Tax practitioners should be ready for increasing compliance and enforcement efforts by tax authorities. These abated somewhat due to the pandemic, but are now on the rise, according to observers.
“The IRS and state government agencies have been ramping up attention toward controversy-related matters, such as tax collection and examinations,” said Robbin Caruso, partner and co-leader of the national tax controversy practice at Top 100 Firm Prager Metis.
Many of the suspensions and extensions that were established during the COVID-related state of emergency have now been lifted on notices and certain other government actions such as levies, liens and new audits, she noted. As a result, various notices are being sent to taxpayers to collect taxes and to initiate audits of returns. Effective June 27, 2022, the IRS will begin conducting field examinations in person again.
“We’re also seeing a significant rise in state individual residency audits, mainly related to telecommuting employees, as well as state business tax audits related to nexus issues,” she added.
There are current limitations on the IRS due to reduced staff, the impacts of the pandemic, and a high rate of attrition of examiners with extensive experience, she noted: “As a result, the ability to examine all returns filed may be limited. To mitigate this, the IRS is using more sophisticated technology to identify and resolve certain common errors, such as for tax credits claiming the Earned Income Tax Credit, the Child Tax Credit, and the Advanced Child Tax Credit.”
Caruso indicated that the IRS is reallocating resources to catch up on their backlogs, including processing of mail, addressing older appeals cases, and processing older returns.
“Since the service is focusing on hiring and training, we should anticipate a continued uptick in controversy matters,” she said. “We anticipate more audits related to COVID relief received and potentially fraudulently filed claims for PPP, ERC and RRF.”
Leave no notice behind
Tax practitioners should expect an increasing demand for their services in handling controversies, agreed Steven Jager, a tax partner at CPA firm Fineman West.
“At the most basic level, this would include answering notices. Every IRS notice deserves an answer — there are different types of notices, and not all are created equal but they all deserve a response,” he said.
For example, a math error notice looks very nondescript, and might seem to be unimportant, Jager remarked: “If the CPA disagrees, they must respond to this notice within 60 days and challenge it, asking the IRS to unwind the notice and restore the taxpayer to their original position. If the IRS continues to disagree, in order to make a change they have to issue a statutory notice of deficiency and make an assessment. So what seems to be an innocuous notice could become a Tax Court case, but only if a sharp practitioner makes the response within 60 days.”
Having the issue decided in the Tax Court is a plus for taxpayers, since they are not required to pay the assessment and sue to get it back, as is the case in federal district courts.
The response to the notice doesn’t have to be particularly formal, according to Jager. “It simply should say that the taxpayer ‘disagrees with this notice, and please restore the taxpayer to their original position which we believe is correct.’”
A CP504 Notice is an escalation of the issue, prior to placing a levy on the taxpayer’s assets. But the IRS cannot levy based on just this notice. It must first issue a formal notice of intent to levy and your right to a hearing, which is the next step after Notice CP504. This final notice advises the taxpayer of the right to a collection due process hearing with the IRS Independent Office of Appeals before levy action is taken. A CDP hearing gives the taxpayer the opportunity to discuss alternatives to enforced collection and permits the taxpayer to dispute the amount owed if the taxpayer has not had the prior opportunity to do so.
The taxpayer has 30 days to respond to a CDC notice. “It’s important to understand that the 30 days is measured from the date of the notice,” cautioned Jager. “There are many instances where the revenue officer has delayed the date. For example, particularly during the pandemic, the revenue officer may get to the office once a week to send out mail. By the time the taxpayer gets it, a week has gone by. Once the taxpayer responds, all enforced collection activity must be stopped, but if the taxpayer fails to respond in a timely manner, the IRS is allowed to start levying — taking stuff from the taxpayer. And failure to respond timely can mean a malpractice claim against the CPA, because the delay caused the loss of an important taxpayer right.”
The downside to a timely response is that the statute of limitations for collection is suspended, noted Jager: “Normally the government has 10 years to collect after the return is filed and tax assessed, so there may be times where the best strategy would not be to file for a CDP if it’s for a year that’s close to the end of the running of the statute.”
