Executive Summary

Objective and Scope

Background

Results

Conclusion

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

Executive Summary

If the Internal Revenue Service (IRS) audits a tax return and determines there is an additional tax liability, it generally must be assessed within 3 years of 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. The IRS Restructuring and Reform Act of 1998 (RRA 98) § 3461 requires the IRS 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 only specific issues. This provision became effective on January 1, 2000.

The Congress also required the Treasury Inspector General for Tax Administration to annually evaluate the IRS’ compliance with this statute provision. The overall objective of this audit was to determine whether the IRS provided taxpayers an explanation 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 audit issues. Because the effective date of this law was not until January 1, 2000, we focused our review on the IRS’ readiness to implement the new RRA 98 requirements.

In most of the cases we reviewed with assessment statute extensions, examiners properly advised taxpayers of their right to refuse or restrict the scope of the statute extension. However, in some cases (five percent of our sample) examiners did not indicate in case files whether taxpayers were advised of these rights. As a result, in these cases, we could not determine if the IRS protected the taxpayer’s right to be advised of these statute extension options.

During our review, the IRS distributed guidance to its employees so they would be aware of the new requirements of the law. This guidance should help to ensure that the IRS complies with the law in the future. However, additional information should be provided to taxpayers to adequately explain the potential for additional issues to be audited and the process to limit extensions to specific issues.

To determine whether the IRS advised taxpayers of their rights when requesting extensions of the assessment statute of limitations, we reviewed a judgmental sample of 203 open examination files that contained a request made after January 1, 2000, to extend the assessment statute of limitations. In most of the cases we reviewed (193 of 203), examiners properly advised taxpayers of their right to refuse or restrict the scope of the statute extension. In 10 cases (5 percent), the examination files did not contain any record that the taxpayers had been advised of their rights to refuse or to restrict the request for an assessment statute extension. An IRS internal survey conducted from March to June 2000 identified that 35 case files did not indicate whether taxpayers had been advised of their rights. 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, extensions granted by taxpayers in these instances may not be valid.

Because revised guidance about the RRA 98 requirements was not distributed timely, some examiners in the district offices were not aware until well after the effective date that new guidance and documentation requirements had been implemented. This guidance included the use of a revised cover letter for examination statute extension requests and a revised publication Extending the Tax Assessment Period (Publication 1035) to advise taxpayers of their rights.

However, the new guidelines do not require Examination group managers to review the case file documentation to ensure examiners had properly advised taxpayers of their rights before approving the statute extension agreement. Because the extension agreement may not be valid if taxpayers have not been notified of their rights, this should be a condition of approval to ensure this requirement is met and there is proper documentation of the notification to the taxpayer.

Publication 1035 is the primary source used by the IRS to inform taxpayers about their rights and the procedures for extending the assessment statute of limitations. The IRS made revisions to this Publication in December 1999 to provide additional information on taxpayers’ rights regarding limiting the length or scope of a statute extension. However, the new Publication does not contain certain information that would assist taxpayers in determining whether to request a restricted extension and also what action to take to ensure the restriction is legally binding.

The new Publication does not adequately explain that if a taxpayer consents to an extension that is not restricted to specific issues, the IRS could use the additional time to examine other items on the return which were not previously considered. The Publication also does not completely explain the process for restricting the statute extension to specific issues. It does not explain that the restrictive language must be included on the consent form to ensure that it is legally valid and that the language and terms of the restriction must be approved by IRS Counsel. Both National Headquarters and field Examination managers stated that this information would be helpful to taxpayers in understanding the requirements for inclusion of restrictive language on the consent form.

We recommend that the Assistant Commissioner (Examination) revise existing guidelines to require group managers to review case documentation to ensure that taxpayers have been notified of their rights before approving statute extension agreements. Publication 1035 should also be revised to more fully explain the terms of restricted and unrestricted assessment statute extension agreements and the process to limit the scope of these agreements. All prior versions of Publication 1035 should be replaced once the revisions are completed.

Management’s Response: IRS management agreed with the issues and recommendations in this report. Guidelines will be revised to require group managers to verify that documentation is present indicating that taxpayers have been advised of their rights before approving statute extension agreements. Management will also revise Publication 1035 to advise taxpayers of the additional information included in our recommendation and will notify all appropriate Operating Divisions to exclusively use the revised Publication 1035.

