Fiscal Year 2004 Statutory Audit of Compliance With Notifying Taxpayers of Their Rights When Requested to Extend the Assessment Statute

 

June 2004

 

Reference Number:  2004-40-108

 

 

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.

 

June 9, 2004

 

 

MEMORANDUM FOR DEPUTY COMMISSIONER FOR SERVICES AND ENFORCEMENT

 

FROM:     Gordon C. Milbourn III /s/ Gordon C. Milbourn III

                 Acting Deputy Inspector General for Audit

 

SUBJECT:     Final Audit Report - Fiscal Year 2004 Statutory Audit of Compliance With Notifying Taxpayers of Their Rights When Requested to Extend the Assessment Statute (Audit # 200340052)

 

This report presents the results of our review to determine whether the Internal Revenue Service (IRS) was complying with Internal Revenue Code (I.R.C.) Section (§) 6501(c)(4)(B) (2000), which requires the IRS to provide notice to taxpayers of their rights to decline to extend the assessment statute of limitations or to request that any extension be limited to a specific period of time or to specific 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 when 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, there was not always documentation in the case files that taxpayers were advised of their rights regarding assessment statute extensions.  Current consent forms do not provide an explanation of the taxpayers’ rights to limit or refuse to extend the assessment statute of limitations.  In our sample, 21 percent of the case files reviewed did not contain any documentation to support that taxpayers had been advised of their rights.  In instances in which taxpayers filed a joint tax return, 47 percent of the case files did not contain any documentation that each taxpayer listed on the tax returns was separately informed of his or her rights (i.e., dual notification).  In addition, when a taxpayer had made a declaration of representation, 40 percent of the case files did not contain any documentation that the IRS had provided both the taxpayers and their representatives with the advice of rights.

Although the IRS has revised its internal procedures over the last few years to help enhance controls, our reviews continue to identify instances in which there is no documentation that taxpayers were advised of their rights.  Therefore, we recommended the Deputy Commissioner for Services and Enforcement revise the various consent forms to include a statement that the taxpayers have been informed of their rights regarding assessment statute extensions and have been provided a copy of Extending the Tax Assessment Period (Publication 1035).

Management’s Response:  IRS management agreed in part with our recommendation.  Specifically, they agreed to revise the consent forms to include an additional statement indicating succinctly what rights taxpayers have when the IRS requests a consent to extend the assessment statute of limitations.  However, IRS management did not agree to include wording in the consent forms that a copy of the Publication 1035 has been provided to or received by the taxpayer.  While the IRS will continue to issue Publication 1035 when soliciting consent agreements, management believes it is not advisable to include this wording because the issuance of Publication 1035 goes considerably beyond the statutory requirement for notifying taxpayers of their rights.  Management’s complete response to the draft report is included as Appendix VI.

Office of Audit Comment:  We agree that the IRS would be going beyond the statutory requirement by ensuring the taxpayers had been provided a copy of Publication 1035.  However, the IRS designed Publication 1035 to notify taxpayers of their rights, and we believe that ensuring that taxpayers are provided a copy would be a benefit to taxpayers.  While we still believe this portion of our recommendation is worthwhile, we do not intend to elevate our disagreement concerning this matter to the Department of the Treasury for resolution 

Also, the IRS’ response pointed out that in the Fiscal Year (FY) 2003 report, the TIGTA concluded that the IRS processes used to notify taxpayer representatives of their rights conformed with statutory requirements, while in the FY 2004 report, the TIGTA concluded that the same processes did not achieve conformance.  However, this is not the case.  Both reports state that the IRS had established guidelines to help ensure that taxpayers and their representatives were provided information on the taxpayers’ rights, and that we found some employees were not following those guidelines.  Our FY 2004 report goes beyond our FY 2003 report in making a recommendation to help further ensure taxpayers and their representatives would be notified of their rights.  

Copies of this report are also being sent to the IRS managers affected by the report recommendation.  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

There Was Not Always Documentation That Taxpayers Were Advised of Their Rights Regarding Assessment Statute Extensions

There Was Not Always Documentation That Each Taxpayer Listed on a Jointly Filed Tax Return Was Advised of His or Her Rights Regarding Assessment Statute Extensions

There Was Not Always Documentation That Both the Taxpayers and Their Representatives Were Advised of the Taxpayers’ Rights Regarding Assessment Statute Extensions

Recommendation 1:

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 – Case Review Results by Division

Appendix VI – Management’s Response to the Draft Report

 

Background

The Internal Revenue Service (IRS) is required by Internal Revenue Code (I.R.C.) Section (§) 6501(c)(4)(B) (2000) to advise taxpayers of their rights when 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 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 to the taxpayer’s representative.  However, the taxpayer can use the Power of Attorney and Declaration of Representative Form (Form 2848) to restrict the notices or information the representative is authorized to receive.

