IRS Taxpayer & Tax Preparer Initiatives: Going (for the) “Green”!

By: Kurt K. Ohliger, Jr., CPA (Nov, 2010)

“Going Green” is all the rage these days as individuals and businesses strive to be more eco-friendly and reduce their “carbon footprints”. The Internal Revenue Service (IRS) is doing its part to become more environmentally friendly. For example, they won’t be mailing you a 1040 booklet this year. Yes, they are saving trees! But that is not the primary “green” initiative the IRS is currently undertaking. In addition to “going green”, they have and will continue to implement new initiatives with a focus towards “going for the green”, as in money! With a “tax gap”, the difference between what taxpayer’s should pay and what they actually pay, estimated to be in excess of $300 billion, the IRS has come to the stark realization that money is not growing on those trees they are saving. Their new initiatives are aimed at both the taxpayers and the tax return preparers.

The Small Business/Self-Employed (SB/SE) division within the IRS has focused their priorities on enforcement and compliance. Their primary “targets” will be exactly what the division’s name implies: small businesses and self-employed individuals. From the individual taxpayer perspective, SB/SE will be increasing their audit activity of taxpayers with Schedule C income and/or multiple Schedule E activities. From the business entity perspective, there will be increased scrutiny of pass-through entities (partnerships, LLCs and S Corporations). Taxpayers with multiple pass-through entities linked by direct or indirect common ownership will also be prime candidates for audit examinations. Why the emphasis on pass-through entities and self-employed individuals? The IRS has determined these to be the areas with the greatest potential for abuse.

The SB/SE division has undertaken an extensive research program to educate the field auditors and refine the methodologies for audit selection. The national research program was conducted using 13,000 individual and business tax returns. The auditors were trained to select those returns which exhibited certain characteristics easily identified by simply looking at various line items on the tax returns. For example, S corporations that report a negative Accumulated Adjustments Account (“AAA”) and also report “loans to shareholders” on the balance sheet may indicate an opportunity for the IRS to recharacterize reported nontaxable distributions (i.e. the “loan” to the shareholder) as a taxable distribution due to having negative AAA. The agents have been trained to identify potential “quick hits” through the refined audit process. These “line item” audits also allow the agents to employ the “GIGO” method of auditing: Get in, Get out!

The National Taxpayer Advocate office estimates that 58 percent of individual taxpayers and 80 percent of small business taxpayers hire paid tax return preparers to complete their tax returns for them. The tax return preparers are largely responsible for the accuracy of the tax returns. Like our legal brethren who are “officers of the court”, tax preparers are “stewards of the code”. We are advocates for our clients helping them to pay the least amount of taxes allowed by the Internal Revenue Code (IRC) and related regulations. Accordingly, the IRS is implementing initiatives directed specifically at tax preparer oversight to ensure taxpayer compliance. Bottom line, the IRS is not just auditing taxpayers…they’re auditing us too!

The IRS has implemented a set of preparer regulations designed to:

  • improve the compliance levels and ethical standing of the tax return preparer industry,
  • allow the IRS to track the number of return preparers,
  • track the qualifications of the return preparers,
  • allow the IRS to track the number of returns each person prepares,
  • allow the IRS to locate and review returns by specific preparers when misconduct is detected.

For the second consecutive year, the IRS will be conducting “site visits” at approximately 2,500 tax return preparer offices between December 1, 2010 and April 30, 2011. The typical tax preparer selected for a site visit has a high volume of individual tax returns as well as a high volume of pass-through entity returns. The visits entail a compliance audit of the tax preparer’s established policies and procedures which have been implemented to insure not only taxpayer compliance, but tax preparer compliance, with the IRC and related regulations. The visits are designed to assist the IRS in determining if we, the preparers, are exercising the required due diligence and reasonable care to prepare the most accurate tax returns possible.

Closing the aforementioned “tax gap” through enforcement and compliance is an immediate priority for the IRS. The audit initiatives are a first step. Another deterrent is penalty assessments. Where applicable, they continue to assess accuracy related penalties pursuant to IRC Section 6662 against the taxpayer and preparer penalties pursuant to IRC Section 6694 against the paid preparer. We expect more initiatives in the near future as the IRS continues to refine their audit examination process and develop new approaches to increase compliance, with the ultimate goal of going for more green. We are committed to being your advocate to insure as much of that green as possible stays in your pockets!

As always, please feel free to contact your Dermody, Burke & Brown tax advisor if you would like to discuss how these IRS initiatives may impact you or your business.

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