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

Objective and Scope

The Internal Revenue Service (IRS) Restructuring and Reform Act of 1998 (RRA 98) § 3461 requires the IRS 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 only specific issues. This provision became effective on January 1, 2000.

The RRA 98 also requires the Treasury Inspector General for Tax Administration (TIGTA) to provide information annually regarding the IRS’ compliance with this provision to provide taxpayers an explanation of their rights to decline or limit extensions to the assessment statute of limitations. The overall objective of this audit was to determine whether the IRS provides taxpayers an explanation 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 audit issues. Because the effective date of this law was not until January 1, 2000, we focused our review on the IRS’ readiness to implement the new RRA 98 requirements. This is the TIGTA’s first review of this area.

The IRS does not have a system to track statute extension requests or whether they were accepted, declined, or restricted by the taxpayer. In addition, the IRS cannot identify the total number of statute extensions based upon taxpayer consents to extend statutes for any given period. We identified open audits, for which it was likely that the taxpayer had signed a consent to extend the statute of limitations, by analyzing the computer records of all assessment statutes that had been adjusted between January 1 and March 24, 2000. Assessment statutes could be adjusted on taxpayer accounts for several reasons, such as:

• Corrections to the original statute date.
• Statutory provisions extending the statute of limitations, including:
• issuance of a legal notice of tax deficiency giving the taxpayer 90 days within which to appeal to the United States Tax Court.
• fraud and substantial underreporting of income.
• Taxpayers consenting to extend the statute.

If a consent for extension is requested, the IRS generally asks taxpayers to extend the statute to the end of the calendar year or to the end of a filing season month and often extends the statute for at least 6 months at a time.

We selected tax cases to review, which involved the third reason, statutes extended by the consent of taxpayers. We reviewed examination files for tax cases in the Los Angeles, Manhattan, Midwest, Southern California, and Southern Florida District Offices during April and May 2000. The District Offices were selected based on those having the highest numbers of extensions to the statute of limitations.

This audit was performed in accordance with Government Auditing Standards. Details of our audit objective, scope, and methodology are presented in Appendix I. Major contributors to this report are listed in Appendix II.

Background

If the IRS audits a tax return and determines there is an additional tax liability, it generally must be assessed within 3 years of 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. When more time is needed to complete an audit, the IRS may ask the taxpayer to sign a statute extension agreement form (consent). The consent can be negotiated between the IRS and the taxpayer to extend the assessment statute of limitation to a specific period of time or the statute can be extended for an unlimited, indefinite period. The statute is usually extended for a period that both parties agree is reasonable to complete the audit. The consent can also be negotiated to apply only to certain audit issues.

A taxpayer might want to 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 proposed tax or that might allow for a tax refund.
• If the remaining statute for assessment is too short, the IRS may have to prematurely stop the audit process and issue a notice of deficiency in order to protect the government’s interest in assessing a proposed tax. This notice of deficiency limits the time for the normal appeals processes before the taxpayer must file a petition to the United States Tax Court.

There are also certain instances in which a taxpayer may want 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.

RRA 98 § 3461 requires the IRS to advise taxpayers 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.

Results

In most of the cases we reviewed with assessment statute extensions, examiners properly advised taxpayers of their right to refuse or restrict the scope of the statute extension. However, in some cases (five percent of our sample) examiners did not indicate in case files whether taxpayers were advised of their rights to refuse to extend or to limit extensions of the assessment statute of limitations to a specific period of time or to only specific issues. As a result, we could not determine if the IRS always protected the taxpayer’s right to be advised of these statute extension options.

During our review, the IRS distributed guidance to its employees to make them aware of new procedures to comply with the new requirements of the law. This guidance should help to ensure that the IRS complies with the law in the future. However, additional information should be provided to taxpayers to adequately explain the potential for additional issues to be audited and the process to limit extensions to specific issues.

We were unable to determine whether taxpayers requested restrictions in the scope of statute extensions because the IRS case files we reviewed did not contain any documentation indicating that taxpayers made such a request, except for one case in which the restriction was allowed. Therefore, we could not evaluate whether requests for these types of restrictions were properly accepted or denied.