If the IRS examines a tax return and determines there is an additional tax liability, it generally must be assessed within 3 years from the date the return was due or from the date on which 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 date 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 examination.  The consent can also be negotiated to apply only to certain examination issues.

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

·        The taxpayer may want to pursue additional examination 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 examination 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 in which a taxpayer may decide to limit or refuse to extend the assessment statute of limitations:

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

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

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 our fifth annual review of the IRS’ compliance with the statute extension provisions of the law.  In the prior reviews, we evaluated assessment statute extensions processed from January 1 to March 24, 2000; April 1 to September 30, 2000; October 1, 2000, to September 30, 2001; and September 30, 2001, to October 5, 2002, 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.  However, we also reported that improved documentation was needed to ensure taxpayers were informed of their rights.  In response, the IRS agreed to update guidelines; revise Extending the Tax Assessment Period (Publication 1035), which is used to notify taxpayers of their rights; and inform employees of the changes.

For the current audit, we reviewed assessment statute extensions processed from October 6, 2002, to September 27, 2003.  This review was performed at the Large and Mid-Size Business Division Headquarters, the Office of Appeals Headquarters, and the Tax Exempt and Government Entities Division Headquarters in Washington, D.C., and the Small Business/Self-Employed Division in New Carrollton, Maryland, during the period October 2003 through March 2004.  The audit was conducted in accordance with Government Auditing Standards.  Detailed information on our audit objective, scope, and methodology is presented in Appendix I.  Major contributors to the report are listed in Appendix II.

There Was Not Always Documentation That Taxpayers Were Advised of Their Rights Regarding Assessment Statute Extensions

Our review showed taxpayer rights were potentially affected in a total of 106 of 274 tax returns sampled.  Current consent forms do not provide an explanation of the taxpayers’ rights to limit or refuse to extend the assessment statute of limitations.  Therefore, 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 Request to Extend Statute (Letter 907 (L-907)), Letter Transmitting Consent Extending Period of Limitation (Letter 967 (L-967)), or comparable cover letter updated to include an explanation of taxpayer rights addressed to the taxpayer.

·        A record that Publication 1035 was provided to the taxpayer, as documented in the examination activity record or as shown as an enclosure on a cover letter.  This Publication provides a detailed explanation of taxpayer rights.

·        A notation in the examination activity record indicating the taxpayer was given the required notification of rights.

For 58 (21 percent) of 274 tax returns sampled, the case files did not contain any documentation to support that taxpayers had been advised of their rights.  As a result, we could not determine if the IRS protected the right of these taxpayers to be advised of their statute extension options.  This occurred because employees were not following IRS internal guidelines.  Internal procedures and the current Internal Revenue Manual (IRM) require IRS employees to provide the taxpayer with an L-907 or L-967, with Publication 1035 as an enclosure, and document on an activity record whether the taxpayer was notified of his or her rights.

In 111 of the 274 tax returns sampled, the IRS requested multiple extensions.  Although the IRS advised taxpayers of their rights for extension requests at some time during the examinations, there was no record in 20 (18 percent) of the 111 related case files documenting that the taxpayers were notified of their rights for the last extensions requested. 

I.R.C. § 6501(c)(4)(B) (2000) 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 are not notified of their rights, they might not be aware that they have the rights to refuse to extend the period of limitations or to request that any extension be limited to specific issues or to a specific period of time.

Although the IRS has revised its internal procedures over the last few years to help enhance controls, our reviews continue to identify instances in which there is no documentation that the taxpayers were advised of their rights.  To help ensure taxpayers are aware of their rights, we believe the IRS should use the various consent forms to confirm that taxpayers have been informed of their rights to limit or to refuse to extend the assessment statute of limitations.  We believe the various consent forms should be revised to include a statement that the taxpayer has been informed of his or her rights regarding assessment statute extensions and has been provided a copy of Publication 1035.  The specific rights would not need to be outlined on the consent forms. 

There Was Not Always Documentation That Each Taxpayer Listed on a Jointly Filed Tax Return Was Advised of His or Her Rights Regarding Assessment Statute Extensions

For 52 (47 percent) of the 110 jointly filed tax returns sampled, there was no documentation in the related case files that each taxpayer listed on the tax returns was separately informed of his or her rights (i.e., dual notification).  This occurred because employees were not following IRS internal guidelines.

RRA 98 § 3201 requires the IRS to send any notice relating to a jointly filed tax return separately to each individual filing the joint tax 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 are not notified of their rights to refuse to extend the period of limitations or to request that any extension be limited to specific issues or to a specific period of time.