An alternative to the CDC hearing is an equivalent hearing, Jager noted. “If the taxpayer requests the CDC hearing, the statute is suspended but the Tax Court has jurisdiction to hear the case if the taxpayer is not happy with the result,” he said. “With the equivalent hearing, there is no right to appeal to the Tax Court.”
The important message is to read notices very carefully, and answer them on time, said Jager.
“And timely mailing will often become an issue, especially with a 30-day window,” he added. “There’s no better gold standard than certified mail. I’ve seen practitioners make the mistake of using a private carrier such as FedEx or UPS. If they use a private carrier, they have to use the level that the IRS specifies — even if they use a more expensive level, they won’t get the benefit of the ‘timely mailing is timely filing’ rule.”
“And it’s important to keep clients’ addresses up to date due to the concept of ‘last known address,’” he observed. “The law only requires that correspondence be sent to taxpayers at their last known address, usually the address from which the last tax return was filed. So if the taxpayer moves and hasn’t filed a return all the IRS has to do is demonstrate they sent a notice to the taxpayer’s last known address. It’s incumbent on CPAs to warn the taxpayers that if they choose not to file a return, they must at least change their address with the IRS, especially if they’re in collection mode.”
If possible, practitioners should get a power of attorney for each client, and check the box to request copies of correspondence to the taxpayer. “The pandemic taught us that if there’s nobody home at the IRS Service Center, it’s almost impossible to represent the client without a POA,” Jager said.
Filing versus owing
Once it’s clear that the taxpayer will owe money, it is important for the CPA to explain the available options, Jager indicated. The first mistake taxpayers make is to fail to file when they know they can’t pay the tax. If they choose not to file, the statute of limitations does not begin to run for that year.
“The practitioner and the taxpayer should know that it’s possible to get a short-term payment arrangement of 120 days,” he said. “It’s not a formal installment agreement and can be arranged over the phone with the revenue agent. The nice thing about it is that there’s no user fee, and no federal tax lien, and it’s not intrusive — the taxpayer doesn’t have to give full financial disclosure.”
If that’s not practical, the traditional installment agreement is the next option to consider. A subset of the installment agreement is the ‘fresh start’ streamlined agreement, under which a debt of $50,000 or less can be repaid over seven years.
“What a number of practitioners don’t realize is that even if the debt is greater than $50,000, the taxpayer can pay the debt down to $50,000 and still meet the requirements for Fresh Start,” said Jager. “That has the advantage of not having to supply any intrusive financial information, and no federal tax liens. Once in place, the taxpayer can later apply for an offer in compromise. The traditional installment agreement requires substantiating the taxpayer’s inability to pay.”
The number of Tax Court petitions filed in 2021 is double the number filed in 2020, according to Bill Nemeth, president and education chair of the Georgia Society of Enrolled Agents. “Taxpayers and practitioners could not interact with the IRS, so they made the decision to take their cases to the Tax Court to properly resolve their issues,” he said. “Assume a client who has gone through a bad audit. They owe $200,000 because they were not given credit for labor or material expenses. They can go to a tax lawyer and pay them a lawyer’s fee, or they can represent themselves with a $60 fee for a Tax Court petition. The petition is simple, and they can state their case in their own words, e.g., the auditor did not give them credit for ordinary and necessary business expenses, and they have compelling evidence to substantiate those expenses.”
The IRS currently is targeting the top 1% of earners and high-net-worth taxpayers, according to Caruso. “They’re looking closely at FBAR violations, foreign entities, and those improperly reporting digital assets,” she said. “They are also developing more specialized teams to examine transactions they feel are frequently abusive, including conservation easements, offshore audits, and microcaptive insurance arrangements.”
“Since certain tax returns for 2019 and 2020 have not been processed and overpayment requests have not yet been applied to later periods, we are seeing problems with notices requesting payments for 2020 and 2021 where no tax is actually due,” she said. “Getting these payments applied to correct tax periods has proved to be time-consuming and costly.”