Some Examination Case Files Did Not Indicate Whether Taxpayers Had Been Advised of Their Rights

From a computer extract of taxpayer accounts, we identified approximately 4,000 individual tax returns and approximately 7,000 business tax returns reflecting adjustments of the statute of limitation in the first quarter of calendar year 2000 that were likely to have resulted from taxpayer consents to extend the statute period. We reviewed the case files for a judgmental sample of 333 of these accounts in 5 IRS district offices during April and May 2000. Of the 333 case files we reviewed, 98 percent were statute extensions resulting from taxpayer consents and 203 had associated consent forms that were solicited after January 1, 2000, the effective date of the RRA 98 statute provisions.

We reviewed the case files to determine whether there was any indication that taxpayers had been advised of their statute extension rights. Taxpayers were considered to have been advised of their rights if any of the following records were found in the audit file.

• A copy of the cover letter (updated to include an explanation of taxpayer rights) used to request the extension.
• A record that Extending the Tax Assessment Period (Publication 1035) was provided to the taxpayer as indicated by the audit contact record or as shown as an enclosure on a cover letter.
• The audit contact record stated that the taxpayer was given a verbal explanation of his/her rights.

In most cases we reviewed (193 of 203), examiners properly advised taxpayers of their right to refuse or restrict the scope of the statute extension. In 10 of 203 cases (5 percent), we found that the examination case files did not contain any record that the taxpayers had been advised of their rights to refuse or to restrict the request for a statute extension. As a result, for these cases, we could not determine if the IRS protected the taxpayer’s right to be advised of these statute extension options. 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, extensions granted by taxpayers in these instances may not be valid.

The Internal Revenue Manual (IRM), as revised January 1, 2000, requires that IRS employees record in the audit case file whether taxpayers have been advised of their rights. On December 21, 1999, the Assistant Commissioner (Examination) issued a memorandum advising employees that new procedures would be in effect for statute extensions secured after December 31, 1999. This memorandum also advised that the cover letter used for examination statute extension requests and the Publication 1035 had been revised to conform to the RRA 98 requirements.

However, in the district offices we visited, the Examination Division personnel did not know of the new IRM requirements and new publications until well after the effective date of the statute extension provisions of the RRA 98. The memorandum was not distributed in a timely manner to all Examination managers and employees.

To determine whether RRA 98 procedures were being followed, the Assistant Commissioner (Examination) issued a memorandum on March 27, 2000, requesting all district offices to review open examination files having statute extension requests made after January 1, 2000. The district offices were to respond with the number of case files that did not have a record of the taxpayers being advised of their rights as required by the RRA 98.

The results of their survey were compiled in June 2000 and indicated that there were a total of 35 tax cases nationally in which the examiners did not document in the case files whether taxpayers had been advised of their rights. However, we identified additional cases that were not reported in this survey. For example, we identified that seven individual income tax returns in our sample from five districts did not have documentation that taxpayers were advised of their rights. The IRS survey did not report any cases of inadequate documentation for individual taxpayers.

The new IRM requirements do not require Examination group managers to review the case file documentation to ensure examiners properly advised taxpayers of their rights before approving the statute extension agreement. Because the extension agreement may not be valid if taxpayers have not been notified of their rights, this should be a condition of approval to ensure this requirement is met and there is proper documentation of the notification to the taxpayer.

1. The Assistant Commissioner (Examination) should revise the IRM to require Examination group managers to review the case file documentation to ensure examiners properly advised taxpayers of their rights before approving statute extension agreements.

Management’s Response: IRS management will revise guidelines to require group managers to verify that documentation is present indicating that taxpayers have been advised of their rights before approving statute extension agreements.

Extending the Tax Assessment Period (Publication 1035) Can Be Improved to More Adequately Explain the Purpose and Process for Limiting the Assessment Statute

Publication 1035 is the primary written source for taxpayers to obtain detailed information about their rights and procedures for extending the assessment statute of limitations. The IRM, as revised January 1, 2000, requires that this Publication be given to all taxpayers from whom the IRS is requesting an extension of the assessment statute of limitations. The Publication was updated effective December 1999 to explain revised (less restrictive) conditions under which the IRS is likely to grant a taxpayer’s request to restrict a statute extension to specific issues. For example, previously, a restricted consent would not be allowed unless the audit was substantially completed; this is no longer required.

