statistical sample of tax returns closed from the Examination and Appeals process. After ordering the tax returns and related case files identified for a statistical sample size, we were unable to receive the documents in sufficient time to do a statistical review. Therefore, we reviewed all tax returns and related case files we had received by June 3, 2002.

C. Reviewed the 48 tax returns and related case files to determine if the taxpayers were advised of their rights and if the related case file documentation complied with IRS internal guidelines. In addition, we determined compliance with the IRS Restructuring and Reform Act of 1998 § 3201 for the 24 jointly filed returns and compliance with Federal regulations for the 33 tax returns where the taxpayer made a declaration of representation.

II. Determined if the IRS completed corrective actions in response to the recommendations presented in the Treasury Inspector General for Tax Administration FY 2000 and 2001 reports.

III. Followed up with IRS officials to discuss those tax returns and related case files where we determined the IRS did not comply with the law, regulations, or internal guidelines.

Appendix II

Major Contributors to This Report

Michael R. Phillips, Assistant Inspector General for Audit (Wage and Investment Income Programs)

Augusta R. Cook, Director

Kerry Kilpatrick, Director

Anthony Anneski, Acting Audit Manager

Paula W. Johnson, Audit Manager

Lynn Faulkner, Senior Auditor

Areta Heard, Senior Auditor

Vacenessia Daniels Brown, Auditor

Jack Forbus, Auditor

Patricia Jackson, Auditor

Sylvia Sloan-Copeland, Auditor

James Adkisson, Computer Specialist

Appendix III

Report Distribution List

Commissioner, Large and Mid-Size Business Division LM

Commissioner, Small Business/Self-Employed Division S

Commissioner, Tax Exempt and Government Entities Division T

Commissioner, Wage and Investment Division W

Chief, Appeals AP

Director, General Appeals Program AP:G

Director, Compliance, Small Business/Self-Employed Division S:C

Director, Exempt Organizations T:EO

Director, Field Assistance, Wage and Investment Division W:CAR:FA

Director, Field Specialists, Large and Mid-Size Business Division LM:FS

Director, Reporting Compliance, Small Business/Self-Employed Division S:C:CS

Chief Counsel CC

National Taxpayer Advocate TA

Director, Legislative Affairs CL:LA

Director, Office of Program Evaluation and Risk Analysis N:ADC:R:O

Office of Management Controls N:CFO:F:M

Audit Liaison: Director, Compliance, Small Business/Self-Employed Division S:C

Chief, Appeals AP:P:S

Appendix IV

Outcome Measures

This appendix presents detailed information on the measurable impact that the review results will have on tax administration. While no recommendations were made in this report, the Treasury Inspector General for Tax Administration (TIGTA) has made prior recommendations that would have affected its Fiscal Year (FY) 2001 review results. However, the Internal Revenue Service (IRS) did not implement the corrective action for the prior year recommendations until after the current year’s audit period. These benefits will be incorporated into our Semiannual Report to the Congress.

Type and Value of Outcome Measure:

In 37 of 48 tax returns sampled, the IRS did not comply with:

· Taxpayer Rights and Entitlements – Potential; I.R.C. § 6501(c)(4)(B) (Supp. IV 1998) in 16 of 48 taxpayer accounts affected (see page 3).

· Taxpayer Rights and Entitlements – Potential; IRS Restructuring and Reform Act of 1998 (RRA 98) § 3201 in 22 of 24 jointly filed accounts affected (see page 6).

· Taxpayer Rights and Entitlements – Potential; 26 C.F.R. § 601.506 (2001) in 24 of 33 tax accounts where the taxpayers declared a representative (see page 7).

Methodology Used to Measure the Reported Benefit:

We selected a judgmental sample of 48 tax returns with consents to extend the assessment statute of limitations period. The returns were identified from the FY 2001 Individual Master File and Business Master File databases. The review showed taxpayer rights were potentially affected in 37 of 48 tax returns sampled. Each sampled tax return and related case file could have multiple findings for each criterion. Related case files were not documented in 16 of 48 taxpayer accounts to show the taxpayers or their representatives received their rights to refuse or restrict the scope of the statute extensions. There was no documentation in the related case files that each taxpayer listed on the return (44 taxpayers) was separately informed of his or her rights in 22 of 24 jointly filed accounts. In addition, in 24 of the 33 tax accounts where taxpayers made declarations of representation, there was no documentation in the related case files that the IRS had provided both the taxpayers and the representatives with the advice of rights.

Appendix V

Management’s Response to the Draft Report

The response was removed due to its size. To see the complete response, please go to the Adobe PDF version of the report on the TIGTA Public Web Page.