The guidelines covering requests for taxpayers to extend the assessment statute require notices relating to joint tax returns be sent to each individual filing the joint tax return.  Specifically, the IRM requires IRS employees to provide each individual filing a joint tax return with an L-907 or L-967.

Although the IRS has revised its internal procedures over the last few years to help enhance compliance with dual notification, our reviews continue to identify instances in which there was no documentation in the case files that each taxpayer listed on the tax returns was separately informed of his or her rights.  We believe the IRS should revise the various consent forms to include a statement that the taxpayer has been informed of his or her rights regarding assessment statute extensions and has been provided a copy of Publication 1035. 

There Was Not Always Documentation That Both the Taxpayers and Their Representatives Were Advised of the Taxpayers’ Rights Regarding Assessment Statute Extensions

For 66 (40 percent) of the 167 tax returns sampled in which taxpayers made a declaration of representation, there was no documentation in the case files that the IRS had provided both the taxpayers and their representatives with the advice of rights.  Again, this occurred because employees were not following IRS internal guidelines.

Internal IRS procedures and current Federal Government 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, 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 Government regulations and notify both the taxpayer and the taxpayer’s representative of the rights to refuse to extend the period of limitations or to request that any extension be limited to specific issues or to a specific period of time.

Although the IRS has revised its internal procedures over the last few years to help ensure both the taxpayers and their representatives were provided information on the taxpayers’ rights, our reviews continue to identify instances in which there was no documentation in the case files that this had occurred.  If the consent forms were revised, the taxpayers that signed the consent forms would be informed of their rights.  In our sample of the individual tax returns, almost half the taxpayers had signed the consent form although they had made a declaration of representation.  In the remaining cases, the representative had signed the consent forms.

Recommendation

1.      The Deputy Commissioner for Services and Enforcement should revise the various consent forms to include a statement that the taxpayer has been informed of his or her rights regarding assessment statute extensions and has been provided a copy of Publication 1035.

Management’s Response:  IRS management agreed in part with our recommendation.  Specifically, they agreed to revise the consent forms to include an additional statement indicating succinctly what rights taxpayers have when the IRS requests a consent to extend the assessment statute of limitations.  However, IRS management did not agree to include wording in the consent forms that a copy of the Publication 1035 has been provided to or received by the taxpayer.  While the IRS will continue to issue Publication 1035 when soliciting consent agreements, management believes it is not advisable to include this wording because the issuance of Publication 1035 goes considerably beyond the statutory requirement for notifying taxpayers of their rights. 

Office of Audit Comment:  We agree that the IRS would be going beyond the statutory requirement by ensuring the taxpayers had been provided a copy of the Publication 1035.  However, the IRS designed Publication 1035 to notify taxpayers of their rights, and we believe ensuring that taxpayers are provided a copy would be a benefit to taxpayers. 

Also, the IRS’ response pointed out that in the Fiscal Year (FY) 2003 report, the TIGTA had concluded that the IRS processes used to notify taxpayer representatives of their rights conformed with statutory requirements, while in the FY 2004 report, the TIGTA concluded that the processes did not achieve conformance.  We believe that the FY 2003 and FY 2004 reports both state that the IRS had established guidelines to help ensure that both the taxpayers and their representatives were provided information on the taxpayers’ rights, and we found employees were not following those guidelines.  In our FY 2004 report, we have made a recommendation to help further ensure taxpayers and their representatives would be notified of their rights. 

 

Appendix I

 

Detailed Objective, Scope, and Methodology

 

The overall objective of this review was to determine whether the Internal Revenue Service (IRS) was complying with Internal Revenue Code Section (§) 6501(c)(4)(B) (2000), which requires the IRS to provide notice to taxpayers of their rights to decline to extend the assessment statute of limitations or to request that any extension be limited to a specific period of time or to specific issues.  To accomplish our objective, we:

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

A.     Reviewed the Examination function Internal Revenue Manual (IRM), IRS memoranda and regulations, and the Office of Appeals (Appeals) IRM and other Appeals guidelines to determine the policies and procedures for processing requests to extend the assessment statute of limitations.

B.     Reviewed a sample of Business Master File (BMF) and Individual Master File (IMF) tax returns with taxpayer consents to extend assessment statutes processed from October 6, 2002, to September 27, 2003.

1.      Obtained BMF and IMF extracts to identify a population of tax returns having extensions of the assessment statute of limitations.  The identified tax return populations were 5,977 and 7,557, respectively.  We selected those extensions processed during cycles 200241 through 200339, which included October 6, 2002, to September 27, 2003.  The IRS processes data in 1-week cycles.