While the revised Publication more clearly explained certain aspects of the process, it also eliminated an important item of information. Both the old and new versions of Publication 1035 advise taxpayers that an unconditional consent provides the IRS with the same "examination authority" as under the original statutory period. However, the prior Publication went further to explain what is meant by "examination authority" and stated that if a taxpayer consents to an extension that is not restricted to specific issues, the IRS may use the additional time to examine other items on the return which were not previously considered.

The IRS removed this specific information to conserve space in the Publication and considered the general information to be adequate for the purposes of the new law. Nonetheless, without this specific information, taxpayers might assume that the consent is being granted to continue the audit for only the issues currently open. Taxpayers may not understand that they are granting authority to the IRS to audit new issues past the normal statute period. For example, these new issues could include additional income, expenses, or deductions that were not questioned previously during the audit.

In addition, the Publication does not clearly explain the procedures for requesting that a consent be limited to specific issues. The Publication states that taxpayers may negotiate the items for restriction and that both parties must agree on the terms of the consent, but there is no direction in the publication as to what form the agreement must take. The Examination Division explained that further details on procedures for requesting restricted consents had not been considered. The IRM states that any language to restrict a consent to specific issues must be reflected on the consent document and must first be approved by the Examination group manager and IRS Counsel. However, the IRM is primarily for IRS internal information and is not being provided to taxpayers along with the statute extension request.

Both National Headquarters and field Examination managers stated that this information would be helpful to taxpayers in understanding the requirements for inclusion of restrictive language on the consent form. Otherwise, taxpayers and representatives may improperly believe that requesting restrictive language in correspondence to the IRS is sufficient.

Furthermore, it is important that Examination Division replace prior versions of the Publication 1035, as well as the statute extension cover letter. After the December 1999 revision of Publication 1035, the Examination Division did not ensure that all examiners were providing the updated Publication and cover letter to taxpayers. In the sample of cases we reviewed, 121 of 203 taxpayers (60 percent) were initially provided the previous versions of the Publication and cover letter even though the new versions were available. The Examination Division did not timely replace the prior versions (including paper versions and computer templates) of these documents in all of its offices.

It is important that the IRS timely provide updated and complete information to taxpayers when requesting assessment statute extensions. This information could affect a taxpayer’s decision on whether to ask that the scope of the extension be limited to specific issues. IRS managers and employees in the districts we reviewed estimated that less than five percent of the taxpayers who signed a consent to extend the statute of limitations after January 1, 2000, requested to have the extension limited to specific issues. In our review of 203 examination cases having statute extensions requested and secured after January 1, 2000, we found that only 1 consent form (0.5 percent) had been restricted to specific audit issues. However, we do not know the number of taxpayers who requested a restriction in the terms of the extension because the case files we reviewed did not contain any documentation on whether taxpayers made such a request.

Recommendations

2. The Assistant Commissioner (Examination) should revise the Publication 1035 to advise taxpayers of the following:

• The IRS may open new audit issues under the extended statute period if the taxpayer does not restrict the statute extension to specific issues.
• Specific restrictive language is required on the statute extension consent form in order for the restrictions to be valid.
• The terms and restrictive language added to the consent form must be approved by IRS Counsel.

Management’s Response: IRS management will revise Publication 1035 to advise taxpayers of the additional information included in this recommendation/finding.

1. The Assistant Commissioner (Examination) should timely distribute notification of the revisions to all Examination Division offices and distribution centers and emphasize that prior versions of the Publication 1035, including local computer templates, must be replaced.

Management’s Response: IRS management will issue a memorandum to advise the appropriate Operating Divisions that a new Publication 1035 is available for immediate and exclusive use, with direction to disseminate the memorandum to all field personnel as quickly as possible. The memorandum will be posted on the Web sites for all Operating Divisions for immediate availability.

Conclusion

In most of the cases we reviewed with assessment statute extensions, examiners properly advised taxpayers of their right to refuse or restrict the scope of the statute extension. However, in some cases, examiners did not indicate in case files whether taxpayers were advised of their rights to refuse to extend or to limit extensions of the assessment statute of limitations to a specific period of time or to only specific issues. As a result, we could not determine if the IRS always protected the taxpayer’s right to be advised of these statute extension options.

During our review, the IRS distributed guidance to its employees so they would be aware of the new requirements of the law. This guidance should help to ensure that the IRS complies with the law in the future. However, additional information should be provided to taxpayers to adequately explain the potential for additional issues to be audited and the process to limit extensions to specific issues.

We recommend the IRS add additional information to the primary publication used to help taxpayers better understand their rights and the process for legally restricting an extension of the assessment statute of limitations.

Detailed Objective, Scope, and Methodology

The overall audit objective was to determine whether the Internal Revenue Service (IRS) provided taxpayers an explanation 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 audit issues. To complete this objective, we performed the following audit tests:

1. Reviewed nationally distributed IRS Restructuring and Reform Act of 1998 (RRA 98) training material.
2. Reviewed national and local memoranda related to statute extension procedures.
3. Reviewed the current Internal Revenue Manual and any revisions that are in process.

1. Reviewed a judgmental sample of cases that had extended assessment statutes to determine if the cases contained documentation that taxpayers were advised of their rights before signing the statute extension request.

1. Obtained Individual Masterfile, Business Masterfile, and Audit Information Management System databases to identify a population of open audits having assessment statutes extended during the period January 1 to March 24, 2000.
2. Identified and extracted data for cases in which the statute period was likely to have been extended by the consent of taxpayers. Cases were extracted in which the statutes were extended for at least 6 months and to the end of the calendar year or to the end of a filing season month.

1. Selected and reviewed a judgmental sample of open case files for taxpayer cases in five district offices, based on the sites having the largest numbers of statute extensions from January through March 2000, to determine whether taxpayers had been advised of their right to refuse or limit the scope of the extension.

1. Reviewed the sample of case files to determine whether there was any indication that the taxpayers had requested restrictions in the scope of the extensions.
2. Interviewed Examination group managers to determine how they process taxpayers’ requests for scope limitations on statute extensions.

1. Reviewed the RRA 98 § 3461 law, analysis, and congressional committee reports to identify criteria for required notice to taxpayers of their rights when they are requested to extend the assessment statute of limitations.
2. Reviewed prior and new national IRS letters, forms, and publications related to assessment statute extension requests for field, office, and correspondence examination.
3. Determined whether new letters and forms had been distributed at each district office visited.

Major Contributors to This Report

Maurice S. Moody, Associate Inspector General for Audit (Headquarters Operations and Exempt Organizations Programs)

Nancy A. Nakamura, Director

Michael E. McKenney, Audit Manager

Daniel M. Quinn, Senior Auditor

Julia M. Collins, Auditor

Cindy L. Wright, Auditor

Report Distribution List

Deputy Commissioner Operations C:DO

Commissioner, Small Business/Self-Employed Division S

National Taxpayer Advocate C:TA

Office of the Chief Counsel CC

Office of Management Controls CFO:A:M

Assistant Commissioner (Examination) OP:EX

Director, Legislative Affairs CL:LA

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

District Director, Los Angeles District

District Director, Manhattan District

District Director, Midwest District

District Director, South Florida District

District Director, Southern California District

Audit Liaisons:

Director, Legislative Affairs CL:LA

Outcome Measures

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

Finding and recommendation:
Some examination case files did not indicate whether taxpayers had been advised of their rights to refuse or to restrict the request for a statute extension. This report recommends that the Assistant Commissioner (Examination) revise the IRM to require Examination group managers to review the case file documentation to ensure examiners properly advised taxpayers of their rights before approving statute extension agreements.

Type of Outcome Measure:
Taxpayer Rights – Potential

Value of the Benefit:
In at least 43 cases, group managers would have ensured that taxpayers were properly advised of their rights and that this notification was properly documented before approving agreements to extend the assessment statute.

Methodology Used to Measure the Reported Benefit:
Through a survey of all district offices, the IRS identified a total of 35 tax cases nationally in which the examiners did not document in the case files whether taxpayers had been advised of their rights as required by the RRA 98. Of these cases, 33 were not included in our sample. Our judgmental sample of cases in five districts identified 10 additional tax cases in which the examiners did not document in the case files whether taxpayers had been advised of their rights. (33 tax cases + 10 tax cases = 43 tax cases).

Management’s Response to the Draft Report

The response has been 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.