2.      Selected for review a statistical sample of 620 tax returns from the category of cases likely to have statute extensions by taxpayer consent from the Examination function and Appeals processes.  We reviewed 620 tax returns and related case files, eliminating 346 tax returns that did not meet our criteria or because we did not receive all requested tax returns and related case files.  Therefore, only 274 reviewed tax returns and related case files met the audit criteria.  This was not sufficient for a statistical sample.  Within this judgmental sample of 274 tax returns, there were 110 jointly filed tax returns and 167 tax returns for which the taxpayers had made a declaration of representation.

3.      Identified which business unit or function requested the extension and discussed any questionable extensions identified with IRS management for concurrence or an explanation of why the IRS believed proper procedures were followed.

4.      Validated the IMF and BMF data for 10 fields on a judgmental sample of 101 of the 13,534 records identified in step I.B.1. above to determine the reliability of the data.

II.                 Reviewed the 274 selected tax returns and case files for documentation verifying that both taxpayers on jointly filed returns were separately advised of their rights related to statute extensions.

III.               Reviewed the 274 selected tax returns and case files for documentation verifying that taxpayers’ representatives were notified of the taxpayers’ rights related to statute extensions, when appropriate.

IV.              Determined the status of the IRS corrective actions proposed to address the recommendations presented in the prior Treasury Inspector General for Tax Administration audit reports.

Appendix II

 

Major Contributors to This Report

 

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

Mary V. Baker, Director

Bryce Kisler, Audit Manager

David Hartman, Senior Auditor

Kristi Larson, Senior Auditor

James Traynor, Senior Auditor

Jean Kao, Auditor

Sylvia Sloan-Copeland, Auditor

Arlene Feskanich, Information Technology Specialist

Judith Harrald, Information Technology Specialist

 

Appendix III

 

Report Distribution List

 

Commissioner  C

Office of the Commissioner – Attn:  Chief of Staff  C

Commissioner, Large and Mid-Size Business Division  SE:LM

Commissioner, Small Business/Self-Employed Division  SE:S

Commissioner, Tax Exempt and Government Entities Division  SE:T

Chief, Appeals  AP

Acting Deputy Commissioner, Small Business/Self-Employed Division  SE:S

Deputy Commissioner, Large and Mid-Size Business Division  SE:LM

Deputy Commissioner, Tax Exempt and Government Entities Division  SE:T

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

Director, Communications and Liaison, Small Business/Self-Employed Division  SE:S:MS:CL

Director, Exempt Organizations, Tax Exempt and Government Entities Division  SE:T:EO

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

Chief Counsel  CC

National Taxpayer Advocate  TA

Director, Office of Legislative Affairs  CL:LA

Director, Office of Program Evaluation and Risk Analysis  RAS:O

Office of Management Controls  OS:CFO:AR:M

Audit Liaisons: 

Commissioner, Large and Mid-Size Business Division  SE:LM:CL

Commissioner, Tax Exempt and Government Entities Division  SE:T:CL

Chief, Appeals  AP:P:S

Chief, Customer Liaison, Small Business/Self-Employed Division  SE:S:COM

 

Appendix IV

 

Outcome Measures

 

This appendix presents detailed information on the measurable impact that our recommended corrective action will have on tax administration.  These benefits will be incorporated into our Semiannual Report to the Congress.

Type and Value of Outcome Measure:

·        Taxpayer Rights and Entitlements – Potential; Internal Revenue Code Section (§) 6501(c)(4)(B) (2000); 78 of 274 taxpayer accounts affected (see page 3).

·        Taxpayer Rights and Entitlements – Potential; Internal Revenue Service (IRS) Restructuring and Reform Act of 1998 § 3201; 52 of 110 jointly filed accounts affected (see page 5).

·        Taxpayer Rights and Entitlements – Potential; 26 Code of Federal Regulations (C.F.R.) § 601.506; 66 of 167 tax accounts in which the taxpayers declared a representative (see page 6).

Methodology Used to Measure the Reported Benefit:

We reviewed a judgmental sample of 274 tax returns with consents to extend the assessment statute of limitations period.  The returns were identified from the Fiscal Year 2003 Business Master File (BMF) and Individual Master File (IMF) databases.  The review showed taxpayer rights were potentially affected in a total of 106 (39 percent) of 274 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 78 of the 274 taxpayer accounts to show the taxpayers were notified of their rights to refuse or to restrict the scope of the statute extensions.  There was no documentation in the related case files that each taxpayer listed on the tax returns was separately informed of his or her rights in 52 of 110 jointly filed accounts.  In addition, in 66 of 167 accounts in which taxpayers made declarations of representation, there was no documentation in the related case files that the IRS had provided both the taxpayers and their representatives with the advice of rights. 

 

Appendix V

 

Case Review Results by Division

 

 

Appendix VI

 

Management’s Response to the Draft Report

